Timing matters: Navigating the UK commercial real estate investment market

Commercial real estate returns vary over time as conditions change in the economy and in financial markets. Since June 2022, we have seen UK commercial real estate values fall by c.22%. This has affected many investors in terms of their reported investment performance and portfolio value, while some will have seen further effects on their funding and business plans. 

However, the effect of a significant downturn does present opportunities for investors. We explore the extent to which past downturns have created a buying opportunity for investors to achieve high annualised returns, with holding period flexibility providing a mechanism to reduce risk. To illustrate this, we examine the impact of previous downturns in the UK commercial real estate market for average investment returns over different holding periods. 

Figure 1 shows movements in capital values over time for the MSCI UK Monthly Index, alongside annualised total returns for real estate over a 5-year and a 10-year holding period beginning at each month in question. The MSCI series provides an extended history of UK real estate performance that includes the early 1990s downturn and the impact from the Global Financial Crisis (GFC) of 2007-09, these are highlighted in grey.

Figure 1: Capital value index and annualised total returns for 10-year and 5-year holding periods

Source: CBRE Research, MSCI UK Monthly Index

The chart demonstrates that investing in real estate at, or near, the trough of a capital value downturn has previously produced attractive returns, with a premium for a shorter holding period. The average annualised total return rates for all possible 5-year and 10-year holding periods were 8.1% and 8.4%, respectively. Yet, if an investor purchased an asset at the trough of the early 1990s downturn in May 1993, they could have achieved a 5-year annualised total return of 12.5%, while the 10-year annualised total return was 11.7%. Moreover, an investor that purchased an asset in June 2009, the trough of the GFC downturn, could have achieved a 5-year annualised total return of 11.2%, or a 10-year annualised total return of 10.3%.

In both downturns analysed, investors that purchased assets at or near the trough of capital values and divested after 5 years, could have achieved a higher annual total return than they would had they held the asset for 10 years. However, a longer holding period in real estate can lower volatility in performance. The standard deviation in the 10-year annualised return rates was just 2.6%, compared with 4.5% for the 5-year annualised return rates. This emphasises that performance over shorter holding periods for UK real estate has been more volatile, and that looking toward a 10-year hold, typical of core investments, is a way of smoothing the effects of market volatility.

Figure 2 shows real total returns, calculated by deflating MSCI total returns using the UK Retail Price Index. The average annualised real total returns for 5-year and 10-year holding periods were 4.8% and 5.3%, respectively. The standard deviations for the 5-year and 10-year annualised real total rates depict the same trend as before, at 4.8% and 2.7%, respectively. Additionally, extending the holding period for assets purchased just before a downturn can increase returns. For instance, an investor that purchased an asset one year prior to the GFC trough would have achieved an annualised real return of 3.9% for a 10-year holding period, whereas the annualised real return for a 5-year holding period was -1.2%. In fact, the longer 10-year holding period has always delivered a positive real total return over the period for which the data is available.

Figure 2: Annualised real total returns for 10-year and 5-year holding periods

Source: CBRE Research, MSCI UK Monthly Index

Given the current economic backdrop where multi-asset investors may be attracted by the higher return rates now offered by government and corporate bonds, it is important to highlight the potential for improvement now emerging in real estate total returns. Furthermore, the current market condition presents opportunities, as investors could time their entry to the market when values appear to be approaching the trough to achieve higher returns in the short-to-medium term. Nonetheless, it is important to note this analysis is performed on total returns data at an all property level, and there has been evident divergence in sector performance over recent years. Moreover, we present an ex-post analysis of real estate total return rates, and past performance is not always an indicator of future performance.