5 min read 23 Aug 23
Economic headwinds and interest rate rises are driving real estate revaluations in markets globally. However, the UK has seen greater mark-to-market adjustments than any other market.
“Since property is an illiquid asset class, it reprices in places where there is more liquidity. As one of Europe’s largest and most transparent real estate markets, the UK has seen more transaction evidence than other markets, while valuers have been faster to adjust values,” says Richard Gwilliam, Head of Property Research at M&G Real Estate.
The government’s ill-fated mini-budget in September 2022 also contributed to steeper repricing, by driving UK bond yields and expected interest rates sharply higher.
While interest rate rises have put upwards pressure on yields, real estate fundamentals appear resilient. Occupier demand remains broadly intact, underpinned by a relatively low supply of modern assets. “Vacancies for prime central London offices for example are still relatively low, while rents across all sectors of the UK property market have grown during 2023,” notes Gwilliam.
Furthermore, long-term structural trends continue to drive several parts of the market, supporting rental growth potential. The shift towards online shopping, for example, calls for well located, efficient logistics properties to fulfil delivery requirements, while the need for more housing continues to support demand for private rented and affordable housing.
With yields having substantially repriced, assets can be acquired more cheaply. For example, prime yields for industrial assets in London look far more attractive than they have in a number of years, having rebased by 40% according to CBRE1.
“Ultimately, the long-term fundamentals specifically for urban, multi-let industrial property in London and the South East look favourable and values have adjusted such that assets can now be acquired at more attractive pricing,” says Gwilliam.
Similarly, Private Rented Sector housing continues to reflect a strong rental growth outlook, while the ability to buy in at cheaper levels could offer an opportunity to enhance risk-adjusted returns through new acquisitions.
The degree of rebasing for UK retail in the past fifteen years has been so substantial that parts of the market may now reflect attractive value. Capital and rental declines have been outsized compared to European markets, however this has now stabilised and core assets often reflect attractive value and high income returns.
“As a result of the pain, the future looks brighter because the sector got to the bottom earlier, and it has rebased to a greater degree,” says Gwilliam.
Rents are now starting to climb across UK retail, particularly for retail warehouses, meaning the sector may now represent more of an opportunity than it has for a number of years.
UK inflation has proven stickier than expected, leading to more interest rate rises. Further rises in debt costs, in turn, could potentially lead to renewed falls in real estate capital values. With inflation moderating however, the end of the interest rate hiking cycle could be in sight, bringing the property market respite.
“We’re moving into a period in the next few months where there are likely to be further valuation falls, however the closer we come to the end point, the more we can think about rebased values versus other global markets,” says Gwilliam.
In a relative sense, we believe the UK is closer to a stabilisation of yields than it is to the degree of further value falls expected in the US, where office values across the board are under intense pressure. Conversely, best-in-class offices in the UK look resilient, with robust tenant demand for properties that meet modern occupier requirements.
While inflation is expected to continue ticking downwards, it is likely to remain elevated compared to other markets in the medium-term. This could support rental growth, particularly for inflation-linked assets, since property is a real asset which can benefit from rising prices. This may help to soften the impact of capital value falls for investors. The UK Living sector is well placed to benefit, given that the market is not subject to rent regulations as per many other countries.
Opportunities could also arise to acquire selective core assets at discounted pricing, as refinancing rates no longer stack up for some asset owners, who may therefore become forced sellers.
When recovery comes, we believe the UK is well-positioned as a key investment target. “The UK historically has been a more volatile market, with deeper downturns and more rapid price falls. On the flip side, when the market recovers, it typically demonstrates a strong pace of growth,” says Gwilliam. “The GFC offers an example: values fell very significantly and sooner than other markets, including the US, but it was first out of the blocks when it came to recovery.”
Additionally, the UK continues to offer a benign investment environment, characterised by a now more stabilised political environment, an established legal framework, and a favourable ownership and leasing structure. Crucially, London remains a key global financial centre, while industries such as technology, life sciences and research and development continue to drive growth.
On balance, we believe UK real estate reflects attractive relative value and a sound investment landscape. Values have fallen by more – and more quickly – than other markets, offering an attractive entry point, while fundamentals appear resilient. The ability to buy assets at higher yields and also benefit from potential rental growth could therefore offer an opportunity to enhance risk-adjusted returns.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.