Stephen Nicolas, partner in the corporate real estate practice at law firm Paul Hastings Europe, gives three broad predictions for the property market in 2024.
After the modest deal volumes of 2023, 2024 looks set to be a year of two halves as the real estate market aims to find an equilibrium after prolonged interest rate rises.
Investors are cautiously adapting to the high-interest rate deal-making landscape by thematically investing and calling on alternative financing arrangements, in lieu of traditional bank and equity borrowing.
Regulatory considerations will also shape behaviour, with sustainability and fire safety requirements renewing focus on due diligence. With regulation in motion, and the potential for updates to legislature in the election year, investors have much to consider when shaping portfolios.
Prediction One: A slow start but hopeful outlook
In the first half of the year, we expect to see greater numbers of restructuring and insolvency transactions than 2023 (where the aim was to survive until 2025 and most positions were simply extended by debt and equity alike) as a result of continuing macroeconomic headwinds.
However, we anticipate the majority of these will likely be consensual restructuring pursued by the banks, particularly as the wave of distressed assets predicted in 2023 failed to materialise, bankruptcies and restructurings are still considerably below where they were in the aftermath of the global financial crisis.
Despite the retreat of the equity markets and reluctant bank lending, financing solutions remain available, thanks to the proliferation of alternative lenders. In fact, even throughout the more turbulent macroeconomic periods of 2023, debt has frequently been readily available to high-quality borrowers with high-quality assets, and this will continue to underpin activity this year.
With rates not looking to soften, at least substantially, until the latter half of 2024, confidence will likely return to the property market, and debt will become more readily available to a wider range of investors, prompting a return to deal-making.
Prediction Two: Investors will continue to invest thematically
In 2024, investors will continue to invest thematically, taking advantage of post-pandemic trends for home, working and leisure, to deploy capital into assets with strong fundamentals and which meet evolving operator demand.
The most obvious post-pandemic shift in behaviour has been in working patterns, with the advent of working from home signalling an end to the era of traditional office buildings. As a result, there will likely continue to be an increase in office conversions, particularly in the office to hotel and office to residential pipeline. However, demand for flexible working spaces will see the service market perform strongly, as hybrid and remote work continues post-pandemic. Many operators are now switching to management agreements, which allow for profit-sharing configurations but do not require liability for long-term leases, demonstrating creativity in how deals are conceived to accommodate for macroeconomic uncertainty.
Likewise, with international travel and study returning to pre-pandemic levels, purpose-built student accommodation will continue to pique investor interest, particularly as supply issues in the sector are well-documented. Similarly, hotels will likely perform well, notably in the super-luxury arena, as Middle Eastern sponsors continue to facilitate activity. On a regional basis, we will continue to see an increasing push from international operators to gain market share, generating profitability for owners through competitive fees and terms on franchise agreements.
Ultimately, it will be those with a strong brand, a savvy management team, and who exploit opportunities to add value, for example through Tesla charging bays or leasing areas, who will be seen as a robust investment for property owners to hedge against inflation.
Prediction Three: Investors will future-proof their assets to adapt to regulation
As amendments to the Building Safety Act came into force in the UK at the end of 2023, we will continue to see investors adapt to new regulations, which primarily seek to improve fire safety. With changes largely focusing on ‘higher risk buildings’, investors will continue to pay greater attention to the type of assets they are buying in order to future-proof portfolios, especially in the residential sector – for example, on one deal in 2023, investors have adapted by removing a building above 18 metres from a target portfolio. These regulations will also prompt greater organisation in proactively assembling key documents, alongside a more rigorous due diligence process on fire safety.
Likewise, investors will continue to understand the updated scope of their sustainability and EPC obligations, as by 2030, non-domestic landlords will be required to obtain a minimum rating of ‘B’ (although this may change following updates to similar residential legislature). As a result, many buildings may need substantial structural work, whilst the underwriting process will necessitate energy efficiency enhancements to be undertaken throughout the loan’s duration. As commercial tenants increasingly seek out energy-efficient buildings/significant landlord contributions to capex works to adapt to the rising cost of energy bills, investors should renew focus on surpassing Minimum Energy Efficiency Standards in order to meet growing demand for high-quality and compliant real estate.
Ultimately, the outlook for 2024 is positive, as we expect to see a more robust sector, sustained by increasingly buoyant transaction valuations and volumes. Whether the 2024 general election in the UK will deliver confidence and further changes to regulations remains to be seen, but with a cautious atmosphere still lingering from 2023, deals will continue to be constructed in creative ways to withstand macroeconomic uncertainty.
