Commercial property examiner summer 2023

A combination of sharply higher inflation and interest rates has created a cost of living crisis that has held back the UK economy.

Following a lack of growth in the three months to February, the economy shrank by -0.1% in the three months to May.

The MPC’s latest forecasts published in August suggest that the economic outlook has weakened slightly since the previous set of forecasts. GDP growth is expected to remain below pre-pandemic rates in the medium term as spare capacity and unemployment rise.

In Q2 2023, All Property total returns, as recorded by the MSCI Monthly Index, increased to 1.0% from 0.2% in Q1. Capital values fell by just -0.4% in Q2 compared to -1.2% three months earlier. However, on an annual basis, All Property total returns decreased to -16.9% in the year to June, down from -14.7% in the 12 months ending in March, as stronger numbers from Q2 2022 fell out of the calculation.

Following a further 25 bp increase in the base rate in August, the Bank of England has overseen fourteen consecutive rises in its base rate to 5.25%, up from 0.1% in March 2020. Interest rates were last at this level in March 2008 when the UK slid into its last major economic downturn. The pricing of UK risk-free assets is once again under pressure as the Bank of England struggles to bring inflation back towards its target level of 2.0%. The yield on the 5-15 year gilt index has softened by 94 bps since the end of the first quarter and now stands at 4.45%.

It now seems likely that UK inflation and interest rates will stay higher for longer. Consequently, expectations of a sharp recovery in All Property returns in 2024, have been trimmed back from 15% to 7% and any stronger recovery delayed until 2025 or 2026. The net effect is that the annualised average forecast for the three years ending December 2025 could be just 2%, representing a 3-percentage point downgrade from Q1’s three-year forecast.