UK real estate markets head into 2025 in ascendancy

The UK real estate market is gaining momentum, with easing inflation and stabilising monetary policy paving the way for recovery in 2025. Recovering asset values and improving financing conditions are spurring increased investment activity, liquidity and capital raising. Falling interest rates and declining borrowing costs, combined with rising rents for prime assets, are driving asset value recovery. These developments follow nearly four years of elevated borrowing costs and macroeconomic uncertainty that restrained investment activity.

In the first nine months of 2024, the UK emerged as Europe’s most active commercial real estate investment market, with volumes rising 11% year-on-year to £32.7bn, surpassing the combined totals of Germany and France, according to MSCI data. London led the region, attracting £11bn in transactions (+14% YOY). Colliers forecast annual investment volumes to reach £45–50bn, driven by stabilising gilt yields and growing clarity around rate policy. Transactional activity in the UK is rebounding as confidence grows, asset prices stabilise, redemptions ease and a lower cost of capital – collectively boosting sentiment. A decisive Labour general election win in mid-2024 reinforced political stability, contrasting with volatility in other European markets like France and Germany. This stability has positioned the UK as a magnet for international capital heading into 2025.

Global Investment and Financing Trends
Global investor interest is broadening, with Asian capital pivoting from China to Europe and Middle Eastern investors increasingly targeting the UK, according to a Colliers report. The UK’s faster property valuation corrections and political stability will support international capital flows in 2025. Institutional capital is increasingly shifting to private markets, focusing on assets linked to climate transition, decarbonisation, affordable housing, economic infrastructure and healthcare.

The UK is likely to benefit from perceived greater political stability relative to ongoing uncertainty in France and Germany. In France, investors are likely to retreat from an economy facing the spectre of a sovereign debt crisis causing borrowing costs to spike relative to other European countries. It followed a motion of no confidence that brought down Prime Minister Michel Barnier’s minority government, which comes only weeks after the collapse of German Chancellor Olaf Scholz’s coalition in November, leaving the EU’s two most powerful member states in limbo. By comparison, investor expectations that underpin the Bank of England’s November economic forecast imply four quarter-point cuts to 3.75% by the end of 2025, driven by stronger jobs growth and inflation due to higher government spending.

North American investors are also cognisant of the UK’s stronger return-to-office dynamics compared to the US. However, demand improvement is more broad-based, spanning prime shopping malls, data centres, hotels, and residential niches. Narrowing bid-ask spreads are accelerating transaction volumes, particularly in markets where valuation repricing has been most acute.

Debt market liquidity has improved significantly, with competition intensifying among banks, insurance companies and non-bank players. Lenders are particularly focused on acquisition financing, reports a UK debt fund. Lower swap rates and narrowing margins have also improved interest coverage ratios (ICRs), easing leverage constraints and broadening opportunities across asset classes. However, increased credit due diligence is extending financing timelines, with intense competition for top-tier assets complicating the landscape. Sponsors with well-positioned properties are benefiting from this competitive environment, while borrowers of non-prime assets face tougher refinancing conditions, often needing to add equity to meet stricter LTV ratios following adjusted valuations. 

Debt funds have increased their lending capacity by using innovative strategies like loan-on-loan arrangements, also known as back leverage, to fill gaps left by traditional lenders earlier in 2024. Current market conditions remain favourable for lenders across the risk spectrum, particularly where prolonged high interest rates have strained capital structures on quality assets. The retreat of relationship banks has opened opportunities for bridge lenders to step in and fill the gap.

In this more challenged market segment, loan credit quality pressures on banks’ legacy exposures persist. Default rates hover around 5%, and approximately 10% of loan facilities are experiencing covenant breaches, particularly among smaller lenders with less than £1bn in loans under management, according to the Bayes CRE Lending Report for H1 2024. Despite these challenges, lenders are favouring equity injections and short-term refinancing over forced exits to support a gradual recovery.

Sector-Specific Dynamics
Operational excellence and a focus on high-quality sustainable assets are driving rental growth across office, retail and industrial sectors, supported by growing occupier demand and limited supply. Logistics and industrial spaces remain particularly attractive due to robust fundamentals and constrained new supply, with tenant demand bolstered by e-commerce growth and successful supply chain restructuring.

Demand for prime office spaces is supported by stricter energy efficiency standards, stabilising valuations, and a preference for sustainable, modernised properties. While secondary offices face challenges, they present opportunities for value-add refurbishments aligned with sustainability goals. The surplus of legacy office buildings offers skilled developers and asset managers significant potential to deliver high-quality, fit-for-purpose sustainable assets.

In the retail sector, retailers are grappling with rising costs from employers’ higher National Insurance. However, as already mentioned tight supply for premium locations and consistent demand potentially prevents significant downturns in the sector.  

Sustainability remains a defining theme. Increased demand for high-capex refurbishment loans reflects a shift from new developments to upgrades that meet evolving regulatory standards and tenant expectations. In London, constrained commercial real estate supply and back-to-office mandates are further driving demand for energy-efficient spaces. Meanwhile, digital assets such as data centres continue to attract significant investment, despite hurdles like energy supply constraints and rising costs. Data centres remain a magnet for infrastructure capital due to their pivotal role in the global digital economy, though future demand may hinge on technological advances in energy efficiency.

Challenges and Opportunities
Despite improving market conditions, challenges persist. High construction costs and prolonged planning timelines continue to stifle new supply, particularly in logistics and industrial sectors where demand continues to outpace availability. Developers remain cautious about taking on new projects, even with lower interest rates into 2025 and recovering occupier demand implies some relief. In residential markets, supply shortages continue to be impacted by viability challenges (e.g. construction costs, planning and regulation, infrastructure constraints, limited finance liquidity), intensifying the supply-demand imbalance.

Government regulations mean that from 2030, properties with efficiency ratings below B will not be permitted to be rented thereby potentially forcing owners into considerable capital expenditures to improve their buildings. However, owners might find this difficult to finance thereby leaving the UK with many “stranded property assets”.

The Road Ahead
Anticipated rate cuts by the Bank of England in 2025 are expected to drive further yield compression and valuation growth, enhancing equity and debt liquidity. A declining interest rate environment will make debt accretive again, improving the economics of leveraged acquisitions which could pave the way for private equity funds to become more active again. This shift could also unlock larger transactions, as reduced financing costs open the door for more ambitious transactions.

The UK is set to continue to lead Europe’s real estate recovery as sidelined investors return, confident that the valuation cycle has bottomed out. Improved market conditions and robust demand for distressed assets could also prompt banks to release more inventory, accelerating capital flows and completing price discovery for challenged assets.