After defying economic gravity in recent years, the UK property market is beginning to flash amber. During the pandemic, house prices rose after stamp duty on property transactions was slashed and mortgage interest rates tumbled to record lows. However, pressures on the housing market are piling up. 

Developers face significant headwinds. Building costs have spiralled since the start of the war in Ukraine, disrupting already fragile supply chains. The pandemic-induced lockdowns in China are further pushing up prices on mission-critical building materials. To add fuel to the fire, the UK’s Housing Secretary Michael Gove is pursuing a more aggressive stance toward developers over building safety standards.  

Meanwhile, the cost-of-living crisis continues to impact consumer purchasing power. And in an attempt to curb runaway inflation, the Bank of England (BoE) has been forced to pass on higher borrowing costs to buyers.   

Buyers step back  

Fixed-rate mortgages should provide some cushion, but the age of easy money seems to be coming to an end. In a new bold era of monetary tightening, the consumer is entering the eye of an unprecedented affordability storm.   

It is difficult to find consensus among economists, but it is clear that rising prices are not as transitory as some had hoped. Even the hawkish European Central Bank is now conceding they have been caught flat-footed by blistering core inflation figures.  

The BoE says we should see inflation decline to 2% in 2024. However, this remains uncertain, and consumers may already be retreating from the idea of house purchases. A combination of spiralling energy bills and food price inflation tied to rising borrowing costs is creating a headwind to demand. This is already being captured in the data with new buyer inquiries decreasing in May. 

According to RICS’s (The Royal Institution of Chartered Surveyors) monthly UK Residential Market Survey, more surveyors reported a decline than an increase, translating to a net balance of -7%. This was a drop from April, which posted a positive net balance of 8%. 

A tool against inflation   

The short view is challenging, but the longer-term outlook is a different story. In an inflationary environment, real estate has been proven to be an effective inflationary hedge. According to data from BlackRock, commercial and residential real estate and infrastructure outperformed a spectrum of asset classes over periods of elevated inflation – while an inflationary environment benefits fixed-rate investors the most, floating rate investors have also benefited from paying down debt with inflated currency.   

Inflation sensitivity will, of course, differ across property sectors and equity and debt investors. This is mainly because rental income and revenue streams are tied to rising prices.  

From a lender’s perspective a slowdown would be unwelcome for some less resilient market participants, though a deep recession would likely trigger the BoE to slash rates again - creating a more fertile environment for renters, buyers and developers.  

There will also be an onus on the government to support economic activity through a prolonged economic trough. Currently, there is a drive to stimulate property development across the UK, with the government earmarking £1.8 billion for land development, community regeneration and new affordable housing projects. This is good news for developers.   

And those developers, who have traditionally held a diverse set of assets with stable and growing income streams have been better able to handle recessionary environments, should inflation trigger a fresh economic downturn.   

Institutional appeal  

Real estate has increasingly become ingrained as a pivotal part of institutional diversification and asset allocation due to its attractive balance of expected risk-adjusted return potential and inflation sensitivity over the long term.   

While the outlook may have dimmed, we believe institutional investors will continue to seek growing income streams from property’s diverse range of sectors which remain in high demand. For example, according to a survey by Knight Frank into institutional trends, investment into residential assets is set to increase by 65% this year, compared to 2021.   

We have been increasingly focused on enabling our expanding institutional audience to gain access to diverse, high-quality property exposure with inflationary linkage - from making secured loans to developers delivering residential-led schemes, to funding more specialist property sub-sectors such as student accommodation.  

We believe institutional investors can benefit from debt investment secured against residential development projects by targeting attractive yield through our “safety-first” lens, focusing on relationship-based sourcing and working with experienced counterparties. 

We are committed to developers nationwide and diversification across the UK, with a focus on those development opportunities which provide end products with good liquidity and deeper markets or those with structural undersupply.   

Currently, macro-economic headwinds may appear to be conspiring against the property sector. However, if history is any measure, real estate can shine during heavy inflationary weather and developers remain well-supported by growing institutional interest.  

Find out more about our Property Finance team.