Ukraine conflict: UK real estate impacts

While the headlines have highlighted Russian investments into high-end housing, superyachts and football clubs, Russian investors are estimated to account for just 0.3% of UK commercial real estate purchases since 2015.[1]

As our CIO, Sonja Laud, pointed out in her update on what the conflict means for markets, with Russia’s share of global GDP at just 1.7%, the direct implications on the international economy are relatively limited. But Russia’s key economic role is as a major commodity and energy producer.

Prices across a whole range of commodities have increased sharply since the invasion, in many cases from already heightened levels. Chris Jeffery flagged the impact on the overall rate of inflation. As of 28 February, market-implied pricing had UK RPI inflation peaking at over 10% in the next several months and only falling back to ‘pre-invasion’ levels in the second half of 2023.

Purchasing power drag

The magnification of energy and commodity price inflation is likely to be a drag on UK consumer spending and business investment in the coming months. UK consumer sentiment had already weakened prior to the latest crisis. That said, unemployment remains low and economic activity has been improving. A key question in the coming weeks and months will be to what degree ‘supply-push’ inflation weighs on economic growth.

There is also the potential for second-round effects. As Bill Page noted in his recent blog, inflation in materials prices has already had an impact on construction costs. Higher energy prices will only add further pressure.

So, what does all this mean for real estate?

At a high level, we don’t see immediate downward pressure on institutional real estate prices overall. We reference asset pricing in public markets, then bring in rental growth prospects for real estate, when coming to a view on pricing. Given that gilt yields and credit spreads have remained resilient, property prices overall still sit within historic, ‘sustainable’ ranges, in our view. That could change, however, in the event of a sharp slowdown in UK economic growth.

But there may well be further polarisation in the market. Supply and demand conditions are key to pricing power and the ability for rents to match, or exceed, inflation. We see Build to Rent residential and industrial space as especially well positioned. Equally, we believe inflation-linked leases to high-quality credits are a very strong proposition in this environment.

Given the weaker starting position for retail property, and the potential pressure on discretionary consumer spending, conditions there are likely to remain challenging. For the office sector, we’d expected a highly differentiated picture, with those high-quality assets, benefiting from higher utilisation post-COVID, proving most resilient.

Longer-term impacts

 Real estate is a long-term asset class. The ultimate path from both an economic and wider social and security perspective is obviously unknown. But in the narrower context of real estate and infrastructure, there are two things that seem likely to us:

• More focus from occupiers on energy consumption in buildings. This will support our work to transition assets towards ‘net zero’ standards.
• Greater focus from governments on energy security. Heading off the threat of climate change requires a wholesale shift away from fossil fuels and towards renewable electricity. This conflict illustrates that the steps needed are as much about energy security as decarbonisation.

Related content:

• Sonja Laud, our CIO, on what the conflict means for markets, the world economy and how we manage our clients’ assets
• Chris Jeffery looks at how Russia’s invasion of its neighbour might impact consumer prices in developed markets
• Colin Reedie and John Roe discuss Asset Allocation and Active Strategies positioning
• Tim Drayson assesses the overall macro impact of the conflict – and the outlook for the Fed, ECB and BoE

Unless otherwise stated, information is sourced from LGIM analysis as at 3 March 2022. 

Views expressed are of Legal & General Investment Management Limited as at 3 March 2022. Forward-looking statements are, by their nature, subject to significant risks and uncertainties and are based on internal forecasts and assumptions and should not be relied upon. There is no guarantee that any forecasts made will come to pass. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solely relied on in making an investment or other decision.

[1] Source: Property Market Analysis LLP, 24 February 2022