There’s more to building houses than just bricks and mortar.
In his outlook for the real estate industry in 2023, Jason Constable points to significant ongoing activity in residential and other sub-sectors.
Head of Real Estate, Barclays Corporate Banking
Despite the rather gloomy economic headlines that dominated the latter part of 2022, it was a year of mixed fortunes for the real estate sector and, despite all the obvious concerns, I believe there are many reasons to be optimistic about this year.
Looking back to the first half of 2022, the market overall was very buoyant, with many real estate businesses actively pursuing M&A to consolidate their positions.
Of course, things changed fairly rapidly once inflation-driven economic pressures began to bite in Q3, and steadily worsened to give the sector a weaker Q4 performance compared to previous years across all real estate sub-sectors. Acquisitions slowed as many companies waited to see what would happen to valuations for targets, and a number of developments were paused or put on the back burner.
Even so, high levels of refinancing activity among larger industry players meant the second half of the year remained busy for us at Barclays, and we also welcomed a record 30+ new real estate clients during 2022.
This refinancing trend was partly a reflection of the bond market conditions and price expectations which resulted in a number of companies electing to lean into bank market liquidity via increased revolving credit facilities and/or extending duration.
There are of course ongoing economic challenges to be faced in 2023 which will pose risks to some businesses. But there are exciting opportunities too.
Across all sectors we expect there will be a valuation correction in response to the macro issues, particularly influenced by year-end revaluations for institutional funds with big real estate allocations, which will act as a catalyst for determining valuation levels going forward.
Retail, with the exception of food-led dynamics, faces an ongoing struggle as the erosion of high street spending driven by the consumer swing towards eCommerce continues. And, with many banks already having considerable direct exposure to retail, I think few will have much appetite for deepening their exposure to the sub-sector.
The logistics sub-sector, ranging from cavernous big box distribution centres to mid-sized warehouses and last mile delivery hubs, is still fundamentally strong. But it’s experiencing value corrections for the first time in many years, driving yields upwards to a relatively higher level than other sub-sectors.
A key issue for real estate businesses is funding the capital expenditure required to bring commercial properties up to the forthcoming EPC C and B standards – by 2027 and 2030 respectively – largely through retrofitting. Progress on this has perhaps been a little too slow, and we expect commercial landlords to be looking for appropriate transition finance solutions to meet EPC deadlines and avoid hefty fines or unlettable stranded assets.
Unsurprisingly, we’re already having many conversations about organisation’s capex needs, particularly where clients’ portfolios contain older buildings needing extensive attention.
The latest Government energy support package will see the Price Cap removed at the end of March for businesses in England, Scotland and Wales, replaced by a new discount mechanism based on wholesale prices. All businesses are likely to see a rise in costs although energy-heavy sectors will see higher discounts available. In the short term, cash and profits could be impacted and some businesses may look to increase prices or reduce costs to try and maintain margins. Real Estate businesses may look to see how they can reduce energy consumption, for example in construction and in their own estates.
Whilst investment in longer term solutions may hit corporates as an extra cost in the short term, it might also be imperative for businesses to look at how they can future-proof their running costs by developing a more sustainable/renewable approach to their energy consumption. With sustainability high on the agenda for many businesses, it is important that the cost of doing business does not overshadow this important transition. For projects with long-term sustainability at the core, sustainable financing may be a suitable option to support any immediate shortfall in cashflow.
In the residential property market, ESG will continue to be an increasingly critical factor, with potential tenants and homebuyers – particularly millennials and Generation Z – seeking more energy-efficient properties. This demand will likely increase, against a backdrop of prevailing higher energy costs.
This leaves smaller private developers without dedicated ESG teams under significant pressure as they struggle to meet sustainability and environmental expectations on new builds. Recognising this, we’ve recently launched our Sustainable Residential Development Framework setting out the eligibility criteria for our sustainability-linked loans and related financial products which could help facilitate real estate clients to build new homes more sustainably.
Despite the obvious headwinds, I’m confident that 2023 offers good opportunities for developers.
In the residential space there is still a fundamental under-supply of homes. Strategic partnerships between funders and developers – such as our Housing Delivery Fund, launched in partnership with Homes England – will be required to meet the UK’s homebuilding ambitions
Meanwhile, there is still huge potential and significant growth opportunities in the student accommodation, build-to-sell and build-to-rent development sub-sectors over the next 12 months and beyond.
Another key area that looks set to enjoy continued growth is the purpose-built ‘later living’ rental market, particularly in coastal and rural areas, appealing to the growing cohort of mature clientele willing to pay premium rents, but without the need for the medical amenities and aftercare of residential homes.
We also expect to see strong activity in the self-storage and data centre sub-sectors, while life sciences, although still an immature ‘alternative’ sector, seems to be growing and one to watch.
In summary, while the economic landscape for 2023 is one the most challenging we’ve seen for some time, the real estate industry historically tends to be pretty resilient. On balance, I expect the sector to hold up reasonably well, with increased activity in some of the more vibrant sub-sectors.
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