BMI View: T he UK commercial real estate will continue to outperform that of much of the Western European region over the next two years as the country's solid economy recovery continues to support demand across the three sub-sectors we monitor. However, rental rate growth is set to moderate as high supply weighs on demand.
The UK boasts an extremely developed commercial real estate sector, with a strong private sector-led economy supporting robust demand across the office, retail and industrial real estate segments. The market's trajectory has roughly followed that of the wider economy over the past few years, with the UK's recovery from the 2008/2009 financial crisis and subsequent economic downturn among the most impressive of any of the OECD region.
The office and retail real estate sub-sectors in particular have enjoyed particularly strong growth over the past few years with recovery in the financial services and retail sectors supporting new demand for commercial space. Of the two, it is the performance of the retail real estate market that has arguably been the most impressive, as falling unemployment and strengthening consumer confidence has driven household spending and retail sales higher
The odd one out in this equation is the industrial real estate segment, where rental rate and yield growth has been limited over the past few years. The need for manufacturing space has declined as the UK de-industrialises and a sluggish recovery by the UK's main eurozone export markets dampens demand across the sector. However, a lack of supply in logistics and other retail facilities means that rental rates for the industrial market are likely to hold steady over the coming quarters. At the lower end of the market, significant opportunities exist in the high-growth industrial space such as urban and edge-of-town distribution centres for small load deliveries as e-commerce evolves.
One of the main drawbacks in the country's commercial real estate sector until now has been its dependency on London, where the majority of investment and development activity is still channelled. Rental rates for Central London office and retail space remain considerably higher than those of the rest of the country, with the capital still the focus of the UK's financial services and tourism sector.
However, significant expansion in the supply of commercial space in the capital over recent years has started to weigh on rental rate growth, which has started to plateau. Meanwhile, speculative inflows from foreign investors into the market have forced asset prices higher, reducing rental yields. We note the increasing regionalisation of the UK commercial real estate sector as firms look to diversify rental and investment activity away from the capital in an effort to lower costs. H114 saw particular growth in office take-up in Manchester in particular, while smaller regional markets, such as Cardiff have also witnessed strong growth in leasing activity. H214 saw significant growth in transaction activity away from the capital as the UK's economic recovery started to balance out and gain traction across the wider regions. While the majority of investment volumes in the regional market have so far come from local companies, we note that interest from international investors is starting to pick up as well.
In December 2014, industrial real estate developer SEGRO was revealed to have sold a significant portion of its UK industrial real estate portfolio to O rchard Street Investment Management. The company reportedly sold six industrial estates for GBP113.mn in order to help pay off its debts and finance future developments. The estates include 97 warehousing unites in the Greater London area.
Brazil's Safra Group has completed the GBP700mn purchase of the Gherkin building, which is located in the City of London.
Swedish construction firm Skanska is reported to have signed a GBP198mn (USD311.14mn) agreement with Development UK for the construction of a 35-floor office building at 52 Lime Street. Work started in December 2014 with completion scheduled for 2017.
Private equity real estate fund manager Benson Elliot has purchase the Mander Centre in Wolverhampton for GBP59mn (USD92.51mn) from Mander Investments. The 620,000-square-foot property is expected to undergo a renovation worth GBP30mn (USD47.04mn). The centre consists of more than 100 retail units and the purchase is part of Benson Elliot's regional investment programme.
Key BMI Forecasts
Office rental rates in London will continue to rise in 2016, growing by 1-2% and driven by strong occupational market.
Retail and industrial rental rates, meanwhile, are forecast to remain unchanged over 2015-2016 in the three cities we monitor.