7th Jun 2022
3 min read

Mixed fortunes in the commercial real estate market

Overview - winners and losers

As with so many other sectors, the pandemic had a significant impact on the commercial real-estate market, creating both winners and losers. The COVID-19-associated lockdowns that resulted in people working from home and encouraged a surge in e-commerce left many large office blocks and retail outlets virtually empty. But they also drove demand for the very large warehouses, or fulfilment centres, that serve established players in online retailing such as Amazon and the major supermarkets. Moreover, there has been a global explosion in demand for small warehouses, also known as dark stores, located in urban areas and able to deliver goods quickly to their surrounding populations. That’s because consumers have become ever more demanding in terms of the speed with which they want goods delivered, and these small warehouses can meet those expectations.

Some of the pandemic-associated trends have started to reverse in 2022. In the US, for example, online shopping is declining, and retailers are once again investing in brick-and-mortar outlets. Although hybrid working appears likely to stay, leaving the future for offices unknown, the global commercial real-estate market has made a remarkable overall recovery from the pandemic. In 2021, debt and equity capital were abundant, and record transaction volumes made up for the pandemic-induced malaise of 2020.

Environmental, social and governance (ESG) issues are an increasingly important influence in commercial real estate. For example, 60% of respondents to the US commercial real-estate services and investment firm CBRE’s 2021 Global Investor Intentions Survey stated that they had already adopted ESG criteria as part of their investment strategies, with the Americas, EMEA and Asia-Pacific all recording a stronger focus on ESG issues than in previous years.  As an example, institutional investors are focussing on investing in buildings with low carbon emissions.

Current position

The rapid economic recovery from the pandemic in the latter part of 2021 and early months of 2022, and the dropping of COVID-19-related restrictions, drove demand for offices, retail outlets and hotels. In its March 2022 global outlook, the real-estate services business JLL said that net absorption of offices was positive across all regions in the final quarter of 2021, for the first time since the onset of the pandemic, with corporates maintaining their focus on high-quality space. It added that demand for logistics space continued unabated, with rental growth accelerating strongly, while the recovery in the retail and hotel sectors remained market and sub-sector specific. Overall, forward-looking indicators point to an ongoing improvement in occupier activity, with demand broadening across the sectors, JLL concluded.

In the UK, commercial property enjoyed a robust recovery in 2021. Industrial and logistics property led the market, driven by strong rental growth and high demand, while offices and shopping centres lagged. Those trends have continued in 2022. Build-to-rent is another area of strong growth. It provides high-quality, well-managed rental housing to tenants and the promise of relatively high, stable incomes to institutional investors such as pension funds. According to the British Property Federation build-to-rent is fast becoming an established sector in the UK housing market.

The return of inflation – driven primarily by supply-and-demand imbalances caused by the pandemic, as well as Russia’s invasion of Ukraine, which has caused the prices of many commodities to rocket – is likely to be the greatest challenge to the commercial real-estate sector in 2022 and 2023. That’s because central banks around the globe are reining in the easy monetary policies that have been in place since the Great Financial Crisis of 2008. Interest rates rose in a number of emerging economies in the latter half of 2021 and have gone up in the advanced economies in 2022. They are expected to rise most rapidly in the US, given the strength of its recovery, while Europe is likely to lag. In the UK, the Bank of England has also entered a rate-raising cycle.

In general, commercial real estate performs well during periods of higher inflation, since investors view it as a hedge against inflation. However, if interest rates rise rapidly to elevated levels, that could precipitate a recession, affecting demand for real estate from industrial, retail and other commercial investors. Much will depend on how ingrained inflation becomes. If it starts to subside in late 2022 and early 2023 as the global shocks to the economy recede, the outlook for the sector overall should remain bright. If, however, inflation does not prove temporary and borrowing costs rise much higher and faster than currently anticipated, the global economy could experience a long and profound recession given the elevated state of debt levels in both the public and private sectors worldwide. That would have a significant adverse impact on the commercial real estate sector.

“if interest rates rise rapidly to elevated levels, that could precipitate a recession, affecting demand for real estate from industrial, retail and other commercial investors.”

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