Valuers and our clients have, over the last number of years, bounced from one set of uncertain circumstances to another.
Even during challenging times, the commercial property market has been resilient and somewhat of a star performer in the context of alternative investment options. As the property sector emerges from the traditionally quieter summer months, rising interest rates and increasingly uncertain outlook in global markets will have an interesting impact on property values and short-term liquidity.
At the beginning of 2022, the global economy has been hit by a series of shocks including surging inflation, supply chain issues and the potential for fuel shortages linked with the war in Ukraine. This is causing a great deal of unease in general economic sentiment, and there is a growing consensus that major economies including the EU, UK and USA will go into recession later this year or in early 2023.
As a result, there are several opposing forces at play. On one hand we have the lifting of pandemic-related restrictions earlier this year, which drove growth in consumer spending and employment, supporting robust occupier activity across all sectors. On the other hand, surging inflation and sharp increases in energy costs are affecting businesses and consumers alike and this is having a knock-on effect on the real estate market.
With inflation now averaging close to 10% across the Eurozone and similarly high in other economies including the US and UK, central banks have responded swiftly by raising interest rates. The ECB has now raised its main refinancing rate to 1.25%, the highest level since 2011, and it is expected that this will increase further before year-end. The Bank of England raised base rates to a current level of 2.25%, while the US Federal Reserve increased interest rates by 0.75% in September for the third consecutive month to a target range of 3% to 3.25%.
Rising interest rates and persistent high inflation are likely to lead to more conservative bank lending which in turn could contribute to a weakening of the commercial real estate market and with consequent softening of values and outward pressure on yields. Evidence from our colleagues across EMEA indicates that yield movements happened earlier this year in core markets in mainland Europe, as keener yields will be more sensitive to higher interest rates. For example, we saw an expansion in prime office yields in the order of 20-30bps in the main German cities during the first half of the year, while in Dublin and London prime yields remained stable although moderate outwards movements in prime yields are being reported in most locations now that interest rates are rising. Still, the historic value seen in the Irish market against other European cities may be a driving factor against a slower adjustment to yields here.
So far, despite increasing unease and negative media sentiment, we have not witnessed a wholesale drop in demand or appetite for commercial real estate and the latest figures indicate that investment turnover reached €1.8 billion in Q3. Nevertheless, our Capital Markets team reports that investors are certainly more cautious, particularly in relation to vacancy and potential future refurbishment or redevelopment costs which are at present very difficult to predict. In addition, decision-making processes for both investors and banks are taking longer due to more intensive review and approval procedures arising from this more uncertain outlook.
Positively, occupier markets are still performing relatively strongly, underpinned by supply-demand imbalances in the residential, office and industrial & logistics sectors. Office take-up was in the region of 74,305 sq. m. in Q3 (up from 45,896 sq. m. in Q2) with strong demand among financial and professional services companies. Large global retailers and third-party logistics companies are very active in the logistics space, and we have also seen several new store openings on Grafton Street in recent weeks with more expected before year-end. Currency fluctuations and in particular the relative strength of the US dollar may support further opportunistic investment from the US in the short term and there has been anecdotal evidence of other cash-rich European investors seeking to enter the Irish market too.
We believe the market is now in a period of price discovery among investors and vendors, and there has been evidence of price reductions and of some transactions being slow to progress or stalling due to adjustments in pricing or cost expectations on either side. In the absence of a large body of transactional evidence, continued vigilance will be required from valuers as the various factors mentioned above unfold in the coming months. The valuation date and market context in which a valuation is carried out will be extremely important and valuations may need to be carried out more regularly to take account of this fast-moving situation. However, with transactional activity now ramping up again the picture will be a lot clearer as we move towards year-end.