Key findings

  • Annual all-property rental growth touched a cycle high of 4.1 per cent in September, marginally ahead of the previous peak of four per cent seen in August 2007
  • The combination of healthy occupier demand and low supply has put upward pressure on Central London office and retail rents leading to a number of new rental records being set of late.
  • Under our main case economic scenario the outlook for occupier markets is broadly positive but with significant variation by sector
  • Our forecast of two per cent annual UK all-property rental growth between 2016 and 2020 is significantly front loaded with average annual rental growth slowing steadily in each of the next five years

From here, we expect rental growth to take over from yield compression as a key driver of UK real-estate returns

Thanks to a combination of restrained supply, falling vacancy rates and steady economic progress, overall rental growth in the UK real-estate market is now at levels not seen since 2007 and is playing an increasing part in total returns as yield compression runs out of steam. According to the latest data1, annual all-property rental growth touched a cycle high of 4.1 per cent in September, marginally ahead of the previous peak of four per cent seen in August 2007.

Since bottoming-out in 2009 in the aftermath of the global financial crisis, the London office and prime retail sectors have led the rental growth recovery. Regional occupier markets took much longer to stabilise but are now firmly in recovery mode and, in some cases, exceeding previous highs.

At the sector level, industrial rents are now growing more than three times as fast (4.6 per cent2) as they were back in 2007. Meanwhile, office rents are currently growing at 8.5 per cent pa, which is close to 2007 peak levels.

But there are still pockets of relative weakness. At just 0.5 per cent, growth in retail rents is now bringing up the rear. Back when the financial crisis hit in late 2007, retail rents had been growing continuously for over a decade. The sector is still struggling to slough-off the excesses of these years while facing up to a range of structural challenges to its existing formats.

This helps to explain why total returns from UK retail properties in the third quarter (2.2 per cent) were around half those delivered by office and industrial properties.

Looking ahead, while yield compression slows we expect rental growth to remain positive over the next five years. Under our main economic scenario, rental values should grow steadily rather than powering ahead, although there will inevitably be variation around the country.

Nevertheless, our forecast of two per cent annual UK all-property rental growth between 2016 and 2020 is significantly front loaded with average annual rental growth slowing steadily in each of the next five years as both occupier demand and the development response become more balanced.

The UK office market

With around 20 per cent more inhabitants than the UK’s ‘Big Six’ office markets – Bristol, Birmingham, Manchester, Leeds, Glasgow and Edinburgh – put together, London’s office markets will always exert a strong pull on domestic and international office occupiers. London is also the most volatile rental market but since bottoming-out in 2009, the Central London office occupier market has gone from strength to strength. So far, this is showing few signs of slowing down (see Chart 1).

In the first half of the year, Central London vacancy rates dropped to just six per cent (see Chart 2), half the current average vacancy rate seen in the Big Six markets. The last time that UK vacancy rates were lower was back in 2001.

The nadir in vacancy rates reflects the restrained levels of new development that have come onto the market since 2007. The excesses of the previous cycle are still fresh in the memory of many developers while banks have been far more reticent when it comes to lending. Although there are clear signs that credit conditions are improving, there are substantially more developments now being financed via equity than was the case back in 2007, which partly reflects this newfound risk aversion.

According to CBRE, take-up in London’s three major sub-markets of the City, West End and Midtown remained well above the 10-year average in the third quarter. This combination of healthy occupier demand and low supply has put upward pressure on rents leading to a number of new rental records being set of late.


We expect this to continue in the near term, but further ahead there are signs of a supply response gathering pace. Overall availability actually rose in Central London in the third quarter, after eight consecutive quarters of decline, as the leading edge of a wave of new supply began to be marketed. According to Deloitte’s Central London Crane Survey, the first half of this year saw the second-largest increase in new starts in the past 20 years bringing the total volume of office space now under construction to 9.5m sq ft, with almost half of this in the City. Assuming levels of occupier demand remain robust, this level of construction is not a major cause for concern. Nevertheless, an increase of supply on this scale should ease the pace of rental growth in the years ahead.

Encouragingly, we’re also now seeing far more buoyant demand in the UK’s key regional markets. The second quarter saw a surge in lettings with DTZ estimating that total take-up in the eight largest regional markets – namely the Big Six plus Cardiff and Newcastle – was 50 per cent up on the long-run average. After seven consecutive quarters of above-trend take-up, availability continues to decline across all eight of these locations with Grade A space becoming especially scarce.

This is now driving rental growth in the UK’s regional office markets and prompting developers to respond. As in London, this means that rather than booming, rental growth in the regions is likely to be more measured over the medium term.

Industrial markets

Although slower to recover than prime offices, a combination of limited availability and slowly improving economic fundamentals have finally delivered rental growth to the industrial sector. We are forecasting rental growth for all-industrial properties to hit 3.9 per cent this year, driven by growth of more than five per cent in the South East.

Looking further ahead, our forecast of 2.5 per cent average annual industrial rental growth over the five years to 2020 is significantly higher than the 1.9 per cent and 1.6 per cent we’re forecasting for the office and retail sectors respectively.

After two years of unspectacular expansion, activity in the manufacturing sector is now softening but forward-looking indicators such as new orders remain positive. This suggests that a pronounced decline is not on the cards. Despite being some five per cent below its 2008 peak, the weakness in UK manufacturing activity has not deterred leasing activity in the industrial and logistics sectors.

According to DTZ, the manufacturing sector still accounted for a healthy 28 per cent of floor-space lettings in the first half of the year, but it’s retailers which are the largest players in today’s market. They accounted for 36 per cent of take-up in the first six months of the year as non-food retailers continued to build the distribution networks they need to grow their online sales.

Although there was a sharp decline in speculative development in the wake of the financial crisis, recent quarters have seen a marked pickup with still more on the cards, altering the supply dynamics in the sector. This should halt the downward trend in availability given time.

In the meantime, with demand strong and availability still low, negotiating power has tilted towards landlords. Incentives have tightened and rents are still advancing in most parts of the market with the most significant recent increases seen in the West Midlands and London.

UK retail markets

The fundamentals of the UK’s consumer sector have been steadily improving for some time now. Retail sales growth remains robust with August sales volumes up by 3.7 per cent. This was the 29th consecutive month of year-on-year growth – the longest period of sustained growth since 2008.

Although the pace of sales growth may now be easing, it seems unlikely that this is a precursor of a more pronounced weakening. Conditions in the labour market remain supportive of household finances, wages are now growing faster than general prices while employment growth continues its strong run of recent years.


After declining for the last six years or so, average retail rents finally stabilised in 2014 and are now seeing modest growth. Across the UK as a whole, high street rental growth is now a modest 0.5 per cent3 but this naturally masks diverse extremes in performance by region and asset quality. Unsurprisingly, Central London shops continue to outperform with low vacancy, booming tourist numbers and extremely strong demand from international retailers still driving new records.

Retail rents in Central London may have risen by over 13 per cent in the year to September, but they are struggling elsewhere and even declining modestly in some areas. So far, it’s been prime locations that have proved most resilient while many less affluent town centres continue to battle with high levels of vacant and what’s now probably obsolete space.

Outlook for rental growth

The outlook for UK real-estate total returns remains positive over the short and medium term and we are now forecasting average annualised returns of 6.4 per cent for the five years to 2020.

Although yield compression will continue to be central to near-term prospects, we expect rental growth to contribute a greater proportion of portfolio returns over the medium term (see Chart 3). This means we can expect above-trend returns to continue into next year. In the medium term, total returns are likely to ease as yield compression slows. The extent to which rental growth can offset this slowdown will be central to delivering attractive total returns in future.

1 Source: IPDMI year-on-year all-property rental growth to 30 September 2015

2 Source: IPDMI year-on-year industrial rental growth to 30 September 2015

3 Source: IPDMI year-on-year data to 30 September 2015

Important information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 12 November 2015. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Some of the information within this document is based upon Aviva Investors estimates. It is not to be relied on by anyone else for the purpose of making investment decisions. This document should not be taken as a recommendation or offer by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation.

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