UK Capital Markets: UK second most invested in location
Despite moderation from a record Q1, in the face of increasing geopolitical and economic headwinds, the second quarter was the fifth highest Q2 on record.
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Q2 Investment volumes reached £15.7bn in Q2.
While there was a slowing in cross-border activity in Q2, both globally and in the UK, as investors assessed the changing global landscape, the UK remained the second most invested location after the US.
Activity levels mixed across sectors
Transaction activity was mixed across sectors. Logistics saw its second highest Q2 on record and the specialist sectors enjoyed the highest Q2 on record. However, while the office sector saw well over double the activity seen in the pandemic challenged Q2 2020, activity for Q2 2022 was the second lowest Q2 for this cycle.
Inbound activity reached £6.8bn in Q2 2022. This remains 29% above the long term Q2 average, albeit a reduction on over £9.2bn seen in Q1 this year.
What could drive commercial real estate investment for the remainder of the year?
1. Riding the uncertainty wave. Higher inflation, the global economic outlook downgraded, supply chain pressures and the conflict in Ukraine has caused a high level of global uncertainty, which the UK is not sheltered from.
When volatility and uncertainty is high, investors typically move away from riskier assets such as equities. Year to date, the FTSE 250 and US S&P 500 are down 19.55% and 13.92% respectively. Furthermore, over the last 12 months FTSE 250 total returns are down -19.49%, whereas the All UK property total return was 21.6% in the 12 months to July.
Here, investors seeking an income producing asset with strong return profiles could turn to property as a safe haven asset, in an uncertain world.
2. Property as an inflation hedge. The UK has also not been able to hide from the global issue of higher inflation. Currently, inflation has topped a 40-year high of 10.1%. The Bank of England (BoE) has revised up its inflation forecast, now projecting inflation to peak 3% higher than its previous forecast at over 13% in Q4 2022, before paring its 2.0% target in the second half of 2024.
Investors looking to circumvent these higher rates of inflation could turn to commercial real estate, with strong growth potential, particularly assets with indexation, as a means of doing so. UK All property market rents increased by 4.7% in the 12-months to July. Over this same period, UK Industrial rents grew by 12.9%.
3. Cross border investors may take advantage of weaker sterling. Economic uncertainty and market views on inflation has led to currency volatility, with sterling depreciating to $1.18. UK commercial real estate provides potentially more relative value for some overseas capital.
This is supportive of our Active Capital research, which expects the UK to remain as the second-largest global destination for capital in 2022. In particular, our forecast expects US private equity companies to be the largest deployer of capital, targeting a wide range of UK sectors.
4. Higher cost of debt. Following five successive rate rises, the Bank of England base rate is currently 1.75%. The market is expecting the interest rates to rise above 2.00% by the end of the year and as high as 3.00% by the end of 2023, although there is considerable variation in outlook by different forecasting houses.
UK SONIA interest rate five-year swaps have increased above 3% to 3.26% at the time of writing, a 100bps increase over the month. There remains a question of whether heightened cost of debt might have a (lagged) impact on yields and this may lead to increasingly polarised performance of real estate. A higher cost of debt may also encourage a rotation towards equity-backed investment.
5. Polarisation. In an uncertain and volatile outlook, the case for UK real estate remains, however, we expect increased polarisation in performance. UK commercial real estate which offers one or more of; inflation hedge properties, growth potential, diversification benefits, income and/or relative stability, is expected to see strengthened interest from investors looking to achieve these aims.
Sources; Knight Frank, Macrobond, Property Data, RCA
Read more or get in contact: Victoria Ormond, head of Capital Markets Research
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