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Mat Oakley tells us why 2025 will see greater investor confidence in UK commercial property, and which sectors are seeing both strength and recovery
The foundations of the commercial real estate recovery are in place
Given the major change of direction that is likely in US politics on 20 January 2025, starting our outlook with a quote from an inauguration speech seemed like an easy win. Franklin D Roosevelt, in 1933 at the depth of the Great Depression said, “The only thing we have to fear is fear itself”. It isn’t a huge leap from this quote to the uncertainty and lack of confidence that continued to hang over the commercial property investment market in 2024, and the inevitable question of whether this fog of uncertainty will lift.
A year ago, we led on the headline that “2024 will be an opportunity to buy at the very bottom of the cycle” and, as the chart below shows, pricing in both offices and industrials turned last year. However, investment volumes remained muted. While they were over 20% above the previous year, they remain 22% below the ten-year average. This wasn’t just about cautious buyers, but also about limited distress in the market and a similarly limited number of willing vendors.
Why will investors be more confident about UK commercial property in 2025?
Twelve months ago we were still speculating on when the Bank of England base rate would start to fall, and now we have two rate cuts under our belt. Our forward view is based around 100 basis points of further cuts over the course of both 2025 and 2026, and this alone will reduce the cost of borrowing, and in most markets and sectors make debt accretive.
There is, however, a very wide range of views around the forward trajectory for interest rates, and this remains an area of uncertainty for investors both at the point of purchase and the eventual exit. The last two years have shown us that, for many investors, heightened uncertainty results in slower decision-making.
Nonetheless, there are areas of uncertainty that we were dealing with a year ago that we can more firmly agree have disappeared. Political risk, at least in domestic politics, has diminished, and it is a reasonably credible argument that the UK looks less politically volatile than many of its nearest neighbours. The new Labour government has had its first Budget, and this should give investors, consumers and businesses a much clearer picture of the world in which they will be operating for a minimum of the next five years.
While economic forecasts have been revised downward a little post-Budget, there is a widespread acceptance that 2025 and beyond will see accelerating GDP growth – something that is always good for real estate
Mat Oakley, Director, Commercial Research
The shape of the economic recovery is also clearer than it was. While economic forecasts have been revised downward a little post-Budget, there is a widespread acceptance that 2025 and beyond will see accelerating GDP growth – something that is always good for real estate.
While downturns are often very uniform, real estate market recoveries tend to be fairly asynchronous, and we do not expect this one to be different. The first sectors and segments to recover will be those where opportunistic investors feel there has been an overcorrection, or where core investors have confidence in occupational and structural drivers.
Occupational market performance has been strong. Will this strength continue?
One of the most unusual characteristics of the commercial property market in the UK in recent years has been the strength of many of the occupational markets through Covid and thereafter. This has been seen in many metrics – not least the relatively low vacancy rates for a recession, the comparatively strong take-up numbers, and ultimately the higher-than-normal prime rental growth that has been experienced in many markets.
The roots of these trends go back almost a decade, to when developer confidence was weakened after the Brexit referendum. This, followed by Covid, surging inflation, high interest rates, and geopolitical shocks has led to a sustained period of under-delivery of new developments. While tenant demand has by no means been booming over the last three years, the lack of prime supply has driven better-than-normal rental growth for this stage of the cycle.
An improving economy will result in business expansion, and this will lead to rising demand levels for shops, offices, factories and warehouses. Furthermore, lower levels of cost inflation should also be good for the profitability of UK plc.
The one wrinkle in this otherwise positive outlook is the fiscal regime, with the rise in employers’ national insurance contributions and the minimum wage, meaning that most companies will now have to look to raise prices or reduce spending to maintain margins. This will be felt in the leasing markets, and we have revised our take-up forecasts downwards a little to reflect a more cautious corporate environment in 2025 in particular.
What hasn’t changed is the undersupply of prime space in core locations, and we do not expect to see development viability improving dramatically in 2025. This will mean that prime rental growth levels are likely to be sustained at their recent high levels and our forecasts assume that this undersupply remains a driver of total returns for all of the next five years.
Will 2025’s recovery just be about Logistics, Life Sciences and Living?
The end of the year always brings a sleigh-full of investor surveys, and this year’s sound remarkably similar to those previous. ‘Beds, Meds and Sheds’ was the great pre-Covid cliché, and not much has changed since then.
The rationale behind such strategies is a solid one, based heavily around economic growth and favourable structural shifts. However, we have always been fans of the paths that are less well travelled, particularly at this stage of the cycle.
Prime shopping centres, retail warehouse parks, and substantial high street parades are all expected to be popular buys in 2025
Mat Oakley, Director, Commercial Research
The classic retail property cycle is well underway, with rents having corrected sharply downwards now back on an upwards curve as retailers repopulate repriced prime streets and schemes. 2025 will see more institutional interest in retail than we have seen for a decade, motivated both by the cycle and the rebuilding of household balance sheets. Prime shopping centres, retail warehouse parks, and substantial high street parades are all expected to be popular buys in 2025.
Offices remain the one sector where prime yields are yet to harden, but 2025 will be the year that this happens. The recent rental growth story is undeniable, and no longer just limited to super prime. The majority of major office markets have no new office buildings due for completion in the next three years, and tenant demand will recover in line with economic growth. This will ensure that office rental growth in core locations will remain strong. Some investors will stay away, either because of legacy issues or concerns about the impact of agile working, but the lure of rental growth and yield hardening will be too much to ignore for others.