Big challenges remain for CRE development viability in the UK

Since our previous report on UK commercial real estate a year ago, construction materials price inflation has retreated rapidly and supply chain bottlenecks have eased, reducing pressure on construction costs.

Some are therefore asking if this is a good time to get back into the market and re-initiate development activity. But we think a widespread pick up in development activity is unlikely.

What you will learn:

• New development looks difficult to justify without underwriting strong rental growth. We estimate that developers would need 7%-9% per annum rental growth for a typical office, logistics, or residential scheme to be viable. This is more than double our UK CPI forecast over 2023-2025.
• Financial pressures from surging material costs and supply chain disruption are easing in the UK. However, material prices are still almost 50% higher than pre-pandemic levels and wage growth remains strong.
• The transition to net-zero and the effect of workforce ageing on labour supply are both likely to push construction costs up over the medium term.
• In the short-term, the scale and likely persistence of recent interest rate rises is the chief headwind to development activity, placing a premium on new space in the market.