After a tumultuous 12 months, 2024 is shaping up as a better year for commercial property, with Knight Frank tipping it will be a good time to acquire assets.
After a year where rising interest rates hurt valuations and sentiment in the commercial sector, 2024 will potentially be a period of recovery according to Knight Frank’s Horizon Report.
Knight Frank Chief Economist Ben Burston said the sustained pressure of higher rates had naturally put pressure on asset values and this was still playing out to varying degrees.
“Part of the uncertainty has been a disconnect between formal valuation metrics and market sentiment,” Mr Burston said.
“However, with more deal evidence now coming through and formal valuations likely to be adjusted further in the December cycle, we expect the gap between sentiment and formal valuations to erode substantially over the next six months so that, by mid-2024, the picture will be clearer for buyers and sellers alike, helping to restore confidence and liquidity.”
Mr Burston said that while reductions in asset value were unwelcome, the flip side was the re-emergence of value looking forward.
“Higher yields act to reset the market and provide a more attractive entry point for investors, generating the prospect of higher returns,” he said.
“This is clearly illustrated when we assess historic market cycles and the performance achieved after pricing is reset in the aftermath of interest rate hiking cycles.”
He said that while interest rates might fall in the future, they are unlikely to return to the low levels of 2016-2021.
Knight Frank also predicts that 2024 will see a shift towards residential living sectors, led by build-to-rent (BTR), but also encompassing student accommodation and retirement living.
Knight Frank Head of Alternatives Tim Holtsbaum said the shift to living sectors was part of a wider shift from major institutions to focus on core investment strategies as they seek more stability.
“Related to this, investors are also gravitating toward living sectors because they offer the ability to adjust rental income streams more quickly than other sectors in response to high inflation,” Mr Holtsbaum said.
“These drivers will remain in place in 2024, and we expect a further expansion of interest in BTR and other living sectors to be reflected in continued growth of the pipeline and additional capital partnerships being formed.”
Knight Frank also believes 2024 will see assets that are perceived as being riskier, require far higher yields for investors.
“Core assets that are perceived to offer better income security will trade at tighter internal rates of return (IRR), and for those that also come with strong income growth prospects this will imply that a given return target can be achieved with a lower yield,” Mr Burston said.
“On the other hand, weaker quality stock is likely to be perceived as higher risk and offering less income growth potential, so yields will need to be significantly higher to achieve a given return target.
“This plays relatively well for industrial assets, which are benefitting from strong rental growth and tight supply that is starting to appear structural rather than purely cyclical.”
They also predict the slowdown in office construction will potentially lead to a shortage of stock.
Mr Burston said with developers likely to find it difficult to meet feasibility thresholds in the face of rising construction and funding costs, amidst a backdrop of higher yields impacting asset values.
In addition, higher vacancy rates and elevated incentives are traditional signals pointing to a need for caution.
“However, a slowdown in commencements will impact the pipeline in 2027 and beyond, and even at this early stage it is possible to identify a risk of a shortage of prime space later in the decade,” he said.
“While overall market vacancy rates may remain elevated for some time, the demonstrated strength of tenant demand for newly built space will mean a potential shortage of new buildings at this time.”
Finally, Knight Frank believes 2024 will be another strong year for industrial rents, with current costs as a proportion of operational costs yet to burden occupiers.