Commercial real estate continues to show strong performance despite ongoing geopolitical events

The latest quarterly examiner report by Cluttons Investment Management has examined why All Property Returns have continued to increase, despite recent geopolitical events.

The UK’s commercial real estate market continued to show strong performance, with ‘All Property’ total returns increasing to 23.9% over the last 12 months to the end of March 2022 compared to 19.9% in the 12 months to end December.

The strength of the commercial property market’s recovery has surprised many, largely due to the performance of the industrial and logistics sector, and their increasing weight in the index but also due to a strong recovery in the retail warehousing market.

Yet, the pace of growth in capital values could now start to slow, as higher inflation and interest rates give investors cause for concern on top of a post pandemic and Brexit backdrop, Ukraine war, rising fuel prices and a cost of living crisis. An economic recession now appears to be likely, which in turn could lead to a dampening to investment returns.

The report also highlights that the post pandemic period has seen the move towards home working strengthen further, with Remit Consulting finding the highest average level of office occupancy since Covid was in November 2021 with a level of 23.3%, immediately after the working home guidance was first lifted. This much-mooted “return to work” may already have plateaued. Tube travel into central London midweek has steadied at between 60% to 67% of pre-Covid levels, with a significant rise only on Thursdays, much favoured by the “three-day hybrids”.

A wide range of companies are now beginning to show signs of acceptance of home-working as the ‘new norm’ rather than seeing it as a fad that will phase out or a temporary fix.

Businesses are now more willing to adopt a shorter working week with no loss of pay, as a move to more flexible working gains momentum. With many more jobs available than there are skilled talent, employers want to hold on to their stars, rather than invoke pay cuts that will incite those otherwise satisfied. Some major brands (although admittedly themselves ‘online’) such as AirBnB have publicly declared that workers can work wherever they want without a pay cut while the results of a UK-wide 4 working day week trial are yet to be seen.

With productivity seeming to not be affected by the change in working hours, more businesses are seeking to move operations remotely, with performance data indicating that secondary office buildings that are let on shorter leases are now being left behind. It is commonly held now that prospective office occupiers are focused solely on Grade A energy efficient space and more secondary space is in danger of being left stranded.

As a knock on effect of this, it has been cited that Oxford Street is now struggling to retain its ‘destination’ status. Retail rental values in Central London have fallen 18% since the start of the pandemic on top of the decrease already amortised thanks to the rise of online shopping prior to Covid-19. A dearth in London workers means a significant lack of spending in shops, bars, restaurants and cafes.

Jamie McCombe, head of Cluttons Investment Management, said: “The great return to work that has been widely talked about has so far been relatively muted and may take some months, even years, to gain real momentum. While the age group of 20-35 has more actively embraced a return to the office for social and developmental reasons, we have seen those in a senior or middle management level position adopt a much more flexible lifestyle no doubt motivated by other, potentially family-oriented, factors. It’s important to remember that each person is different and it is these people who make up a workforce so one rule or size does not fit all. Employers need to give workers a reason to want to be in the office and that means the very best properties that provide experiences that workers cannot get elsewhere will prosper and those that don’t match up may very well become obsolete. Landlords need to start working much harder for their asset to measure up, rather than rely on location if they want to retain values and outperform in a difficult market.”