Key Highlights
- Real estate valuations have stabilised with the exception of secondary offices.
- With interest rate cuts expected as early as August, the outlook for real estate capital values is increasingly positive.
- In the first half of 2024, deal flow improved significantly and we are now close to longer term trend levels. We’ve had a high volume of requests for acquisition financing and refinancing from our extensive network.
- Banks are more active in certain asset classes. The result is some inward pressure on spreads for the first time in nearly two years. That said, spreads remain attractive in a long-term context.
- Corporate bond spreads continue to tighten. According to the BofA 3-5 year sterling single A corporate index, the spread over gilts is currently 89 bps, compared with 239 bps in October 2022 and over 40 bps tighter than at the start of 2024.
- As a result, illiquidity pickups of 125-200 bps remain achievable. We have secured a number of transactions in H1 at the upper end of this range.
- We remain very positive on the outlook for investment grade real estate debt, which has the potential to offer total returns of 6-8%.
Out of the doldrums
The recently released Bayes Business School Commercial Real Estate Lending Report for year-end 2023 (1) for the UK lending market reports a 33% reduction in origination volumes, increase in defaults across loan books and record low loan-to-value (LTV) levels.
Closer to normal levels of market activity
However, the first half of the current year has seen a sea change in the lending environment and a move much closer to normal levels of market activity.
UK banks are venturing back
Clearing banks, in particular, have returned to the market. As a result of increased competition and lower interest rates, leverage has ticked up a little from 50% to 55%.
Spreads have tightened by around 15-25 bps in certain real estate asset classes - including ‘best in class’.
This has been more than offset by tightening corporate bond spreads (tighter by about 40 bps) in the quarter, meaning that the illiquidity pickup achievable remains attractive and above long-term averages.
Recovery in sight
In terms of real estate equity markets, the valuation cycle continued to evolve. We’re seeing increasing investor confidence that, for all sectors bar some office and weaker (stranded) secondary assets, we’ve reached the bottom of the current valuation cycle.
According to the Deputy Governor of the Bank of England, interest rate cuts are now possible ‘over the summer.’ Consequently, we believe the start of the recovery cycle for real estate equity valuations is in sight.
What’s on the horizon?
Given that our deal flow continues to increase and our pipeline is back to normal market levels, we’re positive on the outlook for real estate debt.
Despite an uptick in leverage and slightly tighter market pricing, we continue to secure attractively priced deals. In the first half of 2024 we secured several new transactions with a weighted average LTV below 49%, average rating of A-, average spread of 307 bps and an average illiquidity pickup of 190 bps.
Increasing levels of deal flow
In terms of the second half of the year, we’re confident we will continue to see increasing levels of deal flow. We expect spreads to widen once lenders have deployed sufficient capital to meet initial targets. Therefore if, as expected, corporate bond spreads continue to move inwards, the illiquidity pickup achievable could push beyond 200 bps for investment-grade debt.
We remain cautious, and continue to avoid sectors with downside risk, such as secondary assets and those with poor sustainability credentials.
For our sector views, see the table below.
| Sector | Outlook | Our view |
| Prime Office | Unsupportive | Negative outlook, will only consider best-in-class offices or those with clear transition plan to best-in-class. |
| Regional Office | Unsupportive | Negative outlook, will only consider best-in-class offices in big 6 cities or offices in these locations with a clear transition plan to best-in-class. |
| Industrial and Logistics | Supportive | Price correction has brought pricing closer to long-term historic trends and outlook remains positive. |
| Residential | Supportive/Neutral | Positive outlook for well-located assets in key cities due to supply/demand fundamentals albeit ongoing risk to downside in terms of valuation. |
| Hotels | Neutral | Cautious outlook for the hotel market, however, will continue to selectively consider highest quality assets with strong sponsors and income protection at lower leverage points. |
| Retail | Neutral/Unsupportive | Polarised approach with supermarkets and well-let retail parks performing well. Secondary shopping centres and high street retail in particular expected to continue to struggle. |
| Student Accommodation | Supportive | Selective approach favouring high quality assets in strong university towns and cities with undersupply. Preference for secured income from strong covenants. |
Source: abrdn June 2024
About our insurance expertise
Given our heritage, we have a deep understanding of the needs of insurance investors.
Our commercial real estate lending team has long experience of working with insurance clients across general insurance and Matching Adjustment portfolios.
Since inception, insurance clients have been the bedrock of the team. To ensure we are able to support our insurance investors we have developed what we believe is a best-in-class rating methodology. This has been externally validated by PwC, and a number of ratings have also been subject to independent assessment by Fitch and S&P.
We’ve also created a sophisticated valuation methodology used by all our investors as part of their regulatory reporting. We can support our clients in terms of detailed Solvency II reporting, as well as ESG, climate charge, and carbon intensity assessments.
Furthermore, we have experience of successfully supporting our insurance clients through the regulatory approval process. This ensures they can continue to invest in commercial real estate debt, diversify their portfolios and capture significant illiquidity premia.
- Source: Bayes Business School Bi-annual Real Estate Report, 2nd May 2024