It’s been a year of mixed fortunes, but we can look ahead with optimism

This year has been somewhat mixed for real estate, but it draws to a close in better shape than it began – and with a sense of optimism that further progress can be made in 2025.

The year was ushered in on a wave of M&A, with major deals including LondonMetric’s takeover of LXi and Tritax Big Box’s acquisition of UK Commercial Property REIT. The trend was to continue throughout the year, with SEGRO narrowly losing out to Brookfield in its recent attempt to acquire Tritax Eurobox.

The driving forces behind the consolidation among listed REITs remain depressed valuations and lack of scale. Half the market value of the current 44 listed REITs is accounted for by just six companies – SEGRO, Landsec, Unite, LondonMetric, British Land and Tritax Big Box – with the implication that there remains a long tail of sub-scale businesses on the London Stock Exchange. This is not helpful, particularly if institutional capital wants to get a meaningful and liquid foothold in UK real estate via listed equities. We therefore see it is inevitable that there will be further consolidation in 2025.

While share prices have broadly stabilised during 2024, tracking a similar performance with property yields, the movement has been erratic. Growing optimism for the sector earlier in the year, which was buoyed by hopes of interest rate cuts, fuelled a rally in equities, only to be unwound by the recent Budget and Trump victory in the US.

As 2024 began, it seemed that inflation was finally under control and heading back towards the 2% Bank of England target, while the growing likelihood a Labour victory in the General Election also promised a new political stability, reinforcing market confidence in interest rate cuts. These beliefs, however, have subsequently not played out as expected. Increased levels of government borrowing, higher wages and NI for businesses and expected output price rises are sure to lead to inflation rising again in 2025.

This change in outlook has already been well priced in by the money markets with 10-year yields and five-year swap rates rising by almost 50bps from their lows in September and a shallower downward trajectory in rates over a long period now looks somewhat inevitable.

From a real estate perspective, we can draw several positive conclusions about the state of the sector. Property yields in the majority of sectors have stabilised, influenced by the recent downward trajectory in interest rates and improving sentiment among investors. Rents are also generally looking more perky, particularly those on open market reviews in the industrial and logistics sector and retail. Collectively, these have combined in many cases to drive welcome improvements in NTA.

Balance sheets are also looking stronger (Regional REIT and Urban Logistics REIT in particular), with some REITs raising equity capital and/or refinancing debt on the lower swap rates available until recently. This has helped fuel higher levels of deal activity over recent months with British Land (£711m of retail parks) and Assura (£500m of private hospitals) securing some particularly notable acquisitions.

In our minds, the retail sector has been the real star of this results season as both retail parks and shopping centres benefited from yield compression. While both sectors have seen a significant rebasing of values over the past 15 years, the latest upward moves in valuations are well deserved. This reflects low vacancy, growing occupier demand for retail space in good locations and an improving outlook for ERVs, along with greater investor demand for quality retail assets that are no longer being built and therefore are of limited supply.

British Land and Landsec have targeted further expansion where they enjoy strong market positions (British Land in retail parks and Landsec in shopping centres) and we expect to see further progress here with more acquisitions in H2.

Offices also present good opportunities in our view, albeit over a longer time frame and limited to the best, most sustainable assets. While yields have marginally edged further outwards in Central London, an imbalance of demand over supply for prime assets and growing ERVs have stabilised valuations, helping improve transaction activity and offering attractive opportunities for below-replacement cost acquisitions with which to fill the growth hopper ahead of the upcycle (something GPE has been recently taking advantage of).

Taking all of the above into consideration, we expect the combination of improving rents, stabilised yields and moderating interest costs to provide some welcome tail winds for listed REITs 2025 – and also some reminders of real estate’s attractions. With the added impetus of likely further M&A activity and equity valuations remaining subdued, there is reason for investors to look at the sector with optimism in 2025.