UK real estate market outlook Q1 2024 (2024)

UK gross domestic product (GDP) growth rebounded in November, expanding 0.3% month-on-month, which was slightly better than the consensus of 0.2%. Services activity was the main contributor. The Office for National Statistics also noted that fewer strikes in November helped boost growth. Meanwhile, construction activity was weak, in part because of the weather. The monthly profile of GDP remains extremely volatile after a contraction of 0.3% in October. The broad trend remains one of sustained stagnation. Recession-like conditions look set to continue in 2024, but the prospect of further fiscal easing to be announced in March should help to limit the extent of the downturn.

While UK real estate capital values declined over the course of 2023, the pace of decline has moderated. There are tentative signs of stabilisation for some sectors but not all. There is a risk that further price discovery in the first half of 2024 will result in softer pricing, particularly for out-of-favour sectors. Performance has varied across sectors, with those benefiting from structural and thematic tailwinds proving more resilient in the face of a weaker macroeconomic environment. The logistics and living sectors are a clear example of this trend, both of which outperformed the wider market over the course of 2023.

UK real estate capital values fell by 2.6% in the fourth quarter of 2023. This resulted in value declines of 5.6% for the year, according to the MSCI Monthly Index. In line with our expectations, the living and logistics sectors outperformed the wider market, with capital value growth of 1.9% and 0.1% during 2023. The office sector remains the laggard. It recorded a capital decline of 16.6% over the same period, as the sector struggles with changing working habits, higher financing costs, and weak investor sentiment.

At the All-Property level, total returns for the calendar year 2023 were -0.1%. The largest negative contributor to performance was the office sector, which returned -11.9%. The residential sector was once again the strongest performing sector, returning 8.2%. The industrial sector returned 5.1% over the same period.

UK real estate investment volumes for the calendar year 2023 reached £34.3 billion, according to Real Capital Analytics. This represents a year-on-year decline of 47% and means that 2023 was the weakest year for investment activity since 2009. The investment market has been affected by a significant gap between buyer and seller aspirations across several sectors. The buyer pool for UK real estate was thin in 2023 and we expect this to be the case in the first half of 2024. While we expect greater liquidity to return to the market in 2024, this will be driven, in part, by buyer and seller expectations becoming more closely aligned.

The UK real estate listed sector ended the year on a high, with the FTSE EPRA Nareit UK Index posting a total return of 18.9% in the final quarter of 2023. It significantly outperformed the FTSE All-Share Index, which recorded a total return of 3.2% over the same period. The recovery in UK REIT (real estate investment trust) performance in the fourth quarter of 2023 was driven by the market pricing-in an increased probability of rate cuts in the second half of 2024. This is mainly because of better inflation data and the expectation that peak rates have been reached. This was clearly illustrated by the UK interest rate swap market, with the five-year swap reaching lows of around 3.3% by the year-end. This was considerably lower than the peak of around 5.3% that was reached in July 2023. The UK listed real estate index has historically led the UK direct real estate sector by six-to-nine months, which adds weight to the argument that thethat the fortunes for the latter will improve over the course of 2024.

Sentiment towards the office sector remains very weak, as the sector grapples with new working habits and a weaker economic backdrop. Investment volumes reached £8.5 billion in 2023, a 54% drop on 2022 levels. It was the weakest year for investment on record, according to Real Capital Analytics. Overseas investors were the most active source of capital for the sector over the course of 2023, followed closely by private investors. Institutional investors were the largest net sellers of office stock.

The most recent data indicates that vacancy rates across all major office sub-markets have started to plateau, but at elevated levels compared with historical averages. This is being driven by the availability of ‘grey’ or second-hand space, as occupiers rationalise their estates because of a fundamental shift in working habits. We’ve seen a consistent improvement in office occupancy rates across the UK in 2023. However, it’s unlikely this will translate into any meaningful improvement in the vacancy rate, as businesses become more selective about the quality of office stock they want to occupy.

The availability of truly ‘best-in-class; office accommodation remains in short supply. This is creating a two-tier market, which is helping to support prices and rents for prime office assets. We expect headline rents for ‘best-in-class’ office space to move higher from here, as a lack of suitable product and continued strong demand place further upward pressure on rents. Any office stock that falls outside this definition will see further pressure on rents and yields.

The fundamentals for the industrial and logistics sector remain well placed to support the UK occupational market. While the vacancy rate continues to edge up – reaching approximately 4% at the end of 2023, according to CoStar data – it remains below the historical average of 5%. The same can be said for the availability of second-hand space. Construction starts have slowed materially, driven by more punitive financing costs, higher construction costs, and a lack of suitable sites. This is supporting rental value growth for the sector.

Over the course of 2023, industrial and logistics yields remained largely flat following a steep correction in the second half of 2022. Investor sentiment towards the sector remains positive, but there’s a clear polarisation in demand for ‘best-in-class’ ESG (environmental, social and governance) stock. Demand for shorter-let stock also remains strong, with investors eager to acquire assets that allow them to capture any potential rental reversion.

We remain positive on the longer-term outlook for the industrial and logistics sector, supported by structural and thematic growth drivers. Online retailing now accounts for approximately 30% of total UK retail sales. This is lower than the peak reached during the pandemic, but considerably higher than pre-pandemic levels. Additionally, shortening supply chains, onshoring, and a shift from just-in-time to just-in-case facility requirements, will help support tenant demand.

The retail sector faced a challenging year in 2023, with consumer confidence creating a significant headwind for the sector. Month-on-month retail sales volumes fell by 3.2% in December 2023, according to the Office for National Statistics (ONS). Retail sales were down 2.4% compared with December 2022. Black Friday tempted some consumers to bring forward their spending to November, which partly explains the slowdown in December’s retail sales. This is supported by the ONS’s public opinion and social trends analysis. It reported that 46% of adults had or were planning to spend less on Christmas food or presents, with 39% buying food or presents earlier to spread the cost.

The retail warehouse sector continues to garner strong investor interest. The vacancy rate for retail warehouses remains markedly lower than shopping centres or high street shops in the UK. Additionally, footfall has been more resilient than other areas of the retail sector, particularly for schemes with a more discount-oriented line-up. Occupationally, the supermarket sector remains well placed. UK operators experienced their busiest Christmas since before the pandemic, according to Kantar. Polarisation by operator remains a key theme for the sector, with Lidl and Aldi continuing to win market share from the big four supermarkets.

Real wages are now positive, driven by a fall in inflation, which has the potential to provide some support for the sector. However, we don’t expect this to materially alter the fortunes for the sector this year, given the number of mortgages that are due to be refinanced and the ongoing cost-of-living pressures