MUCH attention has rightly been focused on the affordability of mortgages amid the cost-of-living crisis and fall-out from the Chancellor of the Exchequer’s mini-Budget in recent weeks.

Interest rates had been rising gradually from their historic lows of last year on the back of surging inflation before the markets responded so negatively to Kwasi Kwarteng and Prime Minister Liz Truss’s package of unfunded tax cuts, which were announced on September 23 (and have since scaled back with the U-turn on abolishing the 45p top rate of income tax).

Members of the Bank of England’s Monetary Policy Committee had just the day before Mr Kwarteng’s intervention voted to increase the base rate to 2.25%. But so pronounced has been the turmoil in financial markets that followed the UK Government’s plans that interest rates are now forecast by financial markets to rise to 6% next year. It amounts to even more worry for homeowners who were already deeply concerned about soaring energy costs and the general cost of living.

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The impact on the housing market, which had been growing strongly this year until Mr Kwarteng's mini-Budget, has yet to become clear. But just as it is expected that the cost of mortgages and the market for buying and selling homes will be affected in the coming months, so too will conditions in the commercial property sector.

After recording a strong opening six months to the year, during which time the value of investment in Scottish commercial property reached a four-year high, the market began to cool quickly in late summer, as the outlook for the UK economy darkened and expectations of recession grew.

By the time interest rates had increased to 1.75% in August, one senior property industry figure, David Davidson of Cushman & Wakefield, said there had already been “sharp pricing corrections and a slowdown in most geographies, including Scotland”.

Mr Davidson, chairman of the property firm in Scotland, said at the time: “This is a direct response to increases in borrowing rates and the resultant increase in the cost of debt to support commercial property transactions.”

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That was the outlook two months ago, before the upheaval sparked by the UK Government’s mini-Budget.

What can we expect now the cost of borrowing is even higher, and the outlook for the economy even more bleak?

According to property insiders contacted by The Herald this week, the market will cool further still.

Asked if there are signs of property owners putting sales on hold because of the worsening conditions, Mr Davidson replied: “Yes. Investments currently available to purchase are taking protracted periods in marketing and in agreeing legals, and therefore many investors feel reluctant to test [the] market with new product when they fear purchasers are looking for severe discounts or have temporarily withdrawn from the market.”

He added: “The slowdown in the market pre-dates the Truss Government and was largely triggered by the rise in inflation and the response from the Bank of England and the US Fed to put up base rates. However, politicians have not helped any investment decisions and some international investors are sitting out the marketing waiting for calm before assessing where ‘new normal’ pricing lies.”

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Alasdair Steele, head of Scotland commercial at Knight Frank, said concerns over inflation and interest rates have meant the market has not bounced back from its traditional summer lull this year. He said it is positive that the “occupier side of the equation has been remarkably robust thus far, and there remains a huge amount of global money seeking to invest into UK real estate.”

“However, I suspect we will enter a period of reduced transactional volumes whilst investors wait to see what happens next with the economy,” he added.

And it is not just the market for property deals that is being affected. Basil Demeroutis of FORE Partnership, the company behind the new Grade-A Cadworks building in Glasgow city centre, said the “new development pipeline has been dramatically shut”.

Mr Demeroutis told The Herald: “While projects currently under way seem to be continuing, green-lighting new projects has become incredibly difficult as the cost models underpinning those decisions – both in terms of construction and finance costs – have been upended. In some UK markets, we are seeing the supply of new space falling by as much as two-thirds for 2023 and 2024.

“On the flip-side, the demand for certain kinds of office space, buildings that are high quality and highly sustainable, has not abated so ironically we might be seeing a supply shortage of these kinds of buildings in the medium term.”

There is an argument that the weakness of sterling versus the US dollar and the euro seen this year will have increased the attractiveness of commercial property in Scotland among overseas buyers, given more favourable exchange rates. Indeed, Mr Demeroutis said the weak pound is “like a klaxon for international buyers”.

“With the exception of a few weeks in 1985, never since the American Revolution has the sterling been cheaper than it is today,” he said. “And yet, there are incredibly powerful structural reasons to believe in the long-term attractiveness of the UK as an investment destination, particularly in real estate. Deep liquid markets, innovation, a centre of global financial markets.

“Particularly for foreign investors that are cash buyers and not reliant on borrowing, this is a window of opportunity that might not come again for a generation.”

Yet, with interest rates also edging up in the US and eurozone, albeit not as sharply as they now are in the UK, the benefit of the weaker pound for overseas buyers could be limited.

Mr Davidson’s firm is currently marketing 122 Waterloo Street in Glasgow, a building fully let to US banking giant Morgan Stanley. He said the interest being shown in the building from mainland Europe, the Middle East and the US supports the view that the appeal of Scottish property is being stoked by the fall in the value of the pound.

“However, the relative value created by the fall in the pound – particularly against the US dollar – has to be balanced against the perceived economic risks ahead,” he said. “Just like with residential property, the price of commercial property is highly dependent on the availability and cost of debt. The more expensive it is to borrow, the lower the price investors can afford to pay.”

A similar view was offered by Mr Steele, who said that while a weak pound may make commercial property assets more attractive to overseas buyers, “it is not the be all and end all”.

Mr Steele noted: “If it is a major factor in their decision-making, investors also have to believe the pound won’t deteriorate further in value compared to either the dollar, the euro, or other currencies. With the economic headwinds we’re currently facing, that is a difficult call to make. That said, we know that many overseas investors see Scotland as good value, with higher yields in our major cities compared to equivalent assets located elsewhere in the UK and on mainland Europe.”

One thing that most would agree on is the need for a period of calm after the upheaval of recent weeks. Mr Steele said investors “look for certainty and clarity” but that is currently an elusive factor when it comes to interest rates.

“Until there is some certainty over that, there will be many investors who wait to see what happens and delay any significant investment decisions,” he said.