UK economic outlook

Activity

As expected, economic growth slowed over the second half of the year. The UK’s economy failed to grow over the third quarter and growth was revised down over the second quarter from 0.5% to 0.4%. There was a slight monthly uptick during November, although it was below expectations. Changes to business rates and National Insurance contributions aim to raise additional revenue to fund Labour’s growth-centric agenda. But this has been met with shrinking fiscal headroom, as borrowing costs remain under pressure. Indeed, a sell-off in the gilt market at the start of 2025 threatens future spending commitments and questions Labour’s ability to meet its own fiscal rules.

The all-sector Purchasing Managers’ Index stood just above the level of contraction at 50.6 in December, as business confidence has been shaken since mid-2024. Manufacturing led this decline, although key budget-related elements will weigh on the services sector in 2025.

Inflation

The annual Consumer Price Index unexpectedly fell to 2.5% in December, primarily because of a decrease in the price of restaurants and hotels, clothing, and alcohol and tobacco. Crucially, the uncomfortably sticky services inflation component decreased to 4.4%, well below the expected 4.8% increase. With the labour market also showing signs of cooling, the latest inflation print is welcome news for a central bank trying to avoid a hard landing. However, a January 2025 British Chambers of Commerce quarterly survey indicated that over half of businesses are planning to raise prices in the next three months, given rising labour costs.

Policy

After cutting 25 basis points (bps) in November, the Bank of England voted six to three in December to hold the policy rate at 4.75%. It continued its hawkish commentary, citing “global and domestic uncertainties”. At the time of writing, an additional four quarter-rate cuts over 2025 are still officially on the table. A close eye will be kept on wage growth, which remains high. We expect caution to be exercised here, given upside risks to services inflation and potential ramifications from the US government. Still, December’s split vote suggests an appetite for further policy easing in the near term. This could increase in pace during the second half of 2025, once uncertainties have been worked through or if growth struggles more than expected.

Source: abrdn, December 2024
Forecasts are a guide only and actual outcomes could be significantly different.

UK real estate market overview

The UK real estate market recorded a positive total return of 3.4% over the first three quarters of the year, according to the MSCI Quarterly Index. Assuming the fourth quarter maintains this momentum, 2024 would be the first calendar year since 2021 to post positive returns. Capital values appear to have largely bottomed, with the favoured sectors, namely retail and industrial, returning to quarter-on-quarter growth over 2024. Reversionary potential is driving investment activity within the retail and industrial segments, and portfolio transactions dominate from an active listed sector. Wider economic and political events and construction impacts have added to tensions and delays, but the general consensus remains positive. 

Encouragingly, total returns increased for the third consecutive quarter, recording 1.5% over the third quarter of 2024. For the first time since June 2022, all sectors posted positive returns, led by the retail sector. Buoyed by a rebound in capital growth, the favoured sectors proved most popular once again, although offices are clearly slowing in their decline and are acting as less of a drag on the index.

Capital growth for all property was positive over the third quarter of 2024 at 0.3%. A combination of continued growth from the favoured retail (0.8%) and industrial (0.8%) sectors, and slower declines in the office sector (-0.7%), helped drive a positive overall figure. We expect to have seen the majority of capital value declines. Best-in-class assets in the favoured sectors are driving more aggressive pricing, while refurbishment and conversion activity for stranded assets are starting to make more sense.

Investment volumes surpassed £50 billion over 2024, according to Real Capital Analytics. Around 10% higher than the previous year, yet still 35% down on the 10-year average, investors remain cautious in their return to the market. Despite this, we have seen competitive bidding for best-in-class assets and those with reversionary potential. The buyer pool for long-income-producing assets remains shallow. But overseas capital has been active in acquiring portfolios within the hotel sector, given the strong growth fundamentals. Indeed, hotels had their strongest year for investment since 2018, with over £6 billion of recorded transactions.

UK real estate market trends

Offices

The office sector is beginning to attract more attention, as fundamentals increasingly support good-quality and well-located assets. According to JLL data, central London’s net absorption swung strongly positively over the third quarter of 2024, as occupiers competed for appropriate space. Although space under construction in London has ballooned to record levels, delays from contractor insolvencies, down-scaling, and financing issues have reduced expected deliveries over the second half of the year by 30%, according to Deloitte Crane Survey data. These delays are expected to continue while cost-pressures work their way through the construction sector. Prime rents have responded to these combined dynamics by growing at an annualised rate of 9.7% in the West End and by 8.9% in the City during the third quarter.

Capital values across the UK are certainly adjusting their tone. Every ‘big-six’ market and London’s major City and West End submarkets have consistently slowed quarter-on-quarter from their peak declines. Markets with low incoming supply – such as Bristol, Edinburgh, and the West End – are outperforming, as rental growth remains strong. Vacancy rates in these tighter markets are either declining or holding steady. But vacant stock is still increasing in Leeds, Glasgow and Manchester, given development completions and tenant-released space.

Over 2024, investment activity in the office sector was marginally lower than 2023’s levels at just £10 billion (60% below the 10-year average). Although liquidity for large lot sizes remains low, acquisitions for renovation or redevelopment have jumped to nearly 20% of the total, compared with just 6% the previous year, according to Real Capital Analytics data.

Industrials and logistics

As one of the favoured sectors, the growth drivers behind industrials and logistics have translated to a 5% total return over the first three quarters of 2024. Robust capital value growth of 1.6% (versus All Property’s 0.4% contraction) helped drive this figure. Some affordability concerns remain around standard industrial units, where strong rental growth has been recorded. This could curtail rental growth, as some price sensitivity shows in the occupier market.

The occupational market has shown resilience in the face of consolidation, as take-up was stable compared with 2023’s levels across the UK. According to DTRE, vacancy rates for logistics units, compared with the 10-year average, remain elevated at 6.8%, as tenants upscale to new units. Second-hand stock has had little occupational interest, given environmental, social and governance commitments. 

While second-hand stock is unpopular with occupiers, asset management and reversionary opportunities have driven pricing to aggressive levels over 2024 on a net initial basis. Investors have been focused on undersupplied urban industrial units in markets benefiting from strong rental growth. We expect this to continue. Given the structural support, the timing of the cycle, and a slowly shrinking development pipeline, we would expect sharpening yields for logistics and standard industrial units in good locations. This is assuming that economic policy is supportive. 

Retail

Retail led UK property during the third quarter with total returns of 2.3%, according to the MSCI Quarterly Index. Shopping centres emerged as the top-performing segment, generating a 4.1% return and capital value growth of 2.4%, as investor interest returned. Capital values during the first three quarters of 2024 grew by 0.9% after declining 5.7% over 2023. A relatively low vacancy rate of 5.9% also supported the sector’s annualised income return of 6%, versus All Property’s 5%.

Despite rosier returns, the second half of the year was marred by wavering consumer confidence. According to the Office for National Statistics, retail sales declined by 0.8% over the fourth quarter, falling short of expectations and adding to worries about a contracting economy. The latest figures from the British Retail Consortium suggest retail sales rose by just 0.7% over 2024. Food sales were the primary driver, as non-food sales declined by 1.5% over the same period. While we are still seeing positive real wage growth, price increases in clothing and other non-discretionary baskets seem to be deterring in-store sales.

Labour’s Autumn Budget was particularly unkind to the retail sector. Operators were quick to calculate the potential impacts on headcount and free cashflow, as changes to business rates, National Insurance contributions and the National Living Wage were announced. The full effects will filter through over 2025; these could range from higher prices for consumers to wider reductions in headcount. 

Investment activity for retail has been strong, increasing 40% on 2023’s levels and rebounding towards the 10-year average. The listed sector has been particularly active in acquiring retail parks and shopping centres, as capital commitments and recycling chase rebased opportunities with structural support. 

Living

The living sector maintains its strong structural backing, even as the Labour government tries to quash planning and development tensions. A surplus of demand paired with weaker real wages has pushed rents towards affordability limits over 2024, particularly around London and the more costly urban markets. According to Realyse data, rents across Great Britain increased by just 2% over the year to December, with rents in London increasing by just 0.6%. This dynamic is not surprising as mortgages remain comparatively unaffordable. Private-rented sector (PRS) landlords are also removing stock from the market, given less favourable returns and more legal protection for tenants. 

The build-to-rent (BtR) sector aims to pick up a lot of this slack, as institutional capital searches for funding opportunities. With construction and financing costs remaining restrictive, a wave of supply is unlikely despite Labour’s efforts in the planning system. As these newer BtR assets are eventually delivered, they will command higher rents. With greater amenity specifications, they can target the upper quartile of tenants in a way the wider PRS market can’t. 

In the purpose-built student accommodation (PBSA) segment, recent StuRents data highlighted the increasing reliance on international students for UK universities, particularly in the higher-tariff segment of the market . Heading into the 2024/25 academic year, Chinese and Indian student acceptances were down slightly by 1.9% and 3.8%, respectively. Appropriate university and market selection remains crucial in this sector to lower risk exposure. Additionally, as stock is removed from the wider PRS market, the dynamics of some tight PBSA and BtR markets will become increasingly similar.

Outlook for risk and performance

We believe UK real estate will retain much of its forward momentum in the face of global headwinds. Segments such as retail and industrial will continue to outperform because of structural and thematic drivers, although market participants will be watching economic indicators during the period of lacklustre growth. Aside from some tough regional and secondary markets, value corrections in out-of-favour segments have noticeably slowed. 

Despite solid real estate fundamentals, volatility in the fixed-income market is likely to dampen some of the optimism that the market carried into 2025. Global volatility has shaken markets and sent gilts and swaps higher. The Labour government must manage growth expectations without inducing a further sell-off. To achieve this, we expect a reversal in tone that favours spending cuts over additional tax rises. As such, any willing buyers and sellers will aim to wait until volatility subsides; the exception to this will be cash-ready, value-add buyers searching for mispriced opportunities.

Still, real estate fundamentals are supportive, and we expect income yields and active management to drive returns. We have tempered our forecasts over the short term, as capital growth is now expected to take longer to materialise.