What will U.K. Real Estate look like in 2040?

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 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; this we ground with reference to 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 this is 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

Figure 2 shows the assumptions we used for each sector. 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.” For residential, data centers and life science, the table shows a range rather than a single figure due to the incorporation of five different scenarios used that have different views on swing calls that affect these sectors.

Figure 2: Key assumptions driving our scenarios

By sector and by theme

The weightings shown in the sector breakdown in Figure 3 and theme breakdown in Figure 4 are the results of applying our assumptions on growth, price and share out to 2040 across the five scenarios. Our scenario outcomes are highlighted in the outlined box. We provide reference bars on both sides of the box to indicate U.K. universe weights pre-GFC in 2007 and currently, as well as the current U.S. universe weights.

Of the five scenarios, our preferred is conservative beds, strong tech—the beds assumptions are at the lower end of the range shown in Figure 2 while the tech assumptions are at the upper end. 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 slightly constrained assumptions on beds and slightly aggressive ones on tech, by the end of 2040, beds (at 37%) will still account for more than twice the share of the investment universe as compared to tech (at 17%). Sheds, at 24%, and traditional, at 23%, will roughly split the remainder of the investment universe.

The other scenarios emphasize the upside potential of the beds sector. With assumptions in the middle or upper levels of the range, the share of the investment universe accounted for by beds increases to 41%-63%. There is some upside in the tech weighting at 21%, but in many of the other scenarios, weightings are in single digits.

There is much less volatility in the future weightings of the sheds and traditional themes. Traditional is forecast to account for between 16%-25% of the 2040 universe and sheds slightly more at 17%-27%.

Figure 3: U.K. investment universe sectors in 2040

Figure 4 U.K. investment universe themes in 2040

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

Two factors are behind the extent of differences across the five 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 to which this is the case 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 is the data center market with 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 permissions for new supply. Those permissions may determine where the future lies in our floorspace growth ranges (10%-25% 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 weighitngs 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.

In summary, our analysis indicates profound shifts within the U.K. real estate investment universe by 2040, predominantly 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 traditional 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.