In July, Jefferies and European Public Real Estate Association (EPRA) hosted a forum to showcase the UK’s listed real estate sector. Six CEOs, representing about a third of the sector’s market cap, discussed key issues like hybrid work, housing shortages, an aging population, the boom in e-commerce, and the urgent need for student accommodation and primary care facilities.
The UK real estate sector is dynamic and offers significant opportunities for long-term investors.
Market fundamentals are strong. The nation is entering a period of relative political stability, the impact of COVID-19 has receded, and interest rates are expected to decline, potentially in September. Brexit has become a “known known,” ameliorated by hopes that the new Labour government may foster a more constructive relationship with the EU. There are signs of substantial market momentum, with either accelerating or stabilizing rent growth and higher occupancy levels across the UK.
UK Office Market Accelerates in Flight to Quality Amid the Rise of Hybrid Working
After years of COVID-related disruptions and interest rate volatility, office specialists Land Securities and Derwent London have focused on areas of competitive advantage and maintaining robust balance sheets.
As a result of eight years of limited supply, demand is concentrated at the high-quality end of the market. Mark Allan, CEO of Land Securities, believes “the outlook for returns from the development and ownership of best-in-class properties is the strongest in 15 years.”
The shift towards hybrid and remote work has altered market dynamics, but the importance of office space remains clear. Commercial tenants now prioritize sustainability, location (proximity to transport nodes), and amenities to attract and retain their workforce. Additionally, tenants are demanding more space per employee, changing the density of office occupation.
While London remains a unique global city, Paul Williams, CEO of Derwent London, is less optimistic about areas outside the city and remains focused on Central London. He emphasizes the importance of prime locations, ‘If we can’t walk to a building, we’re not interested.'”
The anticipated disruption of demand for flexible office space has diminished. While demand exists, it is now seen as a complement to their other offerings rather than a market disruptor.
Lower Vacancy Rates Leave Room for Rents to Grow
With lower vacancy rates and higher demand, the largest property Real Estate Investment Trusts (REITs) in the UK now see an opportunity to drive rental growth.
In retail, Mr. Allan observes a similar flight to prime locations, accelerated by the rise of online shopping. This trend has forced retailers to rethink their use of physical locations to support an omnichannel approach. They need fewer stores, but those stores must be larger and better equipped — essentially showrooms that draw people in and offer a wide variety of products.
Retail vacancy rates have dropped from 9% during COVID-19 to 4.5%, driven by strong retailers and European entrants. With rents falling to 35% below pre-COVID peaks, Mr. Allan believes we’ve reached an inflection point: “We’re now renewing with existing occupiers ahead of previous passing rents.”
Today, the UK is the largest online retail adopter in the world. Colin Godfrey, CEO of Tritax Big Box, the largest investor and developer in UK Logistics, believes “We won’t see the demise of the high street, but we are going to see an increase of online demand.”
Amid de-globalization, shortening supply chains, and rising manufacturing costs in emerging economies, the UK domestic manufacturing and logistics market is becoming more compelling. A diverse range of occupiers supports the market, in addition to major players like Amazon. Tritax views current hesitancy in uptake as pent-up demand. As demand increases, vacancy rates will decrease, driving rental growth to 4-5%. Significant investments in leasehold improvements also make occupiers sticky and high-quality customers.
Rental growth aspirations are buoyed by the decreasing cost of rent as a proportion of commercial tenants’ total operating expenses. In logistics, property costs are 2-5% of total operational costs, while in the office sector, rent makes up 8% of clients’ cost structure, down from the high teens. With vacancy rates at 3.4%, Mr. Williams expects over 5% annual rental growth for offices over the next five years and Mr. Allan projects rents could grow 30% over the same period.
As a mid-market rental operator, Grainger’s performance is closely tied to wage and general inflation, with rents changing weekly. Grainger’s tenants spend 28% of their income on rent, below the charity sector’s expectation of one-third. The core demographic for build-to-rent is young professionals. Although Grainger could increase rents, they take a conservative approach. Renting remains cheaper than owning, with only 5% of tenants leaving to buy homes and 63% renewing leases. Wage inflation is currently 5%, and as it decreases, rental growth will slow but stay above inflation.
A New Labour Government Spurs Cautious Optimism in Residential, Student Accommodation, and Healthcare
Helen Gordon, CEO of Grainger, the UK’s largest listed residential landlord, expects the incoming Labour government to focus on improving the planning system over implementing rent control, which negatively impacted Scotland’s rental supply when introduced in 2022. “Not only will they not introduce rent control, but they won’t allow the devolved mayors to introduce rent control either, for fear of repeating what happened in Scotland.”
Grainger supports Labour’s intention to implement higher quality terms for renters.
There are housing shortages in most UK university cities due to increasing student numbers and a continued influx of international students. Michael Burt, CFO of Unite Group PLC, reports occupancy rates over 99%, highlighting strong and ongoing demand amid no new supply of purpose-built student housing and a shrinking private market. “All of our conversations with Labour are about how we can accelerate housing supply and make it more affordable. Positively for us, they are very open to innovative housing policy and ways to provide more affordable beds.”
Mr. Burt also believes the new government appreciates the important role that international students play in supporting funding models for UK universities.
Harry Hyman, Founder and Chair of Primary Healthcare Properties, welcomes Wes Streeting as the new health secretary. “He clearly understands that we need to deliver more healthcare outside of hospitals, which will lower costs, increase accessibility, and help tackle the incredible NHS waiting lists. However, we still need to focus on rental growth from the government.”
Mr. Hyman sees rental growth as essential for the development, modernization and expansion of facilities, which are crucial for improving NHS efficiency and providing care at a fraction of hospital treatment costs.
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