Worst Quarter For UK Property Since 2009 As Rate Rises Bite

UK commercial property produced the worst returns since the depths of the financial crisis in the third quarter, as interest rate rises caused values to drop.

Uncertainty about where values will bottom out sent UK investment deals dropping sharply, albeit not as sharply as in other European countries. The standoff between buyers and sellers and lack of certainty about interest rates and income levels mean there are likely further value falls to come. 

The latest data from MSCI highlights how macroeconomic factors influencing real estate are starting to have a tangible impact on values and returns. 

UK property, on average, returned -4.3% in the three months to the end of September, MSCI research showed, the worst quarterly return since the second quarter of 2009. 

That quarter in 2009 was the market's nadir and the point when central banks in the U.S., UK and Europe started programmes of quantitative easing, slashing interest rates to zero to stimulate growth. 

With inflation having spiked to 40-year highs, that process has now gone into reverse.

MSCI said UK property is in negative yield territory for the first time since 2007. The average property yield is now 4.1% against an average cost of debt of 4.2%. If a property was bought at that yield using that cost of finance, it would lose money, meaning values must drop to make buying profitable.

MSCI said industrial suffered worst from falling values, producing a total return of close to -10% for the quarter. That said, industrial rents did grow 13% year-on-year in September this year, per the data. 

MSCI data showed UK third-quarter investment volumes fell 33% to £11.7B, the lowest level since Q3 2020, near the height of the pandemic.

That quarterly fall was smaller than the 34% drop in France and the 37% drop in Germany, however. The UK was the largest commercial property investment market in Europe in the first three-quarters of the year, with £50.8B transacted. 

London was the largest city for investment over the same period, with £19B transacted, though the third quarter saw a 38% drop compared to the third quarter of 2021. The figures were boosted by some sizable transactions in the more benign first half of the year.

MSCI’s data painted a picture of a far less liquid European market. While this isn’t certain to lead to further price falls, it said that is highly likely.

The number of active buyers and sellers in the European market was at a nine-year low, according to MSCI. The number of deals done was fewer than 700 in September, 50% down on September last year and 40% down on August 2022.

This is only the third time on record that more deals have completed during August — normally the slowest month of the year — than September, which is normally one of the busiest, MSCI said.

Using its data to find the average gap between what sellers are asking for a property and what buyers want to pay, MSCI found a differential of about 12% in London.

“When the data number is negative, this indicates that the market is [in] a period of low liquidity and price falls are more likely,” it said.

Pending volume at the end of the third quarter has previously been a reliable guide to where completed volume will be at the end of the fourth quarter, it added.

The slowdown is further evidenced by the lack of pending or in-contract deals in the company’s database. At the end of September, there was just £15.7B in pending transactions, the lowest third-quarter level since 2013.