UK Cross Sector Outlook 2024: Commercial

Mat Oakley discusses why 2024 will be a great opportunity for tactical buyers, and what sectors are likely to recover first and fastest

2024 will be an opportunity to buy at the very bottom of the cycle

We believe that the factors that drove the recent collapse in commercial property values and confidence will all improve in 2024. However, as the storm surge of high inflation and interest rates recedes, some new (and old) rocks will be exposed to challenge investors in certain sectors.

While we do expect that borrowing costs will fall over the next two years, they will not return to the levels that we were used to in the pre-Covid decade. This will mean that not only will prime yields not return to 2019 levels, but also that stronger than normal levels of rental growth will be needed to support some investment and development decisions.

Parts of the UK commercial property market look set to continue to deliver strong rental growth, but even this positivity may not be enough to convince some investors to return to the market when other regions of the world are continuing to experience falling values and distress.

Political change seldom impacts the commercial property market

The UK is one of 40 countries that are likely to have an election in 2024, and the question always comes round as to whether this heightens investor uncertainty. Our analyses suggest that transactional activity is generally lower than normal in the three months prior to the election date, and then recovered in the following six-month period. There is little evidence that a UK general election has ever had a measurable impact on commercial property pricing.

Given the importance of North American investors in the UK market, the fact that they too have an election this year is also a consideration around investor confidence. We find little evidence that a change of leadership in the US has ever notably affected American real estate investors’ international behaviour.

Will 2024 be the year that offices stop being a dirty word?

There is no doubt that some offices and office markets are facing challenges, but we believe that 2024 will be the year when investors stop making sector-wide pronouncements and start to focus on the traditional asset-specific basics. A year ago we were predicting that prime office rents would grow across the UK, and sure enough, they did (averaging 4.2% per annum growth over the post-Covid period).

Cooling inflation, falling borrowing costs, and good rental growth prospects will bring some development schemes back into viability territory in 2024. This will lead to a rise in development and refurbishment starts.

Problems will remain, either where tenant demand has moved on or where the landlord has underinvested to stave off technical obsolescence. 2024 will also see some lenders taking a more forceful stance with borrowers, and this will lead to motivated sales at discounted prices.

At the other end of the spectrum, the undersupply of prime and green office space across the UK’s major office markets remains a fact, and will continue to be a driver of better-than-average rental growth over the short to medium term. Value-add investor demand will deepen in 2024 to capitalise on this, though larger projects will remain challenged by institutional caution.

As is often the case, the first signs of recovery in capital values will come in the markets where income-focused equity investors tend to play, and we expect to see prime yields hardening in both London City and West End offices by the end of 2024.

Retail looks cheap

Some of the pressures on household finances will diminish in 2024, but high prices will remain the norm in many areas, and higher borrowing costs will impact on housing expenses even after the base rate has started to fall. Many retailers will be feeling the benefit of rebased rents and rates, but also the pain of higher operational costs in other areas. Some cautious expansion of retail footprints is expected in 2024, and this will continue the downward trend in vacancy rates that we started to see in 2023.

Opportunistic investors will continue to be attracted to parts of the retail market by the high yields on offer, as well as the medium-term capital growth upside that could come from change of use. We do not expect to see a surge in retail investment volumes in 2024, but some prime yield hardening in some sectors and locations is baked into our forecasts for both 2024 and 2025.

From sheds and meds to logistics and life sciences

Every recent investor survey, including our own pan-European survey from October 2023, has suggested that not only are logistics and life sciences at the top of investors’ shopping lists for 2024, but the weighting towards these sectors has risen. Both sectors offer an attractive mix of structural change-driven demand, restrained supply, and strong rental growth prospects, so it is easy to see why income-focused investors continue to be enthused by them.

Sheer weight of money targeted at these sectors should not only lead to their prices rising in 2024, but also raises the risk of an over-exuberant period of growth thereafter. However, with annual rental growth prospects in the high single digits per annum, the rationale for buying while these sectors are comparatively cheap remains a good one.

Forensic stock selection will be the key to out-performance and capturing the dip in 2024

The noted US fund manager Sir John Templeton said that the four most dangerous words in investing are “this time it’s different”. This can apply equally in terms of denying downturns or getting over-excited by new trends. Technical obsolescence is nothing new in commercial property, nor is an evolving definition of prime. Investors who ignored this have more legacy problems than those who didn’t, and will be less able to capitalise on the impending turning point in capital values than others.

What is also not different this time is the importance of the location and the asset itself. As ever in commercial property buying (or selling), a whole sector is seldom a good strategy – forensic stock selection will remain the key to out-performance.