With real estate encountering strong economic headwinds from inflation and rising interest rates, Property Week contributing editor (news) David Parsley sat down with Phil Westerman, partner and head of real estate at accountancy practice Buzzacott, to discuss the outlook for the industry. Their conversation covered the aftermath of Brexit and the pandemic, the impact of the war in Ukraine and the cost of living crisis, the prospects for real estate’s different sectors, and the market’s resilience.
David Parsley (DP): How are the UK’s main economic issues affecting the property sector?
Phil Westerman (PW): That is a big question. An underlying theme is that there is a huge amount of uncertainty in the UK and global economy, which is being driven by various issues like Brexit, Covid-19 and the conflict in Ukraine. This is all leading to a general uncertainty in the market that is having a direct effect on all aspects of property in the UK.
DP: We’ve heard a lot about inflation and the impact of rising interest rates on material costs in the sector, but what stands out most for you?
PW: I think it depends to a degree on whether you’re a property investor, landlord, tenant, developer or an individual looking at home ownership. But I think if you take the commercial sector, the combination of interest rate rises that have happened and the further increases predicted are adding to uncertainty over the viability of projects and the ability to finance those projects. Looking at the tenant side and the commercial property sector in particular, the impact of rising costs, inflation impacting on wages and the general cost of doing business is making businesses look very hard at their own viability. That in turn leads to higher uncertainty over affordability, both for real estate generally and for property developers. At the moment, it’s a combination of inflation and inflationary pressures, and the supply chain issues that developers are experiencing in terms of both scarcity of resource to deliver the projects – in particular, developers that are looking at longer-term projects.
DP: Who’s suffering most, the larger firms or small and medium-sized businesses?
PW: Typically, the larger firms have stronger balance sheets, stronger existing relationships with lenders and more assets to give as security. So they will have a bit more confidence that they will either be able to secure additional funding or refinance existing facilities. Smaller firms will perhaps have less liquidity, as they have a smaller number of assets on which to secure new funding, and the general view is that there is a higher risk profile associated with smaller businesses. I think there will be a difference in accessibility and funding depending on the size of the business.
DP: Is the wider cost of living crisis having an impact on the property sector?
PW: If you look at the large property businesses, say the investors who own a lot of retail and leisure assets in cities, they rely on consumer spending to enable their tenants to continue to trade and generate cash flow, and then pay their rents. The balance of power has shifted a lot from what was traditionally the power base of the landlords to the tenants when it comes to negotiating rents. We saw this shift begin during the Covid-19 lockdowns, and it’s a growing trend.
DP: What about the build-to-rent and private rented sectors? Do you think this has become a bubble that could burst due to the pressures on the economy?
PW: Well, I don’t know if they’ve overdone it. Everyone knew about Brexit for a long time. Covid came as a surprise to everybody, certainly in terms of its initial impact, and then longevity. And I don’t think anyone foresaw the conflict in Ukraine and the impact that has had on the wider global situation. In terms of residential property, there is still a shortage of supply in the UK and high demand, which is still government-backed in terms of wanting to increase the housing supply. So, looking at the private rented sector, there’s a general view that whilst there will be a longer-term impact from this perfect storm in terms of interest rates and inflationary pressures, I don’t think that’s necessarily going to hit for a period of time yet. The outlook for 2022 will be relatively positive in terms of house prices, but 2023 and beyond looks a little less certain when those factors might well kick in and start to impact the sector.
DP: What about companies with larger, out-of-town shopping malls? Should they be looking at how they can mitigate against the risks over the next two or three years?
PW: Yes, I think so. There’s a slight market difference here between the large, out-of-town shopping malls and the community-based shopping malls that are still actually performing relatively well.
DP: The logistics sector has been the darling of the property world for some years now, but will that continue?
PW: If you go back as little as three months, there was general optimism in that sector that the growth trajectory would certainly continue for a couple of years, and lots of new warehouses or sheds were being put up across the UK and across Europe. There have, though, been recent mutterings questioning whether too many have been built, and is that growth trajectory still in place. People are starting to ask a few more questions about whether there is now enough supply. That probably doesn’t apply universally in all locations, but it certainly does in some locations.
DP: When it comes to office space, how is that part of the property world going to fare in a world of high inflation and rising interest rates?
PW: There is still some uncertainty around the hybrid working everyone is adopting in terms of what percentage of the workforce will be back in the office across the course of a working week, but I don’t think anyone’s expecting 100% of the workforce to be back in every day in any office. There are still decisions to be made by occupiers in offices as to how much space they need and, importantly, what sort of space they need, because there’s a very competitive environment, for example in professional services. There is likely to be less desk space and more hot desking arrangements to reflect the mobility of the workforce. I think there is a recognition that new offices will look very, very different to the traditional office of three or four years ago.
DP: The government does not appear to believe Brexit has had an impact in causing inflation. Do you believe it has?
PW: It’s a personal view, but I would argue that it was the first issue to have an impact, particularly in terms of concerns over availability of labour. People were coming to the UK to work in construction and property development was a big employer of overseas workers. Brexit has been slightly pushed to the back of people’s thinking by other more recent – and potentially more significant – events in the wider world. But it has certainly had an impact.
DP: This conversation has reflected a fairly negative outlook so far, but what are your reasons to be cheerful?
PW: I think there is hope based on the historic resilience of the real estate sector. Generally, there is also a resilience in the people who live and work in this country. We always come out the other side. It’s like a cycle and I think well-run and well-governed real estate businesses will continue to be successful, and that real estate will remain an attractive investment proposition for both UK private investment and overseas investment. It is an area that the government is supportive of, so I think the outlook is that there will be a tough couple of years, but there’s no reason why we can’t come out the other side stronger and in a better place.