​Members of the Bank of England’s Monetary Policy Committee were adamant that the underlying sources of inflation must be under control before rates can be cut. Thursday’s decision to cut rates sent a clear message. But how much will it matter to commercial real estate investors?

In isolation, not a lot. This cut was already “baked in” to swap rates, whether it happened this month or next. Plus, it’s going to take more than 25 basis points to get some corners of the UK commercial property market moving. However, the broader context makes this cut very important indeed. Week by week, the list of reasons to hesitate before investing in commercial real estate is dwindling. The 4 July general election provided the political certainty that many investors had craved, and the UK now looks benign relative to some of the world’s largest real estate markets.A base rate cut was a vital piece of the economic puzzle: members of the Bank of England (Boe) Monetary Policy Committee have been adamant that the underlying sources of inflation must be under control before rates can be cut. Thursday’s decision sent a clear message.

A brightening outlook

A raft of forward indicators are moving in the right direction. The BoE’s updated forecasts suggest the economy will expand 1.5% during the year through Q3 – a marked upgrade on the 0.5% in its May outlook. Growth will ease back to 0.8% next year before picking up to 1.4% and 1.7% in 2026 and 2027 respectively, the forecasts show.
Business sentiment has picked up for several months. The FTSE 350 has outperformed other major indices since the election. Optimism among UK companies surged to its highest level in more than seven years in July, according to a survey by Lloyds Bank. We can expect another dose of optimism when the Federal Reserve begins its cutting cycle, likely next month.

“Anecdotally, we hear that lenders are even tightening margins in an attempt to gain market share”

All of this is coinciding with a brightening outlook for commercial real estate. Investment activity has clearly troughed. Transaction volumes hit £42bn in the year through Q2 2024, down only 5% compared with the same period a year ago. That has narrowed from a 52% annual drop during the year through Q3 2023.
Crucially, financial conditions are improving. The five-year swap rate has fallen more than 120 basis points since the middle of 2023. Lenders responding to the BoE’s Credit Conditions Survey have now reported two consecutive quarters of improving credit availability.Historically, this trend has been a reliable leading indicator for improving transactional activity, excluding during the height of the Covid-19 pandemic. Anecdotally, we hear that lenders are even tightening margins in an attempt to gain market share in popular sectors like residential and logistics.

Combine that with the $2.59tn of “dry powder” sitting in the world’s private equity firms, and we could see a very busy final few months of 2024.

This time it’s different

The recovery will look different to those we’ve seen in the past. Long term, potentially structurally higher levels of inflation will continue to drive capital into inflation hedging assets, resulting in a faster recovery in sectors like residential over cyclical sectors like offices.
However, the outlook is brightening for offices, too. There remains a gap between the values that sellers would like to be paid and the values that buyers are willing to pay, but it’s closing. Prime yields have been stable for six months. The FTSE NAREIT UK Index has returned 12.5% during the past 12 months, which has historically signalled arise in asset values.

“In London’s West End, we expect rents to climb by more than 30%”

Prime rents are rising at a clip, and we expect continued cumulative growth over the next five years. In London’s West End for example, we expect rents to climb by more than 30%. That’s offsetting the remaining relatively small declines in values that we’ve seen in recent quarters.
The BoE is embarking on what is likely to be a slow and steady cutting cycle, and it’s unclear where the base rate will settle. In his press conference following the decision, governor Andrew Bailey stressed that it’s “unlikely that we are going back to the world we were in between 2009, post-financial crisis, and the point at which we started raising rates”.
Still, the BoE will execute another 25 basis points cut before the year is out, before bringing the rate down another 100 basis points through 2025, according to colleagues at BNP Paribas.

That will be enough for investors that have spent nearly half a decade starved of stability: our forecasts suggest that commercial real estate investment volumes will climb to £48bn this year, before rising steadily to £55bn in 2025 as the effects of this era’s great inflation unwind.

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Source: Green Street News