The UK commercial real estate market is currently experiencing a transitional phase. As the Bank of England hints at potential rate cuts, investor confidence is likely to strengthen. Lower debt costs will make commercial investments more viable, leading to increased activity and stabilising yields across sectors.
Since mid-2022, significant shifts in yields have led to a sharp decline in capital values across various sectors, with offices and industrial properties experiencing the steepest drops of -27% and -26%, respectively. The retail sector, already undergoing structural changes, saw a more moderate decline of -19%. However, the rate of decline has slowed, with Q1 2024 seeing a minimal drop of 0.6% quarter-on-quarter compared to -2.2% quarter-on-quarter in Q4 2023.
Interest rate cuts anticipated for 2024 are expected to be a turning point for commercial property. Lower rates will enhance property yields, bolster investor confidence, and improve debt financing opportunities. Despite these positive developments, it may take time for investment activity to rebound to pre-downturn levels, potentially falling short of £50bn in 2024. It is also worth noting that the broader economic context still poses challenges. Persistent inflation and geopolitical uncertainties could temper the impact of lower interest rates. Investors will need to be cautious and selective, focusing on sectors and assets that demonstrate resilience and strong fundamentals.
All-Property equivalent yields have risen by over 150 basis points since Q2 2022, but the pace of increase has slowed significantly. Forecasts indicate that yields will end 2024 at 22 basis points lower than at the end of 2023. Capital values are projected to rise by 5.2% in 2024, with an acceleration to 7.0% in 2025. The combination of sustained rental growth and mild yield compression is expected to boost total returns by 10.2% in 2024, accelerating to 11.9% in 2025. Industrial and retail warehouses are predicted to be the best-performing asset types between 2024 and 2028.
While these forecasts are promising, they rely heavily on the assumption that economic conditions will remain stable and that the Bank of England’s rate cuts will proceed as expected. Investors should stay informed and be ready to pivot their strategies in response to market changes. The property yield/gilt spread, which narrowed to a 15-year low of 244 basis points in 2022, widened to 308 basis points at the end of 2023. Forecasts suggest this spread will remain between 250 and 300 basis points for most of the forecast horizon.
This spread provides a cushion for property investors against potential volatility in the bond markets. However, the reliance on this underscores the importance of monitoring macroeconomic indicators closely. A significant shift in gilt yields could disrupt this balance, impacting property valuations and investment strategies.
2024 is poised to be a pivotal year for commercial property, with anticipated interest rate cuts playing a crucial role in market dynamics. While recovery may be gradual, the outlook is positive, driven by falling inflation, improved debt financing conditions, and a resurgence in investor confidence. Keep an eye on industrial and retail warehouse sectors, as they are expected to lead the way in performance over the coming years. Nonetheless, investors should not become complacent. Vigilance and agility will be key in navigating the evolving landscape. Understanding the interplay of various economic factors and staying ahead of market trends will be essential for capitalising on opportunities and mitigating risks.
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.
