Roundtable: The UK has a reputation to restore

This roundtable was sponsored by Cain International, Fidelity International, Greenberg Traurig, Maslow Capital and Taurus UK

The UK has endured a turbulent – at times verging on chaotic – 12 months. In 2022 alone, three different prime ministers struggled to weather crises including surging inflation and energy prices, widespread strikes by public sector workers and the collapse of market confidence triggered by former prime minister Liz Truss and former chancellor Kwasi Kwarteng’s infamous September ‘mini-budget.’

Despite the UK economy contracting 0.3 percent in Q1 of this year, the Bank of England persisted in raising interest rates to 4.5 percent. Together with continued price increases, this has created a toxic cocktail for the finances of many businesses and households.

For the managers attending PERE’s UK roundtable, the country’s recent unenviable record means that before they can engage investors in discussions around capital deployment, they must first tackle negative perceptions of UK governance and stability.

“The challenge to bringing in international institutional capital to the UK is the reputational damage that has been done,” says Kim Politzer, head of research at investment manager Fidelity International. “Before we can start talking about the market, interest rates, inflation and policy as it stands now, we have to overcome the resistance caused by Brexit, as well as the various developments that followed, culminating in the Kwarteng and Truss budget. A colleague of mine recently attended a pensions investment conference in Canada, where the UK was the butt of nearly all the macroeconomic jokes. We may think we have moved on, but it still is.”

Ellis Sher, chief executive officer at real estate debt provider Maslow Capital, says recent discussions with major investors, including several large sovereign funds, revealed that some currently have limited interest in the UK. “We have done ourselves no favors. Decision-making in this country has been chaotic and without competent leadership. That is slowly improving, but it will take time to put the Truss-Kwarteng era behind us.”

Three consecutive terms of Conservative Party rule are partly to blame, argues Daniel Harris, head of investments for Europe at London-headquartered manager Cain International. “The only ideas our current government has reliably delivered in its 13 years in power seem to have resulted in economic shock or political scandal. At the next general election, we will be choosing between that and a Labour opposition that has re-invented itself to become more middle-of-the-road and acceptable under Keir Starmer’s leadership. Within the next six months we should be able to form a view of who will win that election, or at least how tight it will be.”

“London looks attractive for green offices, and the structural shortage of housing still supports the UK living sector”

Steven Cowins
Greenberg Traurig

If the perception of political stability can be restored, the UK still possesses advantages over competing European markets as a destination for institutional capital, notes Politzer. “UK demographics are more favorable than Germany in particular, and France to a certain extent, because it doesn’t have the problem of a rapidly declining working-age population.”

She adds the UK’s younger population should give it an edge over European counterparts. “However, we mustn’t be complacent. We have a relatively flat working-age population profile, so we need to move on from the perception that when the UK recovers from the recession, growth will be 2.5-3 percent. Our natural rate of growth will be more like 1.5-2.5 percent.

“The one thing Liz Truss got sort of right was that we need a policy to support economic growth. Until we have some compelling solutions to the challenges that are causing the economy to stagnate, we will still struggle to say with confidence that the UK will be a great place to invest.”

Lack of action

The fallout from the Truss interlude, combined with the unfavorable economic climate, has suppressed transaction activity in the UK real estate market. CBRE research shows £10.3 billion-worth ($12.8 billion; €11.7 billion) of assets changed hands in Q4 2022, followed by £8.1 billion in Q1 2023, a sharp decline compared with the totals recorded for the same periods a year earlier, which were £23.7 billion and £21.6 billion, respectively.

Steven Cowins, a partner at law firm Greenberg Traurig, has seen the evidence in his own practice: “Normally we are half-and-half between M&A and transactions, and capital-raising and JVs. At the moment more than 90 percent of instructions are capital-raising and JVs. Since October the normal flow of deals has not been there. The market is fragile, and prices have moved out on a number of transactions. For what deals there are, we have been trying to create structures to bridge the gap between buyer and seller price expectations.”

“We are beginning to see core and core-plus buyers returning to the market”

Daniel Harris
Cain International

“We lost a number of transactions on the back of the toxic combination of interest rates and inflation,” adds Sher. “That made it unworkable for many equity players to invest with confidence. They just said, ‘No, we’re going to shelve it, cancel the option, or go back to planning.’ Ultimately, deal viability comes down to whether equity earns a sufficient risk-adjusted return, and recent events have increased risks without offering higher returns.”

The lack of activity has made price discovery challenging, says Nick Jacobs, managing director at investor-developer Taurus UK. “You can’t pick one deal and say that is good evidence for where the market is. The lack of homogeneity deal-by-deal is making it very difficult to put pricing in place. Even if you can pinpoint a value, too often you are in a position where the vendor will not sell at that price.”

Declining activity has been compounded by the shrinkage of the investable real estate universe, says Harris. “Logistics and the living sectors have continued to show transactions, although they have slowed down dramatically. Meanwhile, offices and retail, which used to make up 70 percent of the market, are not there on the same scale anymore because their uses are evolving, so it is difficult to predict where their values will go in three to five years.”

Brown-to-green offices

The post-pandemic transformation of the office sector is the subject of lively debate at the roundtable. Two of the managers present, Fidelity International and Taurus, are pursuing ‘brown to green’ office strategies. This involves repositioning existing office buildings that struggle to attract tenants by updating them to meet modern occupational needs and improving their energy efficiency.

It is clear which assets will succeed, argues Jacobs: those that offer the right green credentials, internal layout and high-quality experience to attract hybrid workers into the office. “Occupiers love places that are really engaging for the staff and say the right thing about the company. Very few people are creating those correctly and there will be a shortage of them. On the other side of the equation, there will be many buildings that are not fit for purpose, and require a lot of capital expenditure to make them so, including some that do not have the embedded value to make that spending viable.

“We are focused on acquiring buildings where the rents and capital values are high enough to pay for the spending, and you find many of those in London.”

Cowins says his team is supporting several managers to set up office repositioning strategies, but notes that price expectations are a stumbling block to execution. “There’s clearly a gap in the market for that approach. But is it possible yet? I am hearing from clients that by the time they account for all the capex costs, the bid-ask spread between what buyers can pay and the price that sellers expect is still too wide in many cases.”

“The lack of homogeneity deal-by-deal is making it very difficult to put pricing in place”

Nick Jacobs
Taurus UK

The type of building that will attract occupiers is easy to identify, but what the level of demand for those buildings will be is less clear, argues Politzer. “We need to see a lot more evidence on how companies make hybrid working work before we have a full understanding of what the demand will be, and the price they will be willing to pay. There is clearly a shortage of modern space now, so it will trade well in the near term, but beyond five years out it is less certain, and because many investors hold assets for 10 years or more, we have to start thinking about these things now.”

The overall size of the office market may shrink, adds Harris, limiting options for deployment. “For a best-in-class office in a good location in a CBD with all the ESG requirements, you will get great rents. But as soon as you slightly move out of that area, then it becomes very tricky to pick demand. A prime building in the West End will be a fantastic investment. But that is not a sector.”

Regional revival

Office, principally in London, has historically been the dominant segment of the UK property market, but the flipside of the sector’s fall from grace has been to open the eyes of investors to opportunities offered by other asset types located outside of the capital, observes Harris. “Everyone is buying life sciences, logistics, student housing, build-to-rent residential, and they are much more regional. We are looking at creating a big student platform and none of our assets are in London. Our logistics platform is 30 percent in London, 70 percent in the regions.”

“The challenge to bringing in international institutional capital to the UK is the reputational damage that has been done”

Kim Politzer
Fidelity International

As a lender to developers in the living sector, Maslow’s Sher is well placed to identify trends in the residential market. “Student accommodation and BTR housing have been among the bright spots for investment activity during a difficult time. People are increasingly comfortable paying rent for amenity-rich accommodation instead of buying a home. Manchester, Leeds and Birmingham have very interesting demographics and high retention of university graduates. We didn’t intend to invest as much as we did in Manchester, but sponsors kept approaching us with compelling propositions for both build-to-rent and build-to-sell schemes in the city.”

Rented residential is the first sector to see a return of core buyers to the UK market, notes Harris. “In the last six to nine months most buyers have been value-add or opportunistic funds, often heavily debt-laden, acquiring at distressed pricing. But the majority of UK investment capital is lower-cost core capital and that has been out of the market, which typically happens when you have a seismic event like we have had in the last few months.

“Now, we are beginning to see core and core-plus buyers returning to the market to buy income-producing assets. And that will start to provide some clarity around where pricing is, establishing a basis on which we can move forward and the market can come back to life.”

“People are increasingly comfortable paying rent for amenity-rich accommodation instead of buying a home”

Ellis Sher
Maslow Capital

When it does, the UK is comparatively well placed to take advantage, says Cowins. “All of the same macro issues are being discussed around the world. But if you were to ask me where I would choose to invest in some of those themes, London looks attractive for green offices, the structural shortage of housing still supports the UK living sector and pricing for logistics has moved out so quickly in the past six months that the adjustment is probably much more complete here than in many other countries.”

The UK has a potentially winning pitch to sell to investors, suggests Politzer, if they can be encouraged to look beyond the negative sentiment generated by recent political events. “Given how fast the market has moved and how much repricing we have seen, even on a core strategy, you are probably going to get a 10 percent return. Higher yields mean the UK market will be more dynamic than the rest of Europe, where a core return will be more like 7-8 percent post-adjustment.

“You will be compensated for the currency risk and the more isolated position of the UK. But we’ve got to be able to get in the room to tell people that story about the UK market, and that is the challenge.”

UK deals of the year

Activity has been thin of late, but three participants identify standout recent transactions that illustrate key themes

1 Sovereign fund China Investment Corporation sells Winchester House in the City of London to Malaysia’s Gamuda and UK investment manager Castleforge Partners for £247 million ($307 million; €282 million). Sitting tenant Deutsche Bank plans to vacate the building next year.

Kim Politzer: “It is a marker of how the wave of Chinese investment that we saw in 2012-15 is coming out of the market, and the Southeast Asian money that is replacing it. Their plans are enormously ambitious: they want to increase the floorspace from 320,000 to 500,000 square feet by the end of 2027. The development will be BREEAM outstanding, so it is also part of the ESG story. It requires a lot of capital, but in theory there should be big returns to take out of it, if they can make it work and deliver on time.”

2 Private equity firm Aermont Capital raises £2.9 billion of new equity and creates a new company to own and expand Pinewood Studios near London.

Steven Cowins: “They spun it out of an existing fund, following a trend we are seeing for managers and investors to roll over assets into longer-term structures. Film production obviously isn’t the deepest market, but it is an industry in which the UK still excels, so it is a great niche to be invested in.”

3 Legal & General commits to Leeds city center’s largest build-to-rent funding deal to date, providing £140 million for developer Glenbrook’s 500-unit Whitehall Riverside scheme.

Nick Jacobs: “Build-to-rent will be a very important sector for the UK, as the pressure to provide housing grows and the historic culture of home ownership gives way to a greater willingness to rent. It is also an indication that big investors who have been sitting on the sidelines for six months are coming back in. There is an enormous weight of money that wants to be in that market, which can’t access finished product.”

No backsliding on green commitments

While some US and Asian markets have seen ESG deprioritized amid difficult market conditions, social and environmental goals are firmly embedded in UK investing practices, say participants

Daniel Harris: “10 years ago investors were happy to have LEED- or BREEAM-certified buildings as long as it didn’t cost too much. Every building in Europe either has or needs to meet those standards because that is where the market is.”

Nick Jacobs: “It is no longer about ticking a box. It is fundamental to value. Funds will have to put it in the ESG statement in their annual accounts every year. The UK has some really strong legislation setting out the energy performance standards that will be required in future to be able to lease a building or occupy it.”

Ellis Sher: “Big pension funds and other large institutional investors are finding it challenging to source eligible ESG investments on the kind of scale they require. Investment managers have to invest heavily in ESG-compliant strategies to get a seat at the table.”

Steven Cowins: “There is a lot of new ESG legislation to navigate, starting with the EU Sustainable Finance Disclosure Regulation, and with the EU taxonomy, which will establish a list of environmentally sustainable economic activities, hot on its heels. That could eventually lead to the levying of capital charges, according to how compliant underlying assets are, not just for real estate, but for every asset class.”

Kim Politzer: “Global corporations have sustainability at the heart and soul of what they’re doing, and having a framework for sustainable investing should draw capital to Europe. It is vital that when the UK finishes its own sustainable investment legislation, it is well aligned with the European framework, or improves on it, and doesn’t water it down.”

Meet the roundtable

Steven Cowins
Partner, Greenberg Traurig

Cowins is global co-chair of the real estate funds practice at Greenberg Traurig, one of the world’s top 50 law firms by revenue, employing more than 2,650 attorneys worldwide. His practice focuses on private equity real estate matters, advising clients in establishing funds and joint ventures and real estate M&A.

Daniel Harris
Head of investments, Europe, Cain International

Harris joined Cain International in 2017 and leads its investment origination and execution activities across the UK and continental Europe. The privately owned firm also operates in the US, investing in real estate debt and equity, as well as experiential businesses, mainly in gateway cities.

Ellis Sher
Co-founder and chief executive officer, Maslow Capital

Sher co-founded Maslow Capital, focused on providing development loans in the UK living market, in 2009. His team oversees a £1.5 billion book of £10 million-£300 million loans. In December 2021, Arrow Global acquired a significant minority stake in the firm to expand its European direct lending footprint.

Kim Politzer
Head of research, European real estate, Fidelity International

Politzer, who has more than 30 years’ experience in real estate research, joined Fidelity International in 2018. The business manages over €2 billion of European real estate assets, including €525 million in its UK fund, and it is currently acquiring UK office property for a brown-to-green strategy.

Nick Jacobs
Managing director, Taurus UK, Taurus Investment Holdings

Taurus re-entered the UK market in August 2022, recruiting Jacobs to lead its London-based team. Since then, it has acquired around £450 million of UK assets, principally for brown-to-green office and build-to-rent strategies. The multinational investor-developer manages around $5 billion of assets in total.