Global investors have been pausing to consider what sectors are worth buying following a bruising collapse in valuations for UK real estate across its sectors post-pandemic.

At the same time a bigger picture is emerging of a Britain that is priced as though it is the weakest out of Europe’s five largest economies: Germany, France, Spain and Italy, with it continuing to pay one of the highest borrowing costs in Europe.

The macroeconomic context matters because the UK's cost of capital determines how real assets are priced.

The problem, in my view, is that Britain’s economic outlook is no longer being compared with the current macro-economic outlook for Germany, France, Italy and Spain. Instead, it is being compared with a Europe that combines Germany's fiscal discipline, France's productivity and Spain's growth.

But real estate investors don’t invest in Europe they invest in specific countries.

Dig deeper and the picture is much more nuanced.  Since the pandemic, the UK economy has expanded by around 6%, compared with less than 1% in Germany and around 4–5% in France. Looking ahead, the IMF expects the UK to lead Germany, France and Italy in 2026. Spain remains the outlier on growth, but it also has an unemployment rate of above 10%.

The labour market tells a similar story.

Our population is the youngest and fastest growing of the big four and UK unemployment stands at 4.9%, compared with 8.2% in France and 10.3% in Spain. For long-term investors, labour becomes rent, inflation drives income, and demographics form households.

Productivity is an oft quoted counterargument. France and Germany both produce more output per hour than Britain. But productivity statistics require context.

Frances's higher productivity comes alongside unemployment above 8%, while Spain's exceeds 10%. Keeping a larger proportion of lower-productivity workers outside the labour market inevitably lifts measured output per hour. Britain has historically made a different trade-off, accepting slightly lower measured productivity in exchange for materially higher employment. For economists, productivity is rightly critical. For investors in long-duration real assets, employment and household formation are often the more relevant variables.

The same is true of our public finances.  The UK's debt-to-GDP ratio is around 101%, materially below France at 115.6% and Italy at 137.1%.

Yet investors demand around 4.8% to lend to Britain for ten years, compared with 3.7% in France, 3.6% in Italy and 2.9% in Germany.  

The National Institute of Economic and Social Research estimates that UK gilt yields trade around 140 basis points above what Britain's debt burden alone would imply, making the UK the clear outlier among comparable advanced economies.

Today's gilt yield reflects concerns around inflation (lower than the eurozone in May), a current account deficit, fiscal credibility and political uncertainty.  All of which the incoming Labour leader will need to address.  It also reflects a structural imbalance between heavy gilt issuance combined with QT and a shrinking domestic buyer base, which are real concerns, but I wonder whether today's premium has become unfairly burdensome.

Ironically, the UK's higher gilt premium may also be creating the opportunity in real assets. Today financing is often not accretive, forcing investors to buy assets because the underlying cash flow justifies the price, not because financial engineering makes the numbers work. This has removed many of the highly leveraged buyers who dominated previous cycles.

Institutional capital already appears to be recognising this and you can see this reflected in cross-border investment into UK living sectors which increased by 55% last year, and the €22bn it deployed gave the UK 37% of all EMEA living volumes, a larger share than any other European market.

The UK's macroeconomic fundamentals are one of the reasons we at Long Harbour remain positive on UK residential real estate and continue to deploy capital.

Our investment philosophy has always been to focus on the long-term structural drivers of demand rather than short-term market sentiment. Employment, household formation, demographic change and the cost of capital ultimately determine returns far more than quarterly swings in confidence.

Importantly, our investment case is not predicated on a collapse in global interest rates. But if that part of the UK-specific gilt premium narrows over time as perceptions of Britain become better aligned with its underlying fundamentals, financing once again becomes accretive, providing an additional source of return. But that should be viewed as the upside, not the investment case itself.

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