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Budget anxiety saps momentum from typical year-end push

Commercial property returns

According to MSCI, average commercial property values dropped by 0.1% in October, the first negative reading for 14 months. On average, capital values have increased by 3.1% from their cyclical low, but are still, on average, 22.7% below the preceding cyclical peak.

The average decline was driven by the Office sector which saw values fall by 0.9% month-on-month. The sharpest falls have been in the South East; down 2.0% in October and by 41.4% since June ’22. More surprising was the 0.6% drop in Central London office values, following a run of monthly gains. The decline reflects an outward shift in valuation yields rather than a drop in rental values, which have been edging up in most regions.

The Industrial sector is still recording capital growth, but at a much-reduced rate. Values have risen by 2.6% YTD, backed up by solid rental growth of 3.3%. Standard Industrial has outperformed YTD, with capital growth of 2.9% vs 1.9% for Distribution, and rental growth of 3.5% vs 3.0%.

Retail values continue to edge up very gradually, with 0.1% capital growth in October taking YTD growth to 1.4%. This has been fully underwritten by rental appreciation of 2.0%. This slow but steady rate of capital and rental growth appears to be broadly consistent across Retail formats.

Investment market activity

Preliminary data from Real Capital Analytics suggest that October was by far the strongest month for investment so far this year. However, the £6.1bn total was inflated by the takeover of Assura by PHP. RCA data reflects the £3.1bn gross value of Assura’s portfolio of GP surgeries. That transaction aside, the £3bn monthly total was in line with trend.

Another large scale and unusual deal impacted on the figures for October. Oracle founder Larry Ellison committed £890m to expand his technology institute in Oxford. The investment will extend the Oxford Science Park deliver a 2m sq ft complex that can accommodate up to 7,000 staff. Previous plans unveiled in 2023 were to deliver 300,000 sq ft on the site.

Continuing a recent trend for recapitalisations, Sixth Street and Clipstone Investment Management have seeded a new JV by hiving off a £350m portfolio from Clipstone Industrial REIT, a Guernsey-listed entity. The portfolio comprises 37 estates located in the South East.

Two sizable London office deals closed in October. Royal London Asset Management acquired 1 Newman Street, which includes retail frontage on Oxford Street, from GPE for £250m, a yield of circa 4.5%. In the City, Turkish developer Enka bought Park House on Finsbury Circus for £186m.

Two significant but contrasting mixed-use London assets traded in October. Mago Capital acquired the majority of the Notting Hill Gate Estate from a JV between Frogmore and Morgan Stanley for £125m, reflecting a yield of 6.5%. The estate comprises three buildings and accommodates a range of retail and office tenants across 145,000 sq ft. Elsewhere, Aberdeen acquired 2-5 Old Bond Street for £120m, a yield of 3.5%.

Market yields

Market expectations for further rate cuts seem to have been brought forward by the latest inflation data. Strangely, this happened even though inflation had been expected to slow by more than it did. At the time of writing the five-year SONIA swap was priced at 3.6%, with the curve implying a high likelihood of a December cut, and a terminal rate of 3.5% by mid-2026.

The latest property yield sheet from property adviser JLL, continues to show very little momentum on yields in either direction. The only change since last month is that the agency now perceives that the secondary Retail Park benchmark yield is expected to soften from its current level of 7.0%.

In contrast, JLL continue to expect prime benchmarks for larger lot-size Central London office assets to move in. The £125m sale of 1 Newman Street, reflecting a yield of 4.5%, would appear to lend some weight to this. However, the picture is muddied by the mixed-use nature of the asset, with a significant element of Oxford Street-fronting retail included alongside the office element.

JLL perceive that Build-to-Rent benchmarks remain stable, ranging from 4.25% in Inner London to 4.5% for prime regional assets. However, anecdotal evidence would suggest that where trades are happening these are happening at yields of 5%+. This may reflect idiosyncratic issues around the assets being traded, but there is little clear evidence of sub-5% activity.

Auctions

Following their auction in September, which was the largest for 3 years, Allsop’s commercial auction in November was a more modest size. 87 lots were listed, of which 66 were available on the day. 50 assets achieved a sale, raising total proceeds of £31.8m, little more than half of the equivalent auction last year.

The highest price achieved was £2.5m for two large retail units on the Isle of White let to TK Maxx and Mountain Warehouse. The price reflected a yield of almost 14% and a value of circa £42 / sq ft. Trade counter and convenience retail units proved popular with investors, including a Tesco in Maidenhead sold with 7 years on the lease for £1.57m (5.4% net initial yield).

Market forecasts

The latest commercial property forecasts published by property adviser Colliers predict an increase in the rate of capital growth, from a projected 2.6% this year to 4.2% in 2026. Over the five years from 2025 to 2029, Colliers anticipate 2.8% p.a. capital growth, supported by 2.6% p.a. rental growth.

Colliers expect that the Industrial sector will continue to outperform, with capital growth picking up from 3.1% this year to 3.7% next. They expect this to be supported by rental growth of 3.3% next year (down from 3.7% in 2025). Slightly slower growth in later years is expected to add up to 2.9% capital growth p.a. from 2025 to 2029, fully underwritten by rental growth of 3.5% p.a.

The Retail sector is predicted to outperform on a total return basis, with a high income return and moderate capital growth (2.4% p.a.) supporting a total return of 8.6% p.a. over the five-year period. Colliers expect shopping centres to be the top performing sector of all on this basis, with a total return of 10.8% p.a., despite only moderate rental growth of 1.7% p.a.

The outlook for offices looks benign at a market-average level, with capital growth of 2.8% p.a. supported by 2.2% p.a. rental growth. However, total return forecasts at a regional level paint a very mixed picture, with London West End predicted to deliver 7.2% p.a., whilst Outer London is expected to deliver a total return of just 5.0% per annum, implying flat capital values at best.

Looking forward

Whether the property market recovery finally kicks into gear in 2026 seems largely dependent on two factors. First, will the Bank of England deliver the short-term base rate cuts that money markets are expecting? Inflation is expected to drop back over the coming months due to base effects, which will probably give the MPC enough cover to further reduce rates. This should help to make debt accretive for more sectors, although hedging rates will likely only improve if the MPC delivers more than the two cuts that are currently priced in. The effect will be more meaningful if a fall in base rate is mirrored by a decline in Gilt yields, which will in turn be influenced by perceptions of stability and prospects for growth in the UK economy. Lower Gilt yields will encourage more equity into real assets and will make property yields at current levels look more attractive. However, the second factor is arguably the key to whether the market looks good value or simply fair value. Will the relatively benign occupier conditions seen this year persist next, despite fiscal retrenchment and forecasts of sluggish economic growth? According to data from MSCI, commercial property rents increased by an average of 3.3% this year, a headline annualised rate that has remained steady for the last couple of years. In fact, the trends behind this headline number offer still more encouragement, given that growth has become more broad-based and less dependent on the Industrial sector. This rental appreciation has come despite persistently tepid economic growth. The main reason for this apparent anomaly has been the shortage of modern space caused by a constrained development pipeline allowing landlords to benefit from broader inflationary trends. A reminder that as a real asset, property investment does offer a genuine upside to returns relative to bonds.

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