Will the commercial property market recover in 2023?

With various interconnected global factors rocking economies around the world, it’s no wonder that the commercial real estate market in the UK is enduring major struggles of its own.

However, it’s not all doom and gloom. There are still plenty of investment opportunities available in the real estate sector, along with predicted improvements for commercial property.

Here, this blog explores the current state of the market, predictions for the remainder of 2023, and what to anticipate beyond this – including how commercial real estate investors and owners could benefit from a commercial property warranty.

Concerns for commercial real estate

Reports by the Centre for Economics and Business Research (CEBR) and investment management company Schroders reveal that the value of commercial real estate in Britain was worth around £1 trillion in June 2022 – but has since dropped by 21%, or £210 billion.

This nine-month decline is nearly three times steeper than the drop between 2008 and 2010, making it the UK’s largest-ever write-down in non-residential property value.

According to CEBR and Schroders, the primary cause is unexpectedly high-interest rates. Alongside high inflation, higher interest rates drive up costs for landlords, impact cash flows, and reduce the appeal of acquiring new properties with potential debts.

Many commercial buildings have also experienced reductions in value and levels of buyer interest due to the increase in online shopping and working from home spurred by the pandemic.

With investment in non-residential real estate becoming increasingly less attractive in such a rocky economic climate, the question is: will the market find a floor this year?

Will the market improve in 2023?

The Financial Times reports that despite the record low, property investment is picking up again compared to previous quarters, with analysts predicting the market will stabilize in the next few months. That said, analysts remain concerned that the turbulent activity of the banking sector could slow down the property market’s rebound.

When it comes to commercial real estate specifically, Schroders reports a ‘strong possibility’ of its market value settling this summer, at around 25–30% of the mid-2022 £1 trillion peak.

This will depend on what happens next with inflation and Bank of England interest rates – the general consensus among economists is that inflation will drop to around 5% by the end of the year, and the BoE won’t increase their base rate above 4.25%.

Forecasting is a risky business, of course, but history has shown that recessions are typically followed by a strengthening of real estate markets, so investors remain hopeful for the second half of 2023.

Rental values for commercial real estate are predicted to remain mostly flat through to 2024, but it’s believed that investment in sustainable commercial buildings and growth in the industrial sector will offset the decline in leisure, shopping center, and office rental values.

Higher standards for existing commercial property

Uncertain market values, inflation, and interest rates aren’t the only concerns for commercial real estate in 2023. On 1st April, new minimum energy efficiency standards (MEES) laws came into effect, banning landlords from renting commercial spaces with energy efficiency ratings of E or lower.

As reported by The Telegraph, BNP Paribas – the second-largest investment banking company in Europe – stated that this measure means around 8% of the commercial building stock is now obsolete, equating to about 10,000 offices in London alone.

This is part of a wider problem for commercial building owners, who face the prospect of their properties significantly declining in value or becoming completely unsaleable if they fail to meet sustainability targets such as minimum energy efficiency ratings.

These pressures will only increase as measures become ever stricter in the UK government’s push towards carbon neutrality by 2050, with a minimum energy efficiency rating of C due to be set in 2027 and a minimum rating of B in 2030.

Should commercial property owners renovate or drop out of the market?

In order to reach a minimum energy efficiency rating of B or above by 2030, commercial property owners must make upfront investments in improving their buildings. These renovations are likely to be quite costly – with an improvement of C to A costing an average of £26–£40 per square foot according to world-leading property agency Savills.

Commercial landlords with properties rated E or lower now have no choice but to upgrade their buildings if they want to be able to rent them out. However, the other option for commercial landlords with D-rated properties is to cut their losses and sell their properties ahead of the future MEES deadlines.

Refurbishing a commercial building to improve its energy efficiency should help to maintain its value through such trying times for the property investment sector, and the upfront costs should eventually be offset by savings in running costs and emissions-related taxes.

If you are the owner/landlord of a commercial property and decide to carry out structural renovation work to improve its ‘green’ credentials, don’t forget to upgrade your insurance policies – including either updating your commercial property warranty or setting up a new one.

This warranty will help to protect your investment in the ‘new’ building, as it will cover you against structural defects resulting from poor quality materials or workmanship for at least 15 years from the completion of the construction work.

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