Rate Cut Brings Recovery Of UK Real Estate Investment Into The Open

After 959 days of waiting, UK real estate investors finally got what they had been pining for. 

It was widely predicted and already partially priced in by markets. But there’s nothing like a cut in interest rates to put a spring in the step of the property industry.

“That rate cut gives an added level of confidence to investors and markets,” Abrdn Global Head of Real Estate Anne Breen told Bisnow. 

In many ways, Breen said, the Bank of England’s decision to cut rates from 5.25% to 5% after one of the sharpest rate rises in modern history merely formalises a recovery that was already stirring in UK real estate investment — a recovery that is starting to show up in data. 

Longer-term interest rates had already started to drop in anticipation of rate cuts. Rental growth was looking positive in sectors like rented residential, logistics and even some parts of retail, though offices remain challenged. And a new Labour government with a strong majority brought a certain measure of stability after a decade of uncertainty, especially compared to European neighbour France. 

That combination of factors has led Abrdn to declare that the UK is leading the global property recovery. The firm, which manages £508B of assets for clients, predicts that UK property will provide total returns averaging 8% a year over the next three years after producing negative returns in 2022 and 2023. 

It is not alone in hailing a UK recovery.

Data from MSCI showed UK investment volumes growing again in the first half of the year, outperforming those of larger European markets like France and Germany. 

Last week, Bank of London and The Middle East said that on the back of a new government and falling rates, Gulf investors were likely to start increasing the amount they invest in UK real estate, particularly in living sectors like build-to-rent and student accommodation. 

“To some extent, the cut in interest rates was already priced in. It was just a question of timing,” Breen said. “From our point of view, what makes the UK attractive is the differential has returned between running yields and longer-term rates, and the prospects for rental growth. 

“For real estate globally, we’ve moved from underweight to neutral. And when it comes to the UK, we’re overweight.”

UK interest rates started to rise in December 2021 as the Bank of England sought to combat inflation created in the wake of financial stimulus granted during the height of the pandemic. That was exacerbated by energy and food price rises caused by Russia’s invasion of Ukraine. 

Rates rose from 0.1% in December 2021 and peaked at 5.25% in August 2023, plateauing for a year until the cut last week. For an industry used to interest rates only ever going down since the 1990s, particularly after the 2008 financial crisis, it was a dramatic shock to the system. 

For the first time in almost 20 years, yields were lower than interest rates. For buyers who use debt — a big chunk of the real estate industry — that meant the cost of borrowing was higher than the income an average property produced, or that owners lost money when they bought using debt. The situation put those buyers out of the market.

For investors not using debt, yields on government bonds were higher than those on property, meaning more money could be made buying bonds and with none of the risk or illiquidity. For two years, real estate investment just wasn’t that attractive, even before accounting for the structural malaise in the office market. 

Investment volumes fell from a record £64B in 2021 to £26B in 2023, the worst year since 2009, according to CoStar data. In that time, the average yield on central London offices that traded rose from 4.5% to just above 6%, a value drop of close to a third, according to MSCI data. 

But slowly this year, the UK market has begun to recover. Breen said that average equivalent yields on property are now around 240 basis points higher than 10-year government bonds, a key differential that Abrdn monitors, and current initial yields are 170 basis points higher.

“So even if you factor in no rental growth, that’s an acceptable premium for the risk and illiquidity of buying property,” she said. 

Second-quarter UK investment volumes were up 26% year-over-year at £12B, compared with a 22% drop in Germany and a 45% drop in France, data from MSCI showed last week. The prospect of rate cuts helped the UK recover, as did the fact that prices dropped in the UK before other European markets, MSCI said.  

Abrdn’s move from underweight real estate to neutral or overweight in the UK means people making asset allocation decisions, either internally from Abrdn or in the market more generally, are going to start putting more money into property, Breen said.

“People will increasingly have the confidence to put cash in the market,” she said. 

Because good-quality property is now yielding more than cash and bonds, core investors should be encouraged back into a market where opportunistic or value-add capital had mostly prevailed, looking for bargains.

Value-add plays might well underperform as people underestimated the time and cost required to reposition previously underperforming assets, Abrdn said. 

Asked where Abrdn would put capital now targeting UK real estate, Breen pointed to one of the key trends that has emerged in real estate over the past decade, the fact that the sector no longer performs as a homogeneous whole. 

“Not all sectors are created equal,” she said. 

Logistics is in favour. Having fallen in value first and fastest because of the low yield at which assets are priced, it has also recovered first, Breen said. And while rental growth isn’t as strong as in 2021, it is above inflation nonetheless. Retail warehouses, convenient for shoppers to access and acting as small distribution warehouses, are also on the upswing.

But living sectors are its biggest conviction call, a trend mirrored across the market. Living sectors accounted for 33% of the £40B invested over the past 12 months, BNP Paribas Real Estate data showed, the highest rolling 12-month figure on record. 

“Investment in UK commercial properties as a whole is expected to grow to over $4 billion annually,” BLME Director of Real Estate Finance Rashid Khan-Gandapur said in a statement. “This figure will be boosted further by investment in the residential sector, with GCC investors showing a growing appetite for undertaking large-scale living sector investments.”

Abrdn is favouring living sectors like BTR, in which it has a partnership with John Lewis to build above stores and on surplus land the retailer owns. It is also prioritising student accommodation. 

As a big investor in living sectors in continental Europe, Breen said the opportunity now was in the UK. 

“The UK is interesting because BTR is still in the early stages,” Breen said. “Residential is still a small part of institutional allocations at the moment. People want to see the product, so we’re funding the building of good-quality, sustainable, professionally managed assets.”