U.K. Real Estate in 2040: The Rise of Beds and Technology

Factors to forecast 

The Investment Property Forum (IPF) has for many years produced estimates of the size and structure of the U.K. real estate market. Using their latest (end-2023) estimates as our starting point, we forecasted sector growth into the future using the methodology outlined in Figure 1. This shows that for each sector there are three factors we need to predict:

• An assumption on the rate of growth in physical space; grounded by referencing the historical growth rate and a view on how this may change in the future given our view of structural drivers.
• A view on price, specifically the income derived from that space and the rate at which it will be capitalized; again grounded in our view of long-term supply and demand factors and future growth expectations at the end point.
• An estimate of the share of real estate that will be held within the investment universe as opposed to outside (e.g., because it is owner-occupied or in the hands of non-professional investors).

Figure 1: Sector by sector methodology for estimating change in investment universe composition

A multi-scenario approach

Our analysis considers six scenarios, which are designed not just to help quantify the range of potential outcomes for the investment universe but also what would need to happen for those different outcomes to occur.

• Our base scenario encompasses our view on the consensus of what is most likely to occur.
• Two tech-focused scenarios—turbo tech and strong tech—flex even higher our assumptions about the growth and maturation of the data center and life sciences segments.
• Two beds-focused scenarios—higher residential penetration and lower residential penetration—flex upwards and downwards our base assumption on the rate of institutionalization of residential stock.
• A combination of two scenarios—strong tech and lower residential penetration.

Our assumptions by scenario

The next three figures show the assumptions we used for each sector for net addition of floorspace (Figure 2), growth in value of stock (Figure 3) and share of stock in the investment market (Figure 4). As with any long-term (in this case, 15-year) forecast, our conviction level for each individual number is moderate, although we are confident in the relativities. We believe, as the saying goes, “we are approximately right rather than precisely wrong.”

• Some sectors—retail, office (ex-life science), industrial (ex-data center), hotel, leisure and other—see no change in assumptions across the six scenarios.
• Residential floorspace assumptions are also identical across the scenarios; life science and data centers see growth rates vary from 5%-10% and 10%-20%, respectively.
• Our assumptions on the valuation of stock are also unchanged across all scenarios. Our approach here is to think about the nominal rate of income growth that we believe will prevail, and to back solve a yield from this that delivers a return of 7.5%, except in some cases where low volatility justifies a lower return (affordable housing, 7%) or where higher risk warrants a higher return (life sciences, 8% and data centers, 8.5%).
• Investment market penetration assumptions vary for the tech sectors—life science varies from 60%-70%, data center from 50%-60%—and residential sectors—from 2.1% -4.3% in aggregate.

Figure 2: Net addition of floorspace assumptions by scenario

Figure 3: Growth in value of stock assumptions

Figure 4: Investment market penetration assumptions by scenario

By sector and by theme

The weightings shown in the sector breakdown in Figure 5 and theme breakdown in Figure 6 are the results of applying our assumptions on growth, price and penetration out to 2040 across the six scenarios. Our scenario outcomes are highlighted in the outlined box. For reference, we also provide U.K. universe weights pre-GFC in 2007 and currently, as well as the current U.S. universe weights.

Figure 5: U.K. investment universe weights, by sector, in 2040

Figure 6: U.K. investment universe weights, by theme, in 2040

Under our base scenario, by 2040 beds will account for 46% of the investment universe, followed by sheds at 25%, urban at 24% and tech at 5%. Of the five other scenarios, the one we believe most likely is strong tech and lower residential penetration. On the residential side, this is borne of a pragmatic sense that the slow-moving machinery of the U.K. residential market may make swift penetration by institutional capital challenging; on the tech side, it is based on an observation that no matter how aggressive assumptions are on the rate of change in technology, the truth always seems to somehow outpace them. We do not believe that beds have less momentum than tech; rather, we believe this scenario demonstrates the strength of the beds theme. Even with constrained assumptions on beds and more aggressive ones on tech, by the end of 2040, beds (at 32%) will still account for more than 2.5 times the share of the investment universe for tech (at 12%). Sheds and urban will split the remainder of the investment universe (28% each).

The other scenarios emphasize the upside potential of the beds sector. There is no scenario in which it is not the largest, similarly there is no scenario in which tech is not the smallest. The future weightings of the sheds and legacy themes are fairly similar, ranging collectively from just over 40% (turbo tech) and 60% (lower residential penetration).

Figure 7 simplifies these results showing the range of weightings for the four asset themes under all six scenario outcomes, against the current weighting.

• Residential weightings increase significantly from around 16% currently to 32%-54%. It is the largest in all six scenarios.
• Tech weightings range from 4%-18%, always the lowest across the six scenarios. Data centers typically account for 66%-75% of the tech weighting, and 80% in turbo tech.
• The sheds weighting declines slightly from 34% to 21%-30%; this does not represent a decline in the value of the stock in aggregate (it actually increases 47% in nominal terms), just a reduction in its share of a growing universe.
• Urban’s share falls from 49% to 21%-30%. In all scenarios it is marginally smaller than sheds.

Figure 7: U.K. investment universe weights, by theme, in 2040

Appetite is the constraint on beds, capacity is the limit on tech

Partly because of how we have designed the assumptions, we can identify two factors behind the extent of differences across the six scenarios: the extent to which beds are institutionalized by the investment universe and the growth rate of tech, particularly in data center floorspace.

The total value of residential property dwarfs that of commercial property in the U.K., but only a very small proportion of residential is in the investment universe since historically institutional investors did not allocate to the sector. The starting point is a small percentage of a very large pie. The extent to which that percentage grows is key. Our starting points are that 1.5% of affordable and 4.0% of private rental housing are in the investment universe; the range of outcomes for each is 3.8%-11.3% and 7.5%-22.5%, respectively. The lower end of the range can be achieved by a high degree of capture of new stock by the investment universe, but the upper end would require greater institutionalization of existing stock. The extent of the institutionalization of existing stock will be a function of investor appetite—but given the strong risk-adjusted return profile of the beds sector, this could easily be at the upper end of our range.

At the other end of the spectrum, the data center market has a low starting point in terms of floorspace that is likely to grow rapidly, but at a rate which is highly dependent on various factors largely outside of its control. Data center demand is set to grow exponentially due to the needs of AI, while the requirement for life science space is also forecast to snowball. Certainly in the former case, the limitations of resources—in particular power and water—are a significant constraint to permission for new supply. Those permissions may determine where the future lies in our floorspace growth ranges (10%-20% per annum (p.a.) and 5%-10% p.a. for data centers and life science, respectively).

Portfolio construction implications

For many investors, particularly those seeking diversified exposure to a cross-section of real estate sectors, investment universe composition is an important initial consideration when thinking about a model portfolio. But capital takes time to deploy; portfolios are often built up and mature over a number of years. If an investor is seeking similar weightings to the universe or even if they wish to have specific overweight and underweight positions, a view on what the investment universe weightings will be throughout a portfolio’s life, not just at the outset, is critical. Investors with medium- or longer-term universe composition views in mind may need to be comfortable having different short-term positions relative to the universe as they build their model portfolio and wait for the universe to catch up and give them their desired relative weightings.

The IPF estimates on investment universe also include a breakdown by investor type, and for the first time we have attempted to forecast this out to 2040. We completed this breakdown on the base scenario only, and we do not break down the investor type numbers by real estate sector—both because it would be a step too far and because the IPF data does not contain a starting point for such a breakdown. Our approach is deliberately simplistic, looking at historical growth rates, and tweaks these going forward, except for a couple of investor types where definite trends—principally the sell-down of private defined benefit (DB) schemes—allow us to make bolder calls.

Figure 8 shows the progression of the universe weights over time. The main headline is that we expect 2038 to be the crossover point at which the U.K. investment universe becomes majority overseas owned, from its current share of around 40%, 25% in 2013 and 15% in 2003. Our main assumptions here involve the U.K. segregated pension fund landscape, where we have assumed private DB reduces to zero by 2040, public DB holding steady in nominal terms, but aggressive growth in public defined contribution (DC) so that overall, the U.K. segregated fund real estate share holds relatively steady.

Figure 8 U.K. investment universe weights, by investor type, in 2040

In summary, our analysis indicates profound shifts within the U.K. real estate investment universe by 2040, characterized by the rise of the beds sector and significant growth in the tech sector. Beds are projected to become the largest sector, with tech expanding its footprint considerably, while sheds and legacy sectors are expected to see a decline in their relative importance.

For investors, these trends underscore the necessity of adapting portfolio strategies to align with the evolving market landscape. Emphasizing sectors with strong growth potential, such as beds and tech, while strategically managing exposure to declining sectors, will be crucial for optimizing returns.

We believe investors need to stay informed and agile, ready to capitalize on emerging opportunities and navigate potential constraints, particularly in sectors like data centers where growth is contingent on external factors.