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The UK property market is poised to bounce back and is already ahead of continental Europe

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Opinion piece by Henry Timmis, Co-Managing Director of UK – Real Estate at Sienna Investment Managers

Has the UK reached the bottom of the market? 

While the real estate sector has been slow to come out of the recent downturn, the UK market has generally corrected at a far quicker pace than the rest of Europe. This was partly helped by the UK’s 2022 budget which ‘spooked’ the market, and the Bank of England having to aggressively increase interest rates from a low of  0.1% to a peak of 5.25% in order to tame inflation.

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Whilst we haven’t witnessed considerable receivership sales, a number of UK property funds suffered from significant redemptions. As such these property funds have had to sell some of their better-quality assets in a market where very few buyers were willing to acquire and, whilst the deal turnover substantially slowed, it has created some valuation evidence.

There have been fewer receivership sales than expected, as the view has been taken to see through this period particularly if a loan is being serviced. In fact there have been examples in 2024 of receivership sales where the receivers have come close to closing and then decided not to sign or close, as they believe pricing will be considerably improved in say 12 months.

The most dominant buyers in the last 24 months have been private investors, both local and international, often already present on the UK market. French institutional equity has also been active, being attracted to the higher returns coupled with long leases. At Sienna IM, we represent a number of these types of investors and as such we have been able to take advantage by buying long income, institutional grade hotels at close to 6% net initial yields, or core City of London retail at 7.5% net initial where the rents have been rebased post-covid. We are already witnessing rental growth and are actively pursuing further institutionally grade investments throughout the UK but are starting to see more competition for them.

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In the last number of months, we have started to see one or two UK institutions take advantage of the pricing. They are typically purchasing ‘core’ long income buildings at ‘core plus’ pricing. They will undoubtedly be looking to take advantage of compressing yields going forwards. For example, the City of London prime yield has moved from a peak of 3.75% in Q1 2022 to 5.25% currently. The gradual increase in the number of buyers on the market should strengthen the confidence of owners in their selling decisions.

What are the dynamics which are likely to take the market forward?

One of the key changes in the markets back in 2022 was the fact that borrowing costs increased substantially in the UK. 5 year swap rates increased from a low of 0.16% (July 2022) to a peak of 5.67% (September 2022) and as such borrowing was not accretive. The number of buyers substantially reduced and the world became a very cautious place.

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We are now seeing declining interest rates with the Bank of England rate 50 bps below its recent peak at 4.75% (4.34% 5 year SWAP). Coupled with pricing having moved out, for example provincial city office prime yields increasing by 225 basis points from 4.75% to 7.00%, debt is starting to become accretive which will undoubtedly build further confidence.

Tenant office take-up has also been relatively healthy, with a key demand for newly-developed or refurbished buildings in core city locations with strong environmental credentials. For top quality office space there has been, and is forecasted to remain, good rental growth which is partly due to a limited supply for the best buildings. With high inflation impacting construction costs over the last few years, the viability of new developments has been questioned along with the uncertainty of the investment values when selling.

Retail is also an interesting market. The UK high streets have suffered for a number of years however, following covid, rents and rates (taxes) have fallen dramatically, allowing it to become more affordable for tenants to trade. In the prime high street city locations there is also significant competition for new units and in turn rental growth. Prime yields are now 6.50% having peaked at 7.00% in 2023.

What are the risks in the market?

Inevitably the main risk is the wider macroeconomic trends which will impact not just the UK but the rest of Europe as well, whether this is the ongoing wars or new US administration.

Where the market is still struggling to find its feet is with more of the value-add types of  opportunities. It is likely that owners haven’t fully appreciated the impact of construction costs on their development values and in certain locations this may take further time to work through. For example, the majority of our investment acquisitions in 2024 have been at a price below the replacement value, which obviously poses the question as to what rental levels and yields need to be achieved for viability. As such we may still see one or two receivership sales for these types of assets, particularly in secondary locations.

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