Navigating the UK REIT market: The impact of interest rates and valuations

Real estate has been one of the hardest hit asset classes since the start of the rapidly rising interest-rate cycle in 2022. The performance of real estate investment trusts (REITs), publicly traded real estate funds that can potentially benefit from lower capital barriers and higher liquidity, has lagged broader equities over this period.[1]

However, with central banks beginning to cut rates and inflation moderating, the market appears to be at an inflection point. Now seems an opportune moment to reassess the investment case for REITs. In our view, the merits of a hybrid ‘blended’ property strategy are appealing, and we will explore this in a future piece. This analysis focuses on REITs in light of recent market volatility.

Research highlights that, over the short term, REIT prices are significantly influenced by interest-rate movements, earnings surprises, and credit spreads [2][3]. Historically, there has been an inverse correlation between rate hikes and short-term REIT price movements, as rising rates weigh on property valuations and increase the financing costs that REITs rely on to acquire and develop properties.

Over the past 12 months, we’ve observed that the link between REIT performance and markets rates has been particularly pronounced, with performance closely tracking rate movements. As shown in the chart below, the 12-month peaks and troughs in the UK 10-year gilt yield has coincided with inverse lows and highs in the UK EPRA NAREIT Index, all within a three-day window.

Furthermore, we’ve seen this rate-driven market volatility also manifesting in deep discounts to NAV across the wider UK REIT sector. As the following chart demonstrates, this underperformance has been broad-based, with the recent market-wide sell-off being ‘sector agnostic’. 

While REITs have exhibited short-term sensitivity to interest rate swings, our analysis suggests they also have the ability to recover and outperform in a higher-rate environment over the longer term. The nuance around what is driving this can also be important, an environment where rates are higher because growth is higher benefits the real estate sector, in our view.

We examined three-month periods where UK gilts or US treasuries rose by over 50bps. We then looked at REIT returns over these three-month periods and over longer subsequent periods, comparing performance against broader equity indices. We found that although REITs typically underperform during rate spikes, they tended to recover quickly, often outperforming equities over the subsequent six to twelve months.

REITs, therefore, tend to experience sharper short-term declines in response to rising rates according to our analysis, but this is often short-lived. Given the current volatility in UK and global rate markets, which in our view are likely to remain hypersensitive throughout 2025, this remains a downside risk. However, our analysis also suggests: 

·         Investors with a longer-term outlook could benefit from maintaining or increasing their positions during periods of rate uncertainty, particularly given current discounts to NAV

·         Any stability in market rates, even in a ‘higher for longer’ rate environment could potentially support REIT performance, allowing bottom-up fundamentals to drive performance once again – especially in cases where higher rates are associated with higher economic growth.

This brings us to the question of whether investors should focus on stock selection of individual REITs or broader asset allocation. In our view, a broad, diversified REIT strategy may be advantageous in the current market. 

UK direct property investments, as represented by the MSCI UK Index, are still heavily concentrated in traditional Retail, Office, and Industrial sectors. In contrast, an allocation to UK REITs may provide enhanced diversification benefits and possible exposure to emerging sectors through higher weightings to specialised and diversified REITs. We also believe the additional case for geographical diversification via a global REITs allocation is compelling – being particularly valuable to an asset class highly sensitive to local economic cycles and regulatory changes. Global REITs may also give investors exposure to parts of the market that are otherwise illiquid or hard to access.

Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass. Past performance is not a guide to the future. It should be noted that diversification is no guarantee against loss in a declining market.

 
[1] Bloomberg. Analysis of UK FTSE EPRA NAREIT & Global FTSE EPRA NAREIT versus FTSE 100 & MSCI World. Feb 2022 – Feb 2025.
[2] Green Street. Heard on the Beach - A theory of everything. 2023.
[3] NAREIT. REITs and Interest Rates. 2021.