- Warehouse values rising; office value slumping
- 'Affordable housing' boom likely to continue
The past 12 months for the real estate market have been defined almost entirely by interest rates. As rates climbed throughout the year to levels not seen for 15 years, asset values continued to slump. But now those rises are seemingly at an end, investors will inevitably be asking whether 2024 will mark a fully fledged recovery for the sector.
As is always the case for market movements, it is impossible to say for sure. What is likely is that many things other than interest rates are likely to shape the market in 2024. Here are five trends shareholders in real estate investment trusts (Reits) and housebuilders should keep an eye on.
1. Some, but not all, valuations will bottom
When the ‘mini’ Budget caused market interest rates to spike last year, the effect on the property market was universal, even if it merely accelerated changes that were already in train. Both housing and commercial real estate share prices slumped, as did, ultimately, most asset values. Buyers' budgets became more constrained and rising discount rates took their toll, too.
The recovery has not been universal, and we expect this divergence to accelerate. On the positive side, warehouse values as though like they have already bottomed. In fact, according to CBRE data, valuations have been on the rise every month since March this year. Yet most warehouse Reits' results this year have not reflected this. That is not just because reported numbers are backwards-looking; it has also been due to tough comparatives, given the investor excitement caused by warehouses’ foundational role in the online shopping boom. That had pumped up values to what turned out to be unsustainable levels. The deflation of this enthusiasm may explain why many are still trading at a discount to their net asset value (NAV), but we believe this represents an investment opportunity, particularly for high-quality warehouse Reits such as Segro (SGRO).
Warehouse values are rising now in part because tenant demand remains strong. The same cannot be said for office assets, whose valuations are still slumping because it has become clear that the post-Covid working world means a lower overall demand for office space. We are particularly bearish on Great Portland Estates (GPE) and Helical (HLCL), which we believe will continue to post valuation declines and stagnating rental income in 2024.
2. Reit pain will cause pivots
The contrasting fortunes of industrial and office assets hint at another trend likely to speed up next year: Reits pivoting their portfolios. As the UK’s two largest Reits that focus on a mix of assets rather than one specialism, Landsec (LAND) and British Land (BLND) showcase this best. Worried about measly returns, both have been ‘recycling capital’, selling buildings they don’t want to buy ones they do.
For example, Landsec is offloading City office buildings and investing in high-spec offices in the West End, a region of London where office vacancy is lower because of a supply shortage and the general buzz of Theatreland and Soho post-pandemic. Meanwhile, British Land is bullish on London warehouses and retail parks because it believes both will have a big role to play as online shopping and discount shopping increase in popularity.
British Land is also long rental housing, with its 53-acre Canada Water redevelopment slated to deliver 3,000 homes for rent and sale. It might turn out to be a wise move. The Reits that own rental housing – whether for students or the general market – outperformed in 2023, and the market has priced them accordingly. Grainger (GRI) and Unite (UTG) are trading at or around net asset value (NAV). While we believe this is justified, the rental boom cannot last forever.
3. Residential rental growth will ease
Rents have been rising at a landmark rate for most of 2023, with each passing month breaking the record set four weeks earlier. A lack of stock, landlords passing on the costs of higher interest rates and record immigration are driving this. As Savills has forecast, this growth will ease off in most parts of the country next year, with affordability issues and slightly more attractive mortgage rates playing a part.
Residential Reits, such as Grainger, are fully prepared for this. Chief executive Helen Gordon told Investors’ Chronicle in November that, despite posting rental increases of 10 per cent for the year to 30 September, the company still develops assets assuming rental growth of just 3.5 per cent a year. A return to this level of growth might make some investors less excited about the company, but we believe the long-term demand for rental housing will remain. As it happens, it may be the commercial real estate sector where investors pay more attention to rental growth next year: if values continue to stabilise, the focus may well turn to how well commercial property owners of all kinds are sweating their assets.
4. ‘Affordable housing’ development will boom
The long-term demand for rental housing has driven the major housebuilders towards bulk-selling homes for rent. They describe this as building for “affordable housing”, which is a fair description for some of the deals but not all. The model sees housebuilders construct homes not for individual private sellers but for institutions who buy or pre-order the properties for their rental portfolio. Some buyers are social housing providers and local authorities, who will rent the homes at a discount. Others are private institutions such as PRS Reit (PRSR), pension funds, local authorities and private equity firms, who are more likely to rent them at a market rate.
Vistry's (VTY) share price jumped after it announced it intended to shift its entire business towards this model. So did that of Scottish housebuilder Springfield Properties (SPR) after it revealed a deal it had signed with a local authority to build council housing in this way. Bellway (BWY) and Crest Nicholson (CRST) have also said they are also moving towards this activity because of a slump in private house buying.
However, there is a distinction between housebuilders, such as Vistry, who have announced a clear strategy, and others running headlong towards selling in bulk. One housebuilder executive suggested to the IC that while those selling for rent according to pre-orders have planned out their returns in advance, those who are bulk-selling pre-built housing are simply shifting at a discount what the private market will not buy.
5. Housebuilders will fight to ‘survive until 2025’
Whatever strategy they choose to employ, 2024 will be challenging for housebuilders. The end of rate rises might have made buyers of commercial property bullish, but few predict as much confidence from house buyers. Online property portal Rightmove (RMV) anticipates house prices will fall 1 per cent next year, believing that the sluggishness from high interest rates is still feeding its way through to the market.
Housebuilders are ready for this, and smaller ones have even adopted the unofficial slogan ‘survive until 2025’ as a reflection of their belief that it is then when the market will boom back to life. For most listed players, survival should not be a problem as they have enough net cash and land holdings to keep going in a prolonged period of weak earnings. Still, investors should not expect dividend growth to return until 2025.
The real question is whether now is the time to buy. More pain for housebuilders in 2024 seems as likely as a recovery in 2025, so investors should wait until the performance slumps to its lowest ebb, likely next summer, before taking advantage. Housebuilders' valuation metrics have been indicating that much of the bad news has already been priced in, but the rally of recent weeks may indicate overoptimism about the speed of the recovery, and its scope. Nevertheless, 2024 should bring more opportunity for housebuilders and Reits than 2023 has.
