UK real estate investment market approaches key juncture

Sending a powerful statement to the industry, M&G Investments’ latest mid-year real estate outlook put forward the case that: ‘For the majority of markets, this year will likely mark the bottom of the cycle and the end of significant capital value falls.’

M&G’s prediction follows one of the fastest interest rate hike periods in modern history, with the UK’s Bank rate rising sharply from nearly zero (0.1%) at the beginning of December 2021 to 5.25% by August 2, 2023 – a level it has maintained for 11 months and counting.

Alongside this monetary tightening, there have been simultaneous macroeconomic and political shocks, including global conflicts, inflation, and, closer to home, a succession of prime ministers over five years. Factors that have caused major uncertainty and instability.

The UK real estate market has remained resilient, with sectors such as life sciences, flexible offices and build to rent continuing to attract high levels of investment and even showing strong growth potential – driven by a shortage of space and evolving occupier demands. 

Shoosmiths’ real estate investment group has been supporting its investor clients through this period, completing £1.2bn in deals during 2023. 

A proportion of this deal activity has been driven by investors looking past current hurdles and identifying the long-term potential in an asset, with many aiming to realise this through redevelopment, refurbishment, or other innovative strategies.

However, it is fair to say that the real estate market has been severely impacted. 

The expectation of 'higher for longer' interest rates and persistent inflation has taken its toll, exerting significant downward pressure on the market and leading to the postponement or reconsideration of some deals.

This was echoed during an investment-focused roundtable hosted by Shoosmiths and the GRI Club during UKREiiF 2024, with Mark Stansfield, senior director of UK Analytics at CoStar, explaining: “On the transaction side, volumes are pretty weak. Q1 2024 was a weak quarter, so any hopes for an immediate 2024 rebound were short lived.”

Also commenting on the dealmaking landscape, Sheelagh Cooley, partner and co-head of real estate finance at Shoosmiths, said:

“The general deal metrics are being kept under review at all stages. It is not because anybody wants to necessarily go slow - everybody has to get those second, third approvals the whole way through. In the meantime, there’s been another event (macroeconomic or political) in which case it has to be taken away again.”

Returning to M&G’s outlook, there is cause for a more optimistic view: ‘While expectations for fast and furious interest rate cuts globally have been dialled back, an increased risk premium for property, combined with improving rental growth prospects given a brighter economic outlook, supports the view that yields may have moved out by far enough.’

So, this raises the question – has the UK real estate market reached a turning point, what factors will influence this, and should investors potentially consider redeploying their capital?

Influencing factors

“There’s a lot of fatigue around interest rates,” said Ben Fry, managing director for housing and investment at Gresham House, during the roundtable at UKREiiF. “A lot of people thought rates were going to come down – every time they thought that it went the other way.”

The minutes from the Bank of England’s June 2024 meeting revealed that the decision was 'finely balanced', against the backdrop of inflation falling to the Bank’s 2% target in May. 

The shift to a more dovish position and the prospect of future cuts are having a short-term effect on the market, as Brian Hession, real estate partner at Shoosmiths, explained:

“Part of the problem at the minute in terms of deal volumes is that because there's this sort of baked-in expectation of a reduction (in interest rates) then this encourages people to just sit on their hands and wait. Anyone who’s going to an investment committee to buy something now with a base rate of 5.25% is going to be asked ‘why not wait?’.”

Whether inflation remains at current levels and the BoE cuts rates at its next meeting on 1 August is uncertain. Nevertheless, the trajectory is likely downward. Other central banks, including the European Central Bank and Sweden’s Riksbank, have already taken this step.

Then there’s the outcome of the general election to consider.

Today, Friday 5 July 2024, the UK has woken up to a new majority government led by Sir Keir Starmer. The impact of this change on the prosperity of the UK, including its real estate industry, remains unknown.

What is clear, however, is that this presents an opportunity to provide stability, which holds significant implications for decisions regarding investment and development in the UK.

“There has just been too much uncertainty over the last number of years,” said Ava Fairclough, managing director at Praxis, during Shoosmiths’ roundtable. 

Current market

Notwithstanding this challenging backdrop, Shoosmiths’ real estate investment group assisted clients on various projects during Q2 2024. This includes advising Leftfield on the acquisition of a prime warehouse facility in Essex from Abrdn for £23m. In the living sector, the firm also acted on the acquisition of a long-leasehold interest relating to the £66m build to rent element of the Gallions Quarter Phase 2B site at Royal Albert Wharf, London.

The difficult operating conditions have reaffirmed the importance of factors such as sustainability, quality of design, location, and flexibility of space. All of these factors play a key role in meeting the evolving needs of residential and commercial occupiers.

“Compared to this time last year, there's more institutional money here,” said John Milligan, chairman of Milligan, when asked about current investor interest during Shoosmiths’ UKREiiF roundtable. “It is flexible in what it is looking for and there's an element of ‘we will take a little bit of risk if we can get the right quality of what we want’.”

“I think the banks have got a really good understanding of real estate now and what's needed to actually make it successful,’ added Victoria Morgan, head of asset management at Catella APAM.

UK real estate has proven its ability to adapt to major changes in the market, positioning it well for its recovery. As M&G explains: ‘We believe new investments made in the next 6-12 months are likely to be recognised as a robust vintage in the long term, benefiting from high entry yields and strong occupational profiles.’

It is critical that the real estate industry continues to monitor the economy, as well as any potential policy or legislative reform the new government might introduce. Challenges could emerge, but if stability can be secured and the funding landscape softens, the UK real estate market’s strong fundamentals will shine through – stimulating a wave of new investment and development opportunities, and delivering vital economic and social benefits. 

Reflecting on the UK real estate market in 2024, Kate McCall, partner and joint head of Shoosmiths’ real estate investment group, said:

“Investors have been understandably cautious in the first half of 2024. While concerns about inflation and the political outlook may continue to dampen the enthusiasm of some, the projects our team worked on in Q2 demonstrate that the future, though uncertain, holds promise for those ready to adapt and seize opportunities."

“In many ways, this quarter has felt like one of the most challenging during this period of market uncertainty,” added Nathan Rees, partner and joint head of Shoosmiths’ real estate investment group. “We have seen fairly limited activity, as investors continue to take time making decisions on larger transactions. That said, during the second half of June and into early July, there has been a marked change of tone, with far more activity and new mandates coming through. The mood music in the market definitely feels like it is turning, meaning that the second half of 2024 is now looking positive.”

Select quotes are from a roundtable that Shoosmiths hosted at UKREiiF 2024 in partnership with the GRI Club - examining the UK’s real estate investment landscape.