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New semester nerves for PBSA investors as occupancy falls

Commercial property returns

According to MSCI, average commercial property values increased by 0.2% again in August, representing slightly stronger growth than in recent months. On average, capital values have increased by 1.3% so far this year, and by 3.2% from their cyclical low. Nonetheless, values are still, on average, 22.6% below the preceding cyclical peak.

Year-to-date, the London West End office market has delivered the strongest capital growth (4.3%), fully underwritten by robust rental value growth (4.7%). In contrast, offices in outer London have seen values decline by 5.1% YTD, despite modest rental growth (0.6%).

The Industrial sector, which outperformed for much of 2024, is still recording capital growth, but at a much slower rate. Values have risen by 2.5% YTD, backed up by solid rental growth of 3.1%. Standard Industrial continues to outperform with YTD capital growth of 2.8% vs 1.7% for Distribution, and YTD rental growth of 3.2% vs 2.5%.

Retail values have been edging up steadily, with average capital growth of 1.3% so far this year. All formats have delivered moderate levels of growth, supported by similar levels of rental growth. Supermarkets have outperformed from a capital growth perspective (2.2% YTD), despite lagging from a rental value growth perspective (0.9% YTD).

Investment market activity

Preliminary data from Real Capital Analytics suggest a pick-up in market activity in September, following a very quiet summer period. £3.2bn completed in the month, a return to levels seen in Spring. The YTD total of £28bn is however still 13% down on the same period last year.

The beds sectors dominated activity in September, led by KKR’s £230m acquisition of a 7-asset portfolio from Curlew Student Trust II. The assets, located in London, Bath, Leeds, Sheffield, Brighton, Coventry and Norwich were built between 2020 and 2022. The portfolio will be managed by KKR’s pan-European platform Inhabeo.

Elsewhere, Watkin Jones sold a 784-bed scheme in Glasgow into their JV with Maslow Capital. The scheme is expected to be ready for the 28/29 academic year and have a gross development value of £182m. In the BTR sector, Greystar acquired a 595-home scheme in East London from Invesco for a reported price of £170m.

Indurent, the logistics platform backed by Blackstone, have committed an estimated £150m to forward purchase an urban logistics portfolio. The portfolio, sold by a JV between Chancerygate and Bridges Fund Management, will comprise 76 units across 3 assets in Birmingham, Leeds and Coventry. The first two are due to complete next year.

Realty Income Corp added to their huge Retail Warehouse holdings, with the £145m acquisition of 4 assets from a JV between Lone Star and Ediston. The purchase price of the assets, located in Scotland and Wales, reflect a net initial yield in the region of 7.5%.

Market yields

Market expectations for further base rate cuts had been tempered by sticky inflation, with the next cut pushed out until Spring and no further cuts fully priced in. However, hopes of quicker action from the MPC were revived again by the slightly lower than expected inflation numbers for September. At the time of writing, two further cuts are now priced in by April next year.

The latest property yield sheet from property adviser JLL, shows very little momentum on yields in either direction. This suggests, depending on your point of view, either that pricing is stable or that buyers and sellers remain someway apart. The truth is somewhere in between. Price discovery is taking place for the best assets, but for many others liquidity remains very thin.

The only benchmarks expected to firm up in the short-term are for Central London offices and hotels, suggesting that, as with most previous investment cycles, the Capital will lead the recovery. Notably it is the larger office lots - >£40m in the City and >£125m in the West End – where yields are expected to harden. This illustrates the broadening out of demand from predominantly private capital to a wider spectrum of institutional buyers.

Gilt yields, which had been pushed out by concerns around inflation and the UK fiscal position, have firmed up again in recent weeks, providing some support to real estate values. The key benchmark, representing the risk-free rate for institutional investors, had been touching 4.8% in early Autumn, but has dropped back below 4.5% at the time of writing.

Auctions

Allsop’s commercial auction in September contained the highest number of lots of any auction since September 2022. Allsop report a 75% success rate, raising £67m to date, the highest sales proceeds since March 2024. Larger lots have been a notable trend in recent years, with institutions and listed prop co’s increasingly using auctions to shift smaller non-core assets.

Results were mixed for the largest lots however. Of nine lots listed for £2m+, five remained unsold at the time of writing. The highest sale price achieved was £3m, for an office in Bromley with permission for partial residential conversion. Elsewhere, a Halfords in Banbury with 5 years income, and a mixed-use scheme on Eltham High Street sold at yields of 7% and 6.6% respectively.

Market forecasts

The latest commercial property forecasts published by independent forecaster PMA assume tepid GDP growth this year and next and only a moderate recovery after that. Nonetheless, they expect this will be sufficient to deliver steady rental growth of over 2% per annum, which in turn will support around 10% growth in average asset values over the next five years.

PMA expect Central London offices to outperform the rest of the market, with capital growth of almost 20% over the next five years. This capital appreciation is expected to be fully underwritten by robust rental value growth. The picture in other office markets is more mixed, with moderate rental growth but stagnant asset values on a market average basis.

The Industrial sector is also expected to deliver steady rental and capital growth over a five-year horizon, albeit that the former will be somewhat weaker than has been the case in recent years. Rental growth is expected to run at circa 2% p.a., supporting capital appreciation of circa 13% by 2029.

In the Retail sector, rental growth forecasts are healthiest for Central London and Retail Parks, with 2.7% and 2.2% p.a. respectively. From a capital value perspective most formats are predicted to record some growth, with the notable exception of high streets in smaller towns and secondary shopping centres.

Looking forward

Adjusting for beds under nomination agreements (working on the assumption that they are considered to be 100% let), Unite’s results imply that occupancy across their direct-let portfolio looks to have declined from almost 95% to just below 90%. Given the quality of Unite’s portfolio, such a year-on-year drop would unlikely be an issue particular to them. Indeed, anecdotal evidence suggests that some cities have overall occupancy levels well below 90%. There are a range of factors that might be feeding into this decline in occupancy levels. The total number of applicants to universities seems to be holding up well, supported by domestic demographics, even if the picture for overseas students is more mixed. However, the share of these applications across different tiers of the higher education sector has become increasingly uneven. Analysis from Knight Frank using UCAS data shows that whilst higher tariff institutions have seen applications rise by 21% since 2019, those at the other end of the spectrum have seen numbers decline by 7% over the same period. Therefore, those weaker institutions are highly likely to be occupying less PBSA than they were, and the surplus won’t always be in the right locations to be absorbed by those institutions that are growing. This mismatch of supply is the other side of the equation. The market has grown used to a narrative of undersupply of PBSA. However, this is no longer the case across the whole country, with areas of localised oversupply. The picture is muddied further by the “grey” supply available in the rapidly growing Build to Rent (BTR) sector. BTR remains a small part of the overall rental market, but it has more than tripled in size since 2019, and can offer an attractive potential substitute product for PBSA. With a viable alternative increasingly available to students, operators can no longer always rely on scarcity to drive rents ever upwards at a time when affordability is already being tested.

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