The commercial property market gains momentum

There are signs of life in the commercial property market as deal-making returns with a bang. In September, private equity group Starwood announced its £673.5mn acquisition of the Balanced Commercial Property Trust, while listed warehouse group Segro bought Tritax EuroBox’s assets for £553m. London’s Citypoint skyscraper has been put up for sale, while Australian pension fund Aware Super announced plans to invest up to £1bn in London offices.

This flurry of activity marks the end of a prolonged pause in deal-making in the commercial property market and may signal brighter times ahead for investors in the listed REITs market. Transaction volumes had slumped after a series of problems hit the sector: the sharp rise in interest rates, a boom and bust in logistics assets, and the impact of changing working patterns on the office market.

The MSCI World REITs Index, which tracks the performance of listed commercial property companies around the world, has seen a recovery after a tough few years. Over one year, the index is up 28.3%*. While this is still lower than the MSCI World index return of 31.7%*, it appears to call an end to the weakness in this part of the market.

Jason Yablon, head of listed real estate at Cohen & Steers and a manager on the Cohen & Steers Global Real Estate Securities fund, says the stagflationary environment that prevailed in 2022 was a tough moment for listed real estate, but this has passed: “That was where inflation was running too hot and central bankers needed to tighten financial conditions. It led to a resetting of asset values and slower growth expectations. Today, the tail risks are shrinking. We are firmly entering the rate cutting cycle, and this is a great environment for listed real estate.

“The macro regime that we’re entering in today is likely to see lower growth, but also higher interest rates. That is a very good regime to own listed real estate, because it puts a brake on supply.” He says that supply is already constrained in some areas because of the uncertainty of recent years.

Growth themes

The REITs market also captures some important global themes. There is an AI story, for example. Yablon points to the growth in data centres, which is creating an opportunity for commercial property investors: “There is still a lot of value in this part of the market, because the fundamentals are still so strong. Large language models and the AI moon race that’s occurring right now is leading to a lot of data centre demand, and there is huge activity in the sector.”

He says that new supply is coming into the sector, but it is being gobbled up by the large technology companies. New developments are proving much more profitable and cash generative than had been expected at the outset. This is a significant position for the Cohen & Steers fund.

Cell towers are another area of focus. They experienced a boom and bust cycle in the wake of the pandemic, but Yablon says companies in this area now look cheap. “Leasing activity is beginning to inflect positively, and stocks have really de-rated over the last several years. They are a little bit more rate sensitive, so now that we’re into a rate cutting regime and fundamentals are going to inflect over the next 12 to 24 months, we do think that is an area that could perform quite nicely over the next several years.”

The other major area for the Cohen & Steers portfolio is senior care. This is supported by an ageing population. Yablon says: “This is a demographically-driven story. Baby boomers are getting into those years where they require senior housing and additional care, and there’s very limited supply, so occupancies are up, rents are up. Fundamentals are extremely healthy in that business.”
A bumpy path

Nevertheless, the recovery isn’t evenly spread and there are still pressure points in certain parts of the market. Low transaction volumes can mask falls in valuations. It is only once deals start up that problems are revealed. Selectivity is crucial at a moment where some areas still look vulnerable.

The other potential pitfall is carbon emissions. Buildings are carbon-intensive, and can form a meaningful chunk of a company’s carbon footprint, particularly for services businesses such as law and financial services. The market for inefficient buildings is shrinking, and companies are increasingly having to factor redevelopment costs into their forecasts. Land Securities, for example, has put a £135m decarbonisation programme in place.

Marcus Phayre-Mudge, manager of the TR Property Trust, says they are confident in a market recovery, but are picking opportunities carefully: “Investment sentiment for logistics has started to weaken and we continue to be highly selective in that subsector. Vacancy rates across most UK and European markets have increased this year and there is a slowdown in leasing volumes, both on existing portfolios and pre-let on new developments, as occupiers take longer to commit to new space.”

The office market demands similar caution. The Latest Columbia Threadneedle property report says: “Amenity-rich, centrally-located offices are a key focus as sustainability commitments remain important. The outlook for prime, ‘best-in-class’ offices is looking more positive, although there is greater downside potential for secondary office stock.”

Roger Skeldon, manager of the TIME:Commercial Long Income fund, sums up the prevailing view on REIT markets today: “There remains the potential for further volatility across many asset classes, although we are seeing a settling down in many factors. Transactional levels in the real estate market remain relatively low but activity is expected to return to a more normalised state during the remainder of 2024 and into 2025, as further clarity on factors such as interest rate levels become visible and confidence increases around real estate.”

The outlook for commercial property looks more encouraging than it has for some time, but the recovery is not evenly spread. Investors still need to pick the right manager to help them navigate the range of existing and emerging opportunities.

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*Source: Index factsheet, 31 October 2024