Is The Great British Lion Real Estate Market Roaring Back To Life?

Jonathan Read, Principal at Hodes Weill & Associates

The last 5 years, since the Brexit vote in June 2016, have been an interesting time both politically and economically for the United Kingdom. Between COVID and Brexit, Britain has been through two of the most significant events it has seen in decades - simultaneously. Whilst the entire world struggled with COVID, Brexit negotiations continued apace, and Britain finally left the European Union on the 31st December 2020. These two events have had a material impact on the UK real estate market. We are seeing a recovery in both leasing and capital markets which should accelerate once foreign buyers, spurred on by a weaker pound, are able to travel freely to the UK.

Both events, but predominantly COVID, put the country in one of the most challenging economic environments it has seen for centuries. The 9.9% annual GDP contraction in 2020 was the largest since the Great Frost of 1709.[1] The UK economy, like many others, has since seen a rapid recovery. GDP is now only 4.4% below its pre-pandemic level at the end of 2019.[2] This can be attributed to massive government stimulus and policy changes which kept the UK homeowner and consumer positively inclined.

Government stimulus was initially achieved by lowering the Bank of England base rate to 0.1%; lower than even those rates seen after the global financial crisis. High inflation is forcing the bank to consider raising rates in the short term, but markets are expecting them to stay relatively low for the foreseeable future. This means yielding assets are in favour which brings us to the real estate markets.[3]

As noted, following the start of the pandemic, and the subsequent halting of the economy, we saw precipitous drops in both transaction volumes and pricing. In the 12 months from March 2020 through February 2021, UK commercial property values fell 7% on average. Looking at activity, all UK real estate investment is expected to reach £53bn in 2021; significantly higher than the £42bn reached in 2020 and matching 2019 but far off the pre-Brexit record of £70bn in 2015.[4]

Now that we are in recovery, the UK has a lot of catching up to do. This should have a positive impact on pricing. A cheaper Pound following the referendum has made UK real estate significantly discounted and more attractive for international investors.

According to the Q2 2021 pan-European INREV Quarterly Asset Level Index, the high-level numbers are very strong. The UK recorded a total return of 3.7%, the strongest quarter since Q2 2015. The UK index benefited from significant exposure to the industrial/logistics sector which returned 7.36%. It is an uneven recovery across asset classes though, similar to what we are seeing globally.[5]

We will start by looking at capital markets activity. Starting with retail, investment volumes reached £1.05bn in Q1 2021, an increase of 4% on Q1 2020 but below the long-term average. At £2.2bn, all UK office investment was down 65% and 37% in Q1 2021 relative to the previous quarter and Q1 2020 respectively. CBRE is forecasting a continued decline in UK office capital values of 2.2% in 2021.[6]

Looking one level deeper shows a different picture. According to Knight Frank, there has been a sharp pickup in activity in the South East following Brexit and the easing of COVID restrictions. This South East market has seen one of its busiest first halves of the year ever. Total investment into commercial offices in Q2 2021 across the South East (excluding Central London) was £1.49bn (€1.76bn/$2.07bn), the highest quarter for investment volumes since the fourth quarter 2013 and the second highest since 2005.[7]

Investment activity in the quarter was up 400% on Q2 2020, the first phase of the pandemic, but also up 49% on the post-election period of Q1 2020; one of the busiest quarters for investment activity in recent years.[8] H1 2021 saw the highest office sales volume in 16 years; higher than recorded throughout the whole of 2020.[9] These figures would align with the thinking that employers are looking outside London for office space to offer flexibility to their workforce.

Moving to leasing, UK offices have suffered record low occupancy rates due to the “work from home” advice from the government. CBRE forecasts a decline of 5.3% in UK office rental values for 2021 and take-up in UK cities has been slow. Take up in central London office totalled 2.3 million square feet for the year to May 2021. This is a year-on-year reduction of 25% and 55% down on the 10-year average. Office take-up for the UK cities plus the South East markets totalled 1.5 million square feet for Q1, 31% below the 5-year average.[10]

Looking further into the detail, the South East leasing market on its own is showing clear signs of returning activity in the first half of the year. Take-up rose to 1.37 million square feet, up 24% on H1 2020 and the highest first half since 2018. This included six deals of more than 50,000 square feet, the highest number in a first half period since 2016.[11]

All of this indicates an increase in interest and activity in both the leasing and capital markets in the UK real estate market in the first half of 2021. This is most evident in industrial/logistics and South East office. As we continue to navigate COVID and Brexit, we see clear signs that the Great British Lion real estate market is roaring back to life.

[1] Elliot Smith, “UK Suffers Worst Annual Economic Slump since the Great Frost of 1709, a 9.9% Decline,” CNBC, February 12, 2021.

[2] Niamh McAuley, “GDP First Quarterly Estimate, UK: April to June 2021,” Office for National Statistics, August 11, 2021.

[3] William Schomberg and Catherine Evans, “What Might the Bank of England Do to Wean the UK Economy Off Stimulus?” Reuters (Thomson Reuters, July 19, 2021).

[4] Miles Gibson et al., “UK Real Estate Market Outlook Mid-Year Review,” CBRE, July 12, 2021.

[5] Matthias Knab, “Returns Soar for European Non-Listed Real Estate in Q2 - Opalesque,” Opalesque, September 15, 2021, https://www.opalesque.com/industry-updates/6524/returns-soar-for-european-non-listed-real-estate.html.

[6] Miles Gibson et al., “UK Real Estate Market.” July 12, 2021.

[7] “South East Market Heats up as Office Investment Hits £1.49bn in Strongest Quarter since 2013,” Commercial News Media , August 9, 2021.

[8] “South East Market,” Commercial News Media. August 9, 2021.

[9] “South East Market,” Commercial News Media. August 9, 2021.

[10] Miles Gibson et al., “UK Real Estate Market.” July 12, 2021.

[11] “South East Market,” Commercial News Media. August 9. 2021.