Interest Rate Drop Helping UK Investment Market Turn The Corner. Will It Do The Same Across The Pond?

A private equity firm dropping more than half a billion pounds on a portfolio amid fierce competition. Hedge funds buying Mayfair offices. A flurry of M&A deals in the listed sector. 

The run-up to the end of the year in the UK real estate investment market kicked off several large deals of the sort that had been rare, as interest rate cuts lowered the cost of borrowing. And the prospect of rental growth is giving investors confidence in fragile sectors like the office market. 

As the U.S. waits with bated breath to see if a rate cut will be delivered for the first time in two years on Wednesday, a postcard from across the Atlantic, where rates are already coming down, gives insight into what the market might have in store.

The message: While a drop in interest rates isn’t a cure-all, it does start getting things moving in a stagnant market. 

“It is still quiet, but we’re turning the corner,” Avison Young European Capital Markets principal Penny Hacking said. “We’re starting to see some of those larger deals coming through. In most sectors in the UK, we’re at or near the bottom.”

“Turning the corner” is a phrase also used by Savills Head of Global Cross-Border Investment Rasheed Hassan. The decision on 1 August by the Bank of England to drop headline rates from 5.25% to 5% was mainly symbolic, he said, adding the cost of borrowing had already started to drop in anticipation of the move.

The cost of a five-year loan has fallen by about 200 basis points in the last year, Hassan said.

Inflation dropped more quickly in the UK than in the U.S., and GDP is lower because financial markets expected interest rates would fall sooner in the UK. As a result, the longer-dated, five-year debt that is typical in UK real estate dropped by about 150 basis points in anticipation of UK interest rates falling. 

On top of that, lenders dropped the additional margin they charge on the underlying rate by about 50 basis points, reflecting that with rental growth on the horizon and stability returning to financial markets, lending to property looked less risky. 

“There’s plenty of equity and debt out there, but it will take time for investment turnover to improve as there remains a dearth of sellers,” Hassan said. 

UK rates are expected to drop by a further 100 to 150 basis points between now and the end of 2025, Hacking said. As rates drop, values are likely to rise for quality property.

“People are pricing in a 150-basis-point drop in rates, so people want to put money into the market now,” she said.

It’s hard to be definitive about the cause, but second-quarter investment volumes would indicate the expectations of earlier interest rate drops in the UK had a positive impact on deals compared with the U.S. Transaction numbers were up 7% in the UK, according to MSCI data, versus a 1% drop in the U.S. 

“We’re starting to see competition for offices again,” Hassan said when talking about the deals that are representative of a new attitude among buyers. “Buyers are confident about rental growth coming through, and are underwriting deals on that basis.”

Deals in the works include the £130M sale of 14 St George Street for about £131M by Elliott Advisors — a hedge fund buying in Mayfair at a sub-4% yield, a price that would only be paid by a firm expecting rents to grow. A similar dynamic is in play with the purchase of nearby 45 Pall Mall by Ares for £130M.

Outside of London, Lone Star has agreed to buy a £600M portfolio from family-owned company Charles Street Buildings, beating competition from other private equity firms, React News reported. It is one of the largest private real estate deals in the UK in the past two years, with a debt-backed opportunity fund buying a 6.3M SF chunk of property across logistics, offices and retail on the basis that it can buy wholesale and make a profit breaking up the portfolio. 

“Next spring, it will be five years since the beginning of COVID,” Hassan said. “After that we’ve had inflation and rate rises. Before that we had the Brexit vote, and the debate about whether it would be a hard Brexit or not. People are battle weary, but they are starting to look forward again with a greater positivity than I have felt for a long time.”