Commercial Market Outlook

• Following strong growth in the first half of 2024, recent indicators suggest the UK economy has lost some momentum. Output was only just in growth territory in Q3 (+0.1%) and the latest monthly data shows a small decline during September (-0.1%).

• The latest S&P Global PMI survey evidence shows a fall in both manufacturing and service sector sentiment (with the former now in contraction territory). However, the construction sector PMI is showing a strong reading of 55.2 (over 50 indicates expansion), and consumer confidence improved modestly in November on the GfK measure (although it is still a subdued -18).

• The labour market has continued to soften overall, a trend that has been ongoing since the start of 2024. Concerns over the employment cost implications of the October Budget appear to be a factor behind the recent fall in business confidence. A significant announcement was an increase National Insurance (NI) employer contributions, and the Chancellor also confirmed a 6.7% increase in the National Living Wage. These measures together are likely to hold back employment growth and have a further modest loosening impact on the labour market. 

• The Office for Budget Responsibility (OBR) assesses that Budget policies will give a temporary short-term boost to growth, but will ‘crowd out’ some private sector activity in the medium term. A third of the additional revenue generated is destined for capital spending, which should be positive for growth over the longer term. In its assessment for the Budget statement, the OBR forecasts GDP growth of 2.0% in 2025, followed by 1.8% in 2026. Many forecasters are a little less optimistic, with Oxford Economics expecting 1.4% in 2025 and 1.7% in 2026.

• Annual inflation posted a surprise uptick in October, accelerating to 2.3% from 1.7% in September. With last year’s declines in energy prices now falling out of the annual comparison, the consensus forecast is for CPI of 2.4% in Q4 this year. Most forecasters expect CPI to be a little above target during 2025, but it should remain below 3%.

• The Bank of England’s Monetary Policy Committee reduced the base rate by 25 basis points to 4.75% at its November meeting, marking the second reduction from a peak of 5.25%. A further base rate cut in December appears unlikely, with the Bank expecting the Budget to add modestly to inflationary pressures. Further base rate cuts are likely in 2025, although the Bank will be cautious in its approach.

Recent output trends and indicators

• GDP grew by just 0.1% during Q3 2024, down from 0.5% in Q2 and less than forecast expectations of 0.2% growth. The services sector grew by 0.1% during the quarter, while construction grew by a robust 0.8%. Production however declined by 0.2%, driven by a 2.7% fall in electricity, gas and a/c supply. On a monthly basis, GDP declined by 0.1% in September, down from a 0.2% rise in August.

• The S&P Global Manufacturing PMI moved further into contraction territory (a figure below 50), falling to 48 in November 2024, from 49.9 in October. This was the lowest reading since February 2024, with survey respondents citing concerns around the economic outlook, costs and weak demand, notably in new export business. Supply chain issues also remain a concern.

• The UK Services PMI fell to 50.8 in November 2024, from 52.0 in October. This was the lowest reading since November 2023, although it is still in expansion territory. Heightened economic uncertainty and apprehension over the tax increases outlined in the Autumn Budget were cited as concerns, although new business volumes rose for the thirteenth consecutive month, driven by resilient consumer spending. Employment fell for the second month, although by less than in the previous month. However, confidence in the outlook for business activity dropped to its lowest level since December 2022.

• In contrast to manufacturing and services, the construction sector PMI rose in November, to 55.2 from 54.3 in October. This was driven by the sharpest rise in commercial work for more than two years, although residential work declined. New orders across the sector grew for the tenth consecutive month, but the growth rate slowed to its weakest since June 2024. Employment rose marginally, but the rate of job creation eased to a three-month low. Input cost inflation accelerated to an 18-month high, attributed to rising raw material prices and some suppliers passing on increased staff costs.

Labour market

• The latest Labour Force Survey estimates show the UK employment rate declined slightly to 74.8%, down from 75.0% in the previous month. The unemployment rate rose, moving from 4.0% in August’s reading to 4.3% in the latest three months to September.

• The survey found that the number of payrolled employees fell by around 5,000 between September and October 2024. This figure is provisional and should be treated with caution as it is likely to be revised. On an annual basis the total number of employees is up by around 95,000 compared with October 2023.

• The total number of job vacancies continues to decline, down around 35,000 in the three months to October. Total vacancies are now reported to be around 831,000. Vacancies were found to have declined in 16 of the 18 industry sectors.

• Annual growth in average regular earnings (excluding bonuses) was 4.8% in the three months to September (latest). This was down from 4.9% reported the month before and the slowest rate of wage growth since June 2022. Once again, the manufacturing sector posted the highest rate of average wage growth, at 6.0% annually.

Inflation

• Annual inflation posted a surprise uptick in October, increasing 2.3% in the last 12 months, up from 1.7% in September and above the 2.2% consensus expectation. The largest upward contribution came from housing and household services, mainly because of rising electricity and gas prices, reflecting the rise in the energy price cap in October. The largest downward contribution came from recreation and culture.

• Services inflation stood at 5.0% in October, still well above general inflation. Core CPI (excluding volatile elements such as energy and food) remains a little above general inflation, rising marginally from 3.2% to 3.3% in October.

• With last year’s declines in energy prices now falling out of the annual comparison, the consensus forecast is for CPI of 2.4% in Q4 this year. Most forecasters expect CPI to be a little above target during 2025, but it should remain below the 3% threshold for triggering a letter of explanation to the Chancellor. The Bank of England now expects CPI inflation to increase to around 2.75% by the second half of 2025.

Interest rates

• The Bank of England’s Monetary Policy Committee (MPC) reduced the base rate by 25 basis points to 4.75% at its November meeting, marking the second reduction from a peak in the current cycle of 5.25%. The decision was decisive, with eight of the nine MPC members voting to cut.

• The Bank takes the view that the Budget has boosted economic growth but added to inflationary pressures (by just under half a percentage point on CPI at its peak). Given this, and broader uncertainties over the impact of the Budget, it appears unlikely that the base rate will be cut again at the MPC’s December meeting. Further rate cuts will almost certainly be made during 2025, although the Bank is signalling that these will be done at a cautious pace.

Retail occupier market

• Retail sales volumes fell -0.7% in October, down from the downwardly revised 0.1% the month before and far below the 0.3% expected by the markets. This is also the largest decline in four months. Low consumer confidence and uncertainty surrounding the budget appears to have impacted sales volumes.

• However, the timelier GfK Consumer Confidence indicator for November shows a slight improvement, increasing three points to -18, possibly due to the UK budget and the US general election having passed. All five sub-measures rose during the month, with the most significant increase coming from the major purchase index, which climbed five points to -16. It is still too early to say whether the measure will continue to improve, particularly with inflation having risen again this month. 

• The Q3 2024 RICS UK Commercial Property Survey shows a net balance of -4% for retail occupier demand, similar to the -5% in Q2, but a noticeable improvement compared with -25% this time last year. Respondents continued to cite an increase in overall vacant space.

• Average retail rental values have shown very modest growth since 2022, according to MSCI. The Monthly Index reports that average retail rental value growth in the 12 months to October 2024 was 1.0%, up from 0.9% in September, and the highest rate since 2016. However, average retail rental values remain 16.2% below their previous peak in 2018.

• The all-retail trend masks significant variation, depending on the type of property and location. Average rents for standard (high street) shops fell almost continuously from May 2018 to May 2023, by circa -29%. However, growth has returned over the last year. Annual growth accelerated to 1.9% by May 2024, but has subsequently slowed, standing at 0.9% over the year to October 2024 (MSCI Monthly Index). Performance is being driven by the London market.

• Average rental values in the retail warehouse subsector are continuing to rise, by 1.7% in the 12 months to October 2024, the highest rate of growth since 2007.  On a quarterly basis, growth stands at 0.6% (three months to September 2024), the annual equivalent of 2.4%. The recent uptick in UK shopping centre rental growth appears to have stalled. The quarterly rate of growth rose to 1.0% in July 2024, but has since fallen back to zero as at October 2024. Annual growth has remained in negative territory, standing at -0.8% in October.

Office occupier market

• Most businesses have now passed the post-pandemic period of office floorspace downsizing, although some corporates are still adopting policies to encourage (or mandate) employees to return to the office. Overall, national occupancy rates have broadly levelled off, and the three-day office week has emerged as the new normal. However, the latest analysis by Remit Consulting shows a small but sustained uptick in national occupancy which they report at being above 35% for the last five weeks.

• Although corporate real estate is the second-highest cost after salaries for many businesses, the provision of high-quality space remains important to assist with recruitment, retention, and productivity strategies, as well as to enhance staff health & wellbeing. This is reflected in continued robust demand for high-quality space.

• There is also a much greater focus on buildings that are sustainable and energy-efficient, as occupiers try to meet increasingly ambitious ESG aspirations. This is being accelerated by the changes to MEES regulations which came into force in 2023, with the next round of tightening (requiring a minimum EPC rating of C) due to take effect from April 2027.

• We are seeing continued strong demand for serviced and co-working provision from established businesses that wish to lease short-term space, pending a move to longer-term conventional office space once the economic outlook becomes more certain.

• The Q3 2024 RICS UK Commercial Property Survey continues to show a positive net balance for office occupier demand at +4%, down a little from a recent high of +7 in Q2, and similar to the +6 recorded in Q1. Whilst this suggests a relatively modest level of demand, it does appear to have stabilised, and is in sharp contrast to the highly negative balances immediately post-pandemic. More broadly, demand remains heavily focused on prime stock, and in prime central London in particular. The RICS survey suggests that availability is continuing to rise, with the Q3 balance standing at +26 on this measure. Again, this will be reflecting the market as a whole rather than prime stock, which remains in very short supply in key markets.

• Prime rental levels have proved highly resilient, reflecting the focus of occupier demand towards top-quality space of which there is little available stock. Recent development schemes have set new benchmarks in several central London districts and regional city centre markets. The gap with rents for poorer quality grade B stock is likely to widen further.

• Average annual rental value growth for all UK offices was 2.3% per annum in October 2024. This figure has been relatively stable recently, within a range of 2.2% to 2.8% during the first 10 months of 2024, and somewhat stronger than the immediate post-pandemic period (MSCI Monthly Index).

• Average annual rental growth in the West End / Midtown submarket stood at 6.4% in October 2024 on the MSCI Monthly index, the sixth consecutive month where growth has been 6% or more. In contrast, the City of London saw a further deceleration in annual growth to 0.8% in the year to October 2024, compared with a recent peak of 2.3% (in March of this year).

• The rest of the south east recorded average annual rental growth of 1.0% in October 2024, below a peak of 2.0% in January 2024. Average annual rental growth in the regional markets was 2.0% in October 2024, above a recent low of 1.3% in July 2024, but slightly below the peak of 2.4% recorded in January 2024.

Industrial occupier market

• 2024 has seen a positive occupier demand story in the UK industrial and logistics sector, with take-up rising from the recent low seen in 2023, following the exceptionally strong pandemic-driven demand during 2020-2022. Longer-term structural change continues to generate occupier demand, most notably the influence of e-commerce, with ‘last mile’ units for urban delivery being a key area.

• Occupier demand for larger distribution units has been somewhat subdued in recent quarters, amid political uncertainty and elevated interest rates. However, demand for smaller size ranges has remained in line with longer term averages. Occupiers may now be looking ahead to lower interest rates, more sustained economic growth and an increase in consumer optimism post Budget. The Q3 2024 RICS UK Commercial Property Survey showed a net balance for industrial occupier demand of +14%, up from +10% in Q2 and a recent low of +3% in Q3 2023, although still well below the peak of +49% in Q2 2022.

• Vacancy rates have been rising over recent quarters, due to a combination of slowing demand and rising supply. However, vacancy at the national level now appears to be levelling off, and the supply of high quality, energy efficient new units remains very limited across many key markets. This is where demand is focused, particularly as many logistics operators are promoting their ability to maximise their clients’ sustainability credentials within the supply chain. Whilst new schemes are coming forward, the overall development pipeline remains restricted, and so the relative shortage of large high-quality units will continue.

• Competition amongst occupiers for existing and new build product has helped maintain upward pressure on rental values despite the overall lower demand levels. According to the MSCI Monthly Index, average annual industrial rental value growth peaked in August 2022 at 13.2% and has steadily decelerated from this unsustainably high rate, but remains strong at 6.1% in October 2024, still well above general inflation. Growth appears to be levelling off at around this rate, and indeed the rate measured over one quarter has been accelerating modestly, from a low of 4.6% (annualised) in the three months to March 2024 to 5.9% in the three months to October.

• The Q3 2024 RICS UK Commercial Property Survey reported a net balance of +48% expecting prime rents to rise over the next 12 months, a continued strong reading, albeit down from +59% in Q2. A net balance of +18% expected secondary rents to increase (also down a little on Q2).

Transaction volumes

• UK commercial property investment volumes have been broadly stable over the last few quarters. Total investment eased marginally in Q3 2024, with activity in the alternative sectors seeing a notable contraction quarter-on-quarter, while the office, retail and industrial sectors all recorded a marked uptick.

• £9.5bn was traded in Q3 2024. This was down 4% quarter-on-quarter, 29% below the five-year quarterly average, but 17% up year-on-year. The rolling annual total was marginally above the previous quarter but was 29% below the five-year average of £54bn.

• Approximately 33% of all investment (excluding multi-regional portfolio deals) occurred in London in Q3 2024, which is on par with the share recorded in the second quarter but below the five-year average of 51%. Investors targeted offices in prime locations as well as assets in the living sectors, such as hotels and built-to-rent. Overseas capital continued to support volumes in the capital, accounting for 56% of the total.

• Conversely, investment in the regional markets (UK excluding London) accounted for 67% of the total, in line with the share recorded in Q2 2024. The South East region recorded the highest level of investment outside the capital, with circa £820m purchased in Q3 2024, followed by the West Midlands with £650m.

• The alternative sectors accounted for the largest share of the quarterly UK total in Q3, at 32%. The industrial sector accounted for 28% of the total, with offices at 23% and retail at 17%. As a proportion of the total, the alternative, industrial and retail sectors were all slightly above the five-year average, whilst offices were well below the average.

• Overseas investment in UK commercial property totalled £4.6bn in Q3 2024, up 11% quarter-on-quarter but 22% below the five-year quarterly average. As a percentage of total investment, it accounted for 48%, marginally below the 10-year average of 51.9%. US investors had the highest share of overseas investment in Q3 2024, totalling around £2bn.

Recent investment performance

• Property yields have been relatively stable at the all-property level over the last year, with the equivalent yield standing at circa 7.1% since February 2024 (MSCI Monthly Index). This follows the sharp correction witnessed during the second half of 2022 (in reaction to rising interest rates and gilt yields, political uncertainty, and occupier demand uncertainty), and a more gradual upward shift in yields during 2023.

• 10-year gilt yields have risen since mid-September 2024, reaching 4.4% at the end of October 2024. This resulted in a narrowing of the yield gap with the all-property equivalent yield to 270 basis points, compared with more than 300 basis points during the summer. Gilt yields rose further to 4.6% after the November Budget announcement, but have since fallen back a little to circa 4.3% (9th December).

• Although capital values have continued to fall year-on-year at the all-property level, performance has improved significantly over the last year, standing at -1.9% per annum in October 2024, compared with -4.2% three months ago and -21.2% per annum at the bottom of the cycle in June 2023 (MSCI Monthly Index). However, with the stabilisation of all-property yields, plus relatively healthy and consistent rental growth (currently +3.6% pa), capital values have started rising modestly in recent months. Indeed, all property capital values have increased by +0.9% since bottoming out in March 2024. It is therefore likely that values will end 2024 at broadly the same level as the start of the year, and that 2025 will see a positive rate of all-property capital value growth.

• Capital growth performance varies considerably across the main commercial property sectors. Office equivalent yields have continued to move upwards whilst industrial yields have seen some very modest downward movement. Rental performance is differentiated, with industrials rising by 6.1% per annum, offices at 2.3% per annum and retail at 1.0% per annum (MSCI, October 2024). Against this backdrop, industrial capital value growth was in positive territory in the 12 months to October 2024 at +1.5%, up from +0.8% in the year to September, according to the MSCI Monthly Index, with positive rental growth more than offsetting upward yield movement. This contrasts with capital growth of -1.1% for retail property and -9.0% for offices.

• Taking just the last three months’ figures, performance has improved noticeably. Industrial capital value growth during the three months to October 2024 was +1.5%, up from 1.1% in the three months to September. Retail capital values rose by +1.1% in the three months to October, compared with +0.5% in the three months to September. The office sector remains in negative territory, by also improved to -0.7% in October, compared with -1.0% in September. 

• The all-property annual total return peaked at 25.1% in May 2022, and then decelerated sharply, bottoming out at -16.9% per annum in the year to June 2023. Performance has been in positive territory during the first 10 months of 2024, reaching +3.9% pa in October 2024.

• The industrial annual total return is now +6.7%, compared with a low of -23.2% in June 2023. Retail annual returns turned positive in December 2023 and increased sharply to +6.1% in October 2024, compared with a low of -9.6% in July 2023. The total return for offices remains in negative territory at -3.7% per annum in October 2024, but performance has steadily improved in recent months, and is now well above the low of     -18.9% in August 2023 (MSCI Monthly Index). Taking just the last three months, all three sectors are in positive territory (+2.8% for industrial, +2.9% for retail and +0.7% for offices).

Investment outlook

• The Q3 2024 RICS UK Commercial Property Survey showed a net balance for investor enquiries of zero, compared with readings of -4% during the first half of this year. This therefore paints a picture of relatively flat but modestly improving demand. Industrial enquiries remained positive, rising slightly to +14% in Q3 from +10% in Q2. Office and retail remained in negative territory in Q3, at -7% and -10% respectively, although both improved modestly from their Q2 readings.

• Transaction volumes remain muted in a historical context, but following an understandably quieter-than-normal summer period, we have noticed a recent uptick in market activity, particularly in the industrial, retail warehousing, and living sectors, with sentiment now focused on when the market will start to improve.

• With consumer price inflation having been within 30 basis points of the Bank of England’s target for seven consecutive months, investors are now more positive around continued base rate reductions, albeit gradual. Together with greater post-budget certainty, we expect higher transactional volumes going forward, with the potential for yields to sharpen as investor competition increases.

• With improved confidence and reducing debt costs, we anticipate an upward trend in pricing, albeit a gradual upturn. Many investors are readying themselves for increased opportunities and activity over the next 12 months. We are now seeing portfolios and larger lot sizes come to the market, which is a further sign of positivity returning to some sectors.

• The focus remains on core assets in strong locations with increasing demands for ESG-compliant buildings, and this is where yield compression may be witnessed.