Negative sentiment and rising market interest rates are not yet leading to declining demand for commercial real estate

02 Sep 2022

Image of Negative sentiment and rising market interest rates are not yet leading to declining demand for commercial real estate

As the position of companies remains strong, the occupier demand for commercial real estate shows no signs of decline yet. Demand in the office market showed a slight recovery compared to H1 2021, and logistics take-up once again reached record levels. 

Only the total take-up volume of commercial real estate excluding logistics decreased significantly (-28%). However, this can be attributed mainly to the rapidly shrinking supply of suitable business premises: between Q2 2021 and Q2 2022, the total supply of business premises fell by 32%.

Raymond Frederiks, Senior Consultant Market Intelligence at Savills, nuances these findings: “So far this year has presented a fairly stable picture. Yet we should not underestimate the outlook; inflation – and possibly a recession – will eventually lead to problems in the occupier market. While tenants can still accommodate large rent increases as a result of inflation for now, their ability to do so will of course diminish if economic conditions deteriorate. Declining household consumption due to inflation and reduced investment as a result of rising interest rates will also affect the profitability of businesses and subsequently spill over into other parts of the economy. Rents will become less affordable for businesses, especially for those that cannot sufficiently absorb the effects of inflation by adjusting their prices.”

While the fundamentals of the occupier market remain strong, uncertainties in the economic outlook have led to somewhat more caution among investors. Sentiment among real estate investors worldwide has dropped below the level recorded at the beginning of the pandemic.

Due to a relatively strong first quarter, the total investment volume in the Netherlands in the first half of 2022 came to about 8 billion euros, a 1 billion euro increase compared to the first half of 2021 (15%). The investment volume in the second quarter of 2022, however, does reflect the deteriorated sentiment among investors, as it is significantly lower than the average second-quarter volume in previous years. Over the past 5 years, the average investment volume was approx. €4.7 billion, while the second quarter of 2022 registered a total volume of approx. €2.7 billion.

Jordy Diepeveen, Director Investment at Savills in the Netherlands: “The office market in particular saw a drop in investment volume. This is mainly because investors are waiting for more clarity regarding the main uncertainties currently prevailing in the market, and associated price corrections. Due to the limited number of transactions, there is currently not enough market evidence for price corrections. However, initial yields can be expected to increase for all sectors.”

The Savills report shows that this price correction is already visible in the office market of other international cities such as London (+15 bps) and in German cities (+30 bps).

Jordy: “We expect that truly substantial yield adjustments will be seen mainly in the most vulnerable markets, such as the secondary office market – and is much less applicable to core product. At these secondary locations, the risk premium is growing, while price adjustments for residential, logistics, prime office and convenience retail will mainly be driven by higher financing costs.”

Despite the fact that high inflation can ultimately cause vacancy rates to rise due to affordability issues, the Savills report also mentions upsides with regard to inflation. Thanks to its function as an ‘inflation hedge’, Dutch real estate remains an attractive long-term investment at this time, certainly compared to the volatile stock market. The link between inflation and contractual rent increases (CPI) is certainly not 'common sense' in all countries.

Partly because of this, Savills expects that despite current uncertainties, sufficient capital will still be able to find its way to the Dutch real estate market. Savills expects the total investment volume this year to amount to roughly 18 billion euros this year – approximately 1 billion euros less than last year.