Amid the pain and confusion of a global pricing reset, there has been much talk of a historic buying opportunity for property investors. After an extended drought in transaction activity, recent signs suggest momentum for increased dealflow is beginning to build. A number of large deals has closed this year to date – and many are in one particular market.
On the whole, property values in the UK have fallen harder than any other global market, expedited by the economic repercussions of Brexit, the ‘mini-budget’ announced in the short premiership of Liz Truss and the political instability that followed her resignation. According to a report from asset manager Schroders in March, values have fallen approximately 21 percent below their peak in June 2022.
“We think the UK will offer interesting opportunities before other markets,” says Cristiano Stampa, head of investments for Europe at Atlanta-based manager Invesco Real Estate, which is targeting debt and equity investments in the country. He adds that earlier interest rate movements and Bank of England support are helping rebalance market conditions.
Dan Valenzano, managing director of pan-European transactions at Germany-headquartered manager Patrizia, agrees: “The repricing of assets and portfolios has happened most transparently in the UK. And we believe that’s going to be pretty encouraging to the recovery in deal volumes.”
Pricing still a problem
While market participants tell PERE they are seeing more opportunities, there are factors tempering a bona fide recovery. Despite the shocks to the lending environment in recent weeks, access to financing is not even highest on the list.
“We think the UK will offer interesting opportunities before other markets”
Invesco Real Estate
“There is obviously still a pricing gap,” says Stampa. “This is more of a problem than the pricing itself: if people are not forced to, why should they sell now? This is the common thinking at the moment.”
Keith Breslauer, managing director of London-headquartered Patron Capital, says the gap between buyers and sellers’ expectations is narrowing a little, but agrees that seller reticence is still the primary barrier to getting deals over the line: “It’s not the financing at this point, or even the tenant demand, or the available equity. It’s simply, ‘will the sellers sell it at the adjusted prices?’ If I visualized a pie chart, I would say activity is probably at 20 to 25 percent of its potential.”
Among the large and high-profile deals announced in the UK so far this year was the take-private of Industrials REIT by Blackstone, agreed in April. The deal values the REIT at more than £500 million ($618 million; €516 million), representing a premium to market capitalization of more than 40 percent.
“That Blackstone deal has scared everyone, because all of us were looking at metrics that were much cheaper,” says Breslauer.
Valenzano, however, argues that deals from big US private firms such as Blackstone are “encouraging” and help to clarify a difficult valuation picture. “It provides the market with a very tangible litmus test of where a large global investor sees fair value,” he says. “The US private equity funds will lead a lot of those larger deal situations, but it’s the European private equity community that I’m watching in particular to see where the asset- and portfolio-level interest lands, and where the private real estate deals will be struck.”
With pricing still a problem, this is reintroducing an element of competition into the mix – which is taking some managers by surprise.
Valenzano says competition is heating up for multi-let industrial assets with tangible tenant demand. “I think there’s still a demonstrable discount to, say, Q1 2022 valuations, but nothing seems airtight at the moment. It doesn’t feel like bargain pricing, and we’re having to compete against some of our peers and get somewhat aggressive to win these processes.”
According to Breslauer, a similar dynamic is emerging in office, but for a different quality of product. “There’s competition in weird places,” he says. “You try to buy a low-quality office building in a secondary city, and all of a sudden there’s seven bidders. But, on the other hand, you try to buy a relatively nice asset that’s 20 percent vacant and needs very minor work to it, and there might be two bidders.”
Indeed, secondary office is proving a battleground for investors trying to trade. Julian Sandbach, head of Central London office markets at broker JLL, says most of this competition is simmering under the surface, however.
“Generally, it’s a market environment where you don’t call for bids unless you are really, really certain of your outcome, as you have to work with potential buyers,” he says. “You generally try and negotiate an outcome whereby parties can agree on a one-on-one basis, rather than through a formal process of bidding.”
JLL expects investment volumes in London office to reach £2.1 billion for Q1 2023, down 63 percent year-on-year, but up from £1.9 billion in Q4 2022. Sandbach says it is not surprising London offices are attracting significant interest, as yields have moved out around 100 to 125 basis points across the City and the West End. The question is whether they will move further, but interest rates are likely to have peaked, he says.
He notes that while plenty of sellers are still overly optimistic about what their assets are worth, investors that are selling are mainly institutional in nature, seeking to rebalance portfolios, boost liquidity in funds, or plug a gap between equity and debt positions. Blackstone’s sale of mixed office and residential asset St Katharine Docks to Singapore’s CDL for £395 million is an example, says Sandbach: “Blackstone had refinanced over the years and likely taken equity out of the deal. They have completed the business plan, so they were happy to sell at market levels.”
Onwards and upwards?
As to whether the heating up of the UK deal market signals the start of an upward trajectory, consensus was it was too soon to tell. “We need to be patient as there is not going to be a wall of distressed assets attracting capital to invest,” says Stampa. “This will be the same through 2023 – I don’t see signs of acceleration in that space so we have to be patient.”
Sandbach also points out that a lot of Q1 2023 closings were hangovers from Q4 2022, as deals are generally taking longer to work through the system. “I think it’s too early to say that it’s going to be a proper upward volume curve as yet,” he says.
For investors worried about catching a falling knife, however, data from MSCI suggests UK prices could be bottoming out in some sectors. The research firm’s UK Monthly Property Index generated a month-on-month total return of 0.67 percent in March, its first positive return since June last year. The capital return component was 0.21 percent. According to an MSCI blog, residential, industrial and retail sectors led the increase, while office values continued to decline.
“As a general term, the buying window is starting now,” adds Breslauer. “It will accelerate into the fourth quarter. It will last 12 to 18 months, and then it’s over. It’s all about interest rate volatility and the lack of stability with the Bank of England and the ECB. Once that gets cleared up, people will price adjust, and that’s it.”
Germany was touted as the next market to open up, followed by Spain. Savills expects activity to recover slowly, however: the broker forecasts around €36 billion in European investment volume for Q1 2023 based on preliminary figures, down 59 percent year-on-year.
European markets are repricing faster than the US, as evidenced by Green Street’s Commercial Property Price Indices, which show US values have declined 15.2 percent in the past 12 months versus 20.6 percent for pan-European values. A global recovery in transaction activity could therefore be some time yet.
“We’re still spending a lot of time in Germany, in Spain, in Italy, across the Nordic region, monitoring interesting deal situations, but at the moment they just feel less actionable than what’s happening in the UK,” says Valenzano.