Outlook for UK REITs sector positive after a hectic first quarter

After a hectic first quarter, we believe the UK REITs sector looks attractively positioned for the year ahead – albeit the past week or so has provided some timely reminders of the unpredictability of geopolitical and economic factors with the potential to disrupt markets and the anticipated path for the normalisation of interest rates. That said, REITs are increasingly becoming less binary plays on the interest rate cycle and the sector remains highly investable and capable of generating attractive returns through alpha-led strategies.

Geopolitical & inflation worries resurface

The threat of escalating conflict in the Middle East and UK inflation proving stickier than expected, serve as timely reminders of big picture uncertainties that continue to prevail over capital markets. We live in increasingly more uncertain times with so-called, once-in-a-generation ‘black swan’ events now becoming increasingly commonplace. The added uncertainty this brings to the global economy, supply chains and pricing of commodities, goods and services presents risks of new inflationary shocks in the system with the potential to further derail the possibilities of interest rate cuts. It’s not that long ago that UK bond markets were pricing in three rate cuts during 2024 compared to some current expectations of just one, coming as late even as November/December.

Real estate alpha – more than just a binary interest rate play

Clearly the prospect of interest rate cuts looking less imminent is not ideal news for real estate… but at the same time it is not a disaster either. The best businesses have evolved to become far more than just binary plays on interest rates and leverage, developing genuine value-added strategies to drive continued growth through the property cycle. These include timing capital recycling & development, asset diversification and M&A. SEGRO has been actively recycling capital taking advantage of attractive land costs to future-proof its landbank while simultaneously raising new equity capital to accelerate development and acquisitions. LondonMetric and Tritax Big Box have been active with M&A while London office specialists, Derwent London and GPE, along with British Land and Landsec have been accelerating new development starts in response to improving occupier dynamics and stabilising valuations in central London offices. While the eventual normalisation of interest rates will undoubtedly provide a welcome tailwind for the sector, the sector remains highly investable without it and capable of generating attractive returns through alpha-led strategies.

More M&A to come

M&A has dominated the sector from the get-go in 2024, with deal veteran, LondonMetric, successfully acquiring LXi REIT in an all-share transaction after declaring its hand in early January. This was closely followed by Tritax Big Box REIT’s recommended all-share offer for UKCM. We are supportive of this deal, which should it be approved by shareholders, could be further boosted by the additional recycling of capital from disposals into BBOX’s existing development over the next two years. Lok n’ Store has recently agreed to an all-cash takeover from Belgian REIT Shurguard, while Abrdn Property Income (API) has been subject to competing takeover proposals, albeit both unsuccessful, from Custodian (CREI) and Urban Logistics. While its shareholders rejected both proposals believing the significant disposals involved would be value-eroding, we continue to believe M&A will remain a prominent component of activity within the listed REITs sector in 2024, with increasingly frustrated shareholders now looking for alternative ways to drive value.

London offices and sci-tech

The first quarter of the year saw a perceptible shift in investor sentiment toward London offices, particularly in the West End. This is largely a feature of stabilised yields and improving dynamics between occupier demand and the supply of quality new space. British Land’s recent signing of a hugely significant pre-let at its 2 Finsbury Avenue scheme (pictured) as part of the Broadgate campus in the City (held in a JV with GIC) is a strong vote of occupier confidence in the scheme and highly supportive of improving wider occupier dynamics in the City. There is also a growing prominence of life sciences and technology (sci-tech) companies clustering around King’s Cross/St Pancras and University College London on Euston Rd (aka ‘The Knowledge Quarter’). The reimagining of existing office space here into lab and tech-enabled space is helping to attract sci-tech tenants and has become a key focus for real estate companies targeting this sector. Furthermore, the upside for rental levels over existing London office space is compelling, with British Land’s Regent’s Place campus in the Knowledge Quarter targeting up to 40% uplifts in net rents for new fully-fitted lab space.