A festive forecast: What can we expect from the UK real estate market in 2025?

There are signs of liquidity returning to the office investment market, with hopes of interest rate reductions to stimulate activity in early 2025. Grade A office demand continues to be driven by (i) ESG requirements of landlords and tenants and (ii) the need to incentivise staff to return to the office. There is also strong continued interest in living, data centres, logistics and other alternative sectors. Political uncertainty in France and Germany may be denting market activity in Europe, but we are anticipating strong growth of the real estate market in Saudi Arabia. With large volumes of dry powder capital ready to be deployed when the market does come back, the UK is looking like a prime safe haven for inward investment flows.

2025 also promises to be an exciting year for the Herbert Smith Freehills Real Estate practice, as we push forward with our plans to combine with Kramer Levin, a distinguished US law firm with a top-tier brand and a leading destination real estate practice in New York. The combination will provide us with the opportunity to develop a stronger real estate platform together, including end-to-end real asset transactional capability into and out of the US market. We have already seen a lot of interest in our plans from clients and we are looking forward to exploring many more exciting synergies with you in the year ahead.  HSF also recently announced the opening of a new office in Luxembourg in early 2025, which will enhance our ability to service European private capital transactions that involve a Luxembourg law element.

The UK's need for new or refurbished developments across various real estate asset classes, and for additional or upgraded energy and other infrastructure, is well-rehearsed. But pulling together the construction delivery contracts may need some script adjustments. Challenges confronting the market are well-documented, with the collapse of ISG re-emphasising the dangers to supply chain and clients when things go wrong. As the supply chain is increasingly careful about risks taken-on, clients, consultants, suppliers, contractors and all project stakeholders are going to need to be adaptable in order to settle contracts on mutually acceptable terms without jeopardising appraisals. Genuine investment in relationships could be key.

In the real estate sector, with clear water between initial cost plans and tender returns, main contractor’s risk pricing conventionally representing sunk cost whether or not risks materialise, and time/cost certainty to some extent illusory in a market where main contractors are looking to take reduced risk, market conditions may create an environment in some quarters for management contracting to regain traction.

As the energy transition gathers momentum, with continually evolving technology and innovation, procurement strategies and contracts will need a keen eye for optimisation to deal with specific or complex risks and working environments. Contracts will need to support delivery of pricing and programme efficiencies, strike the right balance between risk and value for money and, for procuring clients, be sufficiently market-facing for competent/specialist suppliers/contractors increasingly in demand.  

Great things have been promised about speeding up planning in the Planning and Infrastructure Bill but details so far have been light. I hope that this Bill will slim down the pre-application consultation duties on applicants for "nationally significant infrastructure projects", which have become ever-longer over recent years without a benefit to the public or stakeholders. The Government has indicated they want to deal with environmental laws which block development or make it more expensive, but I am doubtful how far they will be able to go without breaching international treaties and the Trade and Co-operation Agreement which commits us to a level playing field with Europe. With difficult things like this, Governments have a tendency to bring out radical sounding primary legislation but to defer the detail to subsequent Regulations which often never appear. We desperately need the system for major infrastructure to be sped up, particularly to deliver the national grid upgrades required to rewire the country for more renewable energy by 2030, and I really hope the Bill finds the solutions needed.

I think the UK, and in particular London, will remain an investment destination of choice relative to Europe, where political uncertainty may increase in some jurisdictions and so will continue to hold investors back. We will see a return to office investment in London – not at the transaction volumes of the past – but with the supply shortage ever more pronounced, we will see some trophy assets trade at a premium and we'll see an acceleration of the trend to refurbish existing stock. Despite recent government announcements I do not expect housing supply to be unlocked and so the fundamentals remain positive for the institutional rental sector.

I think there will be more optimism in the Grade A office investment market. Tenant demand and lack of supply is really driving rental growth so the underlying fundamentals are strong. With a stabilizing medium term interest rate environment and more realism from sellers around pricing we may see more trading in some of the larger (above £100m) super prime office buildings.

2025 may also see sponsors and lenders of the more challenged secondary/tertiary office stock (where lack of tenant demand, obsolescence and capex requirements to upgrade and repurpose are most acute) take a more interventionist approach. There may be no more "extend and pretend" on loans which have reached maturity or where loan covenants have been breached. Loan / value write downs, enforcements and more trading of these assets could be the order of the day to help unlock the market.

The Living sector will continue to be a real focus for investors looking for above inflation long term returns. We are seeing continued interest in all sub-sectors particularly single family housing, PRS and student accommodation. Labour's housing targets and underlying demographic issues on lack of supply of good quality rented accommodation means this will continue to be a hot sector for many investors (particularly those from overseas).

2025 may also see a return of more investors to the prime retail investment market. With yields having moved out considerably from their peak, rents rising and voids at de minimis levels in the best Centres, investment funds, REITs and Propcos are all showing signs of interest in this market.

Phase 1 of the long-awaited consultation on reforming the statutory protection for business tenancies under the Landlord and Tenant Act 1954 is currently inviting views on the relevance of security of tenure in modern leasing. Whilst it seems likely that some form of this statutory right to renew will be retained, the real importance and interest lies in the second phase of the consultation, which is expected later in 2025. This phase will address critical issues such as the contracting-out process, grounds for termination of tenancies and statutory compensation. It is crucial for all stakeholders – landlords, tenants, surveyors and solicitors – to participate actively in the consultation process to ensure that we develop a streamlined and workable regime that, we hope, will resolve the current idiosyncrasies. These reforms have the potential significantly to impact the leasing landscape, making it essential for everyone involved to stay informed and engaged.

For the UK development market, we expect to see the trend towards mixed-use development continue well into 2025 and beyond. The concepts of "place-making" and "live, work, play" will remain key buzz words for new developments and the enlivenment of existing ones as developments aim to deliver communities which combine residential, commercial and recreational spaces within a single location. The demand to co-locate a variety of functional uses with green spaces and to create dynamic, convenient, sustainable, socially and culturally-inclusive and tech-integrated spaces continues to add complexity to the delivery of projects, but there are also exciting opportunities for developers, investors, occupiers and funders active in this space (and equally for us lawyers able to advise in connection with these types of projects!).