As outward shift in yields slow, positive total returns growth predicted by Colliers

Oliver Kolodseike, Deputy UK Chief Economist at Colliers International

Colliers has revised its expectations for total returns growth down from 5.3% to 4.2% this year in its latest Real Estate Investment Forecast (REIF). The firm also expects all property yields to end 2023 at 6.22 per cent, up from 6.11 per cent at the end of 2022. These changes are a result of expected interest rate and gilt yield forecasts rising to a higher rate than when the Q1 REIF was published.

In the report, Colliers notes that All Property returns were stable in Q1, following declines of 12 per cent and 4.2 per cent in Q4 and Q3 respectively. Over the 2023-2027 forecast period, All Property total returns will average 8.3 per cent per annum.

Oliver Kolodseike, director in the Research & Economics team at Colliers, comments: “Interest rates have now reached a level last seen in 2008 and they may well continue to rise further in the coming months. The consequence of this is a significant slowdown in investment activity. Until a pivot point in the Bank of England’s monetary policy is evident, uncertainty will continue to hinder market activity. Despite the current uncertainty, the economy is so far holding up, and we are forecasting positive total returns growth as yield movements seem to have slowed significantly from the sharp shift seen in H2 2022.

The report notes that the retail sector will be impacted over the next two years as discretionary spending becomes more limited. There will be further modest rental declines across both shops outside of London and shopping centres due to the continuing cost of living crisis and rising re-mortgage costs. However, given the sharp pricing adjustments that have already taken place over the last year, some segments seem to have stabilised.

Colliers predicts All Retail yields will therefore end this year at 6.6 per cent which is 4 bps lower than at the end of 2022. Yields will then continue to move in to 6.38 per cent in 2024. Retail Warehouses (-72 bps) and Standard Shops – Central London (-53 bps) will see the sharpest fall in yields over the forecast horizon. Total returns fell by 4.8 per cent in 2022 but will return to growth of 5.8 per cent this year, driven by income returns, as capital values will remain flat this year. Over the 2023-2027 period, total returns growth will average 7.9 per cent per annum, driven by Retail Warehouses at 9 per cent per annum.

While rental growth of 2.2 per cent was sustained last year in the office sector, yields rose by almost 100 bps in H2, resulting in a 13.2 per cent decline in capital values. Colliers believe that yields will continue to rise over the coming quarter, ending 2023 at 6.71 per cent, up from 6.47 per cent at the end of last year. Average office rents will fall this year although there are large differences between prime, where rents are stable, and secondary/tertiary where rents are expected to decline. Total returns growth will therefore be weak this year (1.3 per cent) before accelerating to 7.3 per cent in 2024. Over the forecast horizon of 2023-2027, total returns growth will average 6.1 per cent per annum.

We expect rental growth in industrial & logistics to slow from the strong rates recorded throughout most of 2021 and 2022, with All Industrial rents to increase by 5.1 per cent in 2023, before slowing to 3.8 per cent in 2024. Rental growth is then expected to strengthen slightly. We predict a further rise in yields in Q2 before stabilising and potentially re-compressing towards the end of 2023. All industrial yields will end 2023 at 5.73 per cent, up from 5.62 per cent at the end of 2022.

All Industrial total returns fell by 14.6 per cent in 2022, but we predict a return to growth in 2023 (+6 per cent). Total returns growth will then accelerate to 13.4 per cent in 2024 and remain close to double digits until the end of the five-year forecast horizon.