The property market like many other sectors has faced numerous challenges over the last couple of years with sustained levels of high inflation, increasing interest rates, continued global supply issues, muted economic growth forecasts, constrained labour markets, wage inflation, increasing mortgage costs, cost of doing business and hybrid working to name a few. However, all that said, the Edinburgh property markets is in general terms continuing to remain remarkably resilient and is weathering the storms satisfactorily all things considered.
Occupational (tenant) demand for all sectors (offices, retail, industrial, land) is reasonably buoyant. What we are instructed to let, we let. Tenants are still signing (on average) c10 years leases with breaks at 5. Tenants’ incentives have generally remained unchanged. Rents are holding firm in many instances, and in some sectors, we are witnessing rental growth as the development pipeline lags due to a fundamental undersupply, the prime example being new Grade A office space within Edinburgh where vacancy rates are sub 1%.
On the sales side, pricing is key. Savers are finally being rewarded for their patience following a decade of super low interest rates. As overall (debt finance) costs increase, investors now require a greater return on capital employed. The biggest challenge facing the investment sector is that with numerous banks now offering 5%+ return for 1 year + deposits, investors are now pausing for breath, adopting a more cautious approach and tucking money away with their banks until the economic headwinds reach maturity which I believe will be H1 2024. As a result, commercial property investors are moving up the yield curve to reflect the risk profile which property presents relative to money held on account if they are to commit now and thus there is some pressure on values, however, there doesn’t yet appear to be much pressure being placed on borrowers. We are now at pivotal point in the market cycle where there is a disconnect between sellers expectations and what buyers are willing to pay.
Following the great financial crisis in 2008, banks had no choice but to tighten their belts and corresponding lending criteria. Commercial property loan to values (LTV’s) reduced to on average 60-70%. Most of the main merchant banks are still willing to lend but are adopting more of a conservative view with LTV’s reduced to 50/50 at best. As debt interest becomes more expensive which is forecasted to continue throughout the remainder of 2023, borrowers are being encouraged to accelerate amortising existing facilities to create some additional breathing space now before future interest rate increases start to bite.
In respect of residential land values, the PLC house builders are having to deal with the perfect storm. Continued supply chain issues, labour costs remaining high, finance charges have and are increasing, build costs remain high and this is expected to continue given the governments rhetoric to create more sustainable carbon neutral homes. Sales rates have slowed all of which are putting pressure on profit margins. That said, land which still requires to obtain planning and whilst not immune from the current economic challenges, will fair reasonably given the 24 month lag between preferred bidder status being confirmed, contracts agreed, DD undertaken, planning achieved followed by the inevitable and often excessively high planning gain contributions sought by local councils.
In such a short article, it’s difficult to accurately appraise and summarise how each sector and their individual nuances within various sub sectors are performing, however, in summary, and very much a sweeping generalisation, we are seeing the following in Edinburgh and the surrounds:
- Local retail rents – generally increasing.
- Office rents – generally increasing with grade A rents in Edinburgh now at £42.50 sqft.
- Industrial rents – stabilising following their sharp rise in the last 36 months.
- Land values – short term land decreasing, strategic land generally remaining firm.
In summary, the property market is facing a number of economic headwinds. It’s now time to batten down the hatches and let the storms quickly pass over and hopefully in around 12 months time, there will be renewed optimism and confidence with inflation having dropped to more normal levels and interest rates starting their downward trajectory.
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