The uncertainty surrounding the future of commercial real estate is reflected in the frequent announcements of wind-ups or mergers related to UK commercial property investment trusts. The sale of iconic buildings at prices that offer a poor return on investment also demonstrates this lack of market confidence. However, with interest rates falling and more companies, particularly in the tech sector, requiring employees to spend more time in offices, there may be potential for a recovery in this asset class.
On the other side, some institutions are moving away from property as an asset. For instance, Dynamic Planner, a portfolio risk monitoring firm, has recently removed property from its portfolio metrics. Matthew Norris, senior portfolio manager at Gravis Capital, believes that while the sector may have reached a turning point, part of the market is unlikely to bounce back fully. As UK base rates drop, corporate bond and gilt yields are falling significantly, making the income from commercial property rents more attractive in comparison. Norris cites data from Knight Frank, which suggests that valuations for most commercial property assets have stabilised, something he considers notable in light of the broader economic challenges.
Looking ahead, Norris expects this stabilisation to soon lead to price increases, especially as interest rates are likely to continue falling. Aaron Hussein, market strategist at JPMorgan Asset Management, emphasises that while property values in the UK, US, and Europe have dropped significantly—between 15% and 25% since the start of the interest rate hikes—the sector has shown signs of stabilising by late 2023. Moving into 2024, Hussein points to modest gains, particularly for properties with solid fundamentals, which he believes may present a rare investment opportunity.
Nonetheless, Norris’ optimism mainly applies to properties that have modern energy efficiency ratings and prime locations, while older buildings, or those in less desirable areas, risk becoming “stranded assets.” The UK government has introduced regulations that will require all properties to have an energy efficiency rating of at least B by 2030 in order to be leased. Meeting these standards will likely involve significant capital expenditure, particularly for older or less centrally located buildings, which might struggle to find buyers in the future.
There are already signs of what is referred to as a ‘brown discount,’ particularly in the case of regional office properties. The Regional REIT, for instance, has written down the value of its assets by 5% over the first half of 2024, and the company has earmarked £20 million of recently raised capital to renovate and redevelop parts of its portfolio. This points to a broader trend where older office assets are becoming less valuable unless substantial investments are made to bring them up to current standards.
Peter Hewitt, manager of the Columbia Threadneedle Global Managed Portfolio trust, has reduced his exposure to property. He prefers to hold assets like Land Securities, which owns prestigious buildings in London, and investments in trusts owning care homes, which benefit from demographic changes rather than the societal trends affecting other property types, such as the shift to remote work.
Currently, only 16% of commercial properties in the UK meet the necessary energy efficiency standards, according to Norris. However, he notes that this situation might provide an opportunity for developers like Derwent, which could acquire these undervalued properties and bring them up to standard. Hussein agrees, highlighting the emergence of a bifurcated market, with energy-efficient buildings in prime locations performing significantly better than their outdated counterparts. This trend is especially pronounced in the office sector, where older buildings risk becoming stranded unless they are upgraded.
James Sullivan, head of partnerships at Tyndall, is cautious about the future of the property market. He points out that while property exposure can still provide diversification within a balanced portfolio, the collapse of open-ended property funds means that investors must now rely on real estate investment trusts (REITs). This presents an additional risk, as investing in REITs exposes investors to equity market fluctuations. Despite this, some investors, such as Ben Yearsley, director at Fairview Consulting, have begun buying UK property trusts. Yearsley believes that while the sector has suffered a significant downturn, the worst is likely over, and current yields make property investments attractive relative to government bonds.
Darius McDermott, adviser to the VT Chelsea range of multi-manager funds, has also been increasing his exposure to REITs. He points to the significant discounts at which many property trusts are trading relative to their net asset values as an opportunity to buy. As bond yields fall, McDermott believes that property income becomes relatively more appealing, and investor demand could help drive prices up, closing those discounts.
Real Estate Credit Investments Limited (LON:RECI) is a closed-end investment company that specialises in European real estate credit markets. Their primary objective is to provide attractive and stable returns to their shareholders, mainly in the form of quarterly dividends, by exposing them to a diversified portfolio of real estate credit investments.
