Scott Wright: Scottish property market hit by 'sharp pricing corrections'

The latest Scotland Snapshot from Colliers, issued on August 4, found investment in commercial property in the first six months of the year soared to £1.3 billion, following a strong second quarter when deals worth around £700 million were concluded. That growth reflected strong interest in offices, with the report singling out the £215m sale of the Grade A 177 Bothwell Street development in Glasgow in April – the largest-ever office deal to be concluded in Scotland.

Total investment in office deals increased to £330m in the second quarter from £90m in quarter one, meaning much of the leap stemmed from the sale of 177 Bothwell Street by HFD Group of Scotland to Spanish investor Pontegadea Inmobiliaria.

READ MORE: US giant Celeros reveals plan to sell off land at historic ClydeUnion site

The overall value of deals in the second quarter was well above the five-year quarterly average of £550m noted Colliers, which underlined the interest of overseas capital in Scottish commercial property across a range of asset classes. It highlighted, among other transactions, the £124m funding and acquisition of Platform Bonnington, a build-to-rent apartment scheme in Edinburgh, by European real estate company Heimstaden Bostad in the second-largest residential deal to ever be recorded in Scotland.

Such deals underscored the appeal of commercial property in Scotland to international investors in the first half, with deals north of the Border perceived as offering better value when compared with other “regions” in the UK.

However, Colliers hinted in its report that uncertainty lay ahead. “It will be interesting to see how the market fares in the latter half of the year as current signs on the health of the economy are mixed,” said Oliver Kolodseike, Colliers’ director of research and economics. “GDP has held up reasonably well so far this year, but economic forecasts are being downgraded and the PMI’s Future Activity Index fell to its lowest level in almost two years, adding to fears of a slowdown in the coming months.”

READ MORE: Monday Interview: Arran distiller toasts a ‘very special’ response to first malt

The Colliers report was only a fortnight ago, but already Mr Kolodseike’s warnings have proved to be prescient, for there are now signs conditions in the market have changed for the worse.

The rapidly deteriorating outlook for the UK economy, which is now forecast by the Bank of England to soon fall into a long recession, has in recent weeks forced a sharp slowdown in transactions, with rising interest rates causing buyers to put deals on hold. The base rate now stands at 1.75 per cent after a series of increases by the Bank to combat rising inflation, meaning higher borrowing costs for those looking to acquire property.

“Current sentiment is mixed and uncertain,” David Davidson, chairman of property firm Cushman & Wakefield in Scotland, told The Herald this week. “Commercial property has been defying gravity and the economic storm clouds, but the market has finally been knocked back by interest rate increases across the globe this summer.

“There have been sharp pricing corrections and a slowdown in transactions in most geographies, including Scotland. This is a direct response to increases in borrowing rates and the resultant increase in the cost of debt to support commercial property transactions. However, it has been exacerbated by the threat of economic slowdown, construction cost inflation making new building extremely expensive, and the growing uncertainty about how this will impact occupiers of property over the next 12 to 18 months.”

READ MORE: New Glasgow office development sold for £215 million

The sudden change in fortunes is a blow to a sector that was thrown into turmoil by the pandemic, the ramifications of which included a dramatic slowing of deal activity (in part because buyers were restricted from travelling to inspect properties) and serious debate about the future of offices in particular.

Indeed, the future of offices continues to be a source of conjecture as many people continue to spend part of their working weeks at home. Should the “hybrid” working trend continue, it is expected to radically shape the amount and format of office space employers require. Equally, the environmental sustainability of office properties is moving increasingly into the spotlight, as developers place net-zero commitments at the heart of their plans.

Mr Davidson underlined the attractiveness of such properties to both occupiers and investors, and suggested environmental factors could lead to an “increased focus on secondary and tertiary property that is incapable of being modernised, and more conversions of obsolescent offices to alternative uses”.

Given rising interest rates, it may be that such activity is shelved until developers feel the investment is more affordable.

Indeed, with the mood surrounding the economy continuing to darken amid elevated inflation and the increasingly dire projections for household energy bills, it is hard to avoid the conclusion that it will be a long time before conditions improve.

Yet Mr Davidson notes that, as far as commercial property is concerned, there are some who believe the current deals hiatus may be a temporary phenomenon.

He also suggested that some international investors, for example large German funds, are the “least likely to be concerned as they take 10-to-15 year views on their investments”.

“With inflation predicted to be under control within the next six months which would result in interest rates reducing before the end of 2023, many see this as a temporary phase and will take a long-term view,” Mr Davidson said.

“Hopefully both the UK and Scottish Governments will take all necessary actions to avert the worst of the cost-of-living crisis and this will avoid a downturn as severe as the GFC (Great Financial Crisis). Property will always be seen as a long-term hedge so the market is likely to pick up once the holidaymakers get back in their offices in September.”