Oliver Kummerfeldt, Head of European Real Estate Research at Schroders Capital:
The UK economy continues its slow and uneven recovery in the face of fiscal challenges, uncertainty over geopolitical events and shifting global trade policy, while the UK real estate market continues its own uneven recovery following a significant correction.
Economic backdrop
The UK economy continues its slow and uneven recovery, with fiscal challenges, uncertainty over geopolitical events and shifting global trade policy continuing to cloud the outlook.
UK-US trade deal in place – but uncertainties persist
Following the seismic shift in US trade policy in April, the UK government succeeded in securing a trade agreement with the US, resulting in tariff reductions for several key exports. This development contributed to notable improvements in May’s PMI figures and prompted an upward revision of the UK Consensus GDP forecast for 2025 in May and June to 1.0%, from 0.7% in April.
However, it is important to recognise that many UK exports to the US will remain subject to increased tariffs, and global trade policy risks persist, with the potential for supply chain disruptions or negative repercussions for the UK from higher tariffs imposed on major trading partners.
Latest business surveys indicate that businesses and consumers continue to face numerous challenges. For services firms, the June PMIs signalled the largest operating margin squeeze in more than two years, following increases in national insurance contributions and minimum wage levels. Simultaneously, households are experiencing renewed financial pressure, following tax increases including higher stamp duty, and a re-acceleration of food price inflation.
UK public finance pressure has intensified
The UK’s public finances also remain under pressure. The June Spending Review underscored the difficult trade-offs facing policymakers, given limited fiscal headroom and elevated borrowing costs. Increased spending commitments for social housing, the NHS and defence – the latter following the NATO summit’s agreement to raise defence spending to 5% of GDP by 2035 – have intensified budgetary pressures. Furthermore, partial policy reversals on welfare spending cuts and winter fuel payments have further eroded the government’s already narrow fiscal margin.
Further interest rate cuts likely later in the year
Monetary policy remains supportive, with the Bank of England (BoE) reducing the policy rate by 0.25% in May to 4.25%. Nevertheless, factors including increases to the energy price cap, National Insurance contributions and minimum wage contributed to a jump in the annual consumer price inflation (CPI) rate to 3.4% in May. At its June meeting, the BoE’s Monetary Policy Committee (MPC) opted to keep rates on hold, pointing to the need to see further progress in the disinflationary process for rate cuts to continue.
However, while the headline CPI temporarily accelerated, broader inflationary pressures continued to moderate. Services inflation decelerated, wage growth in May undershot expectations, and labour market conditions softened, with the unemployment rate rising to 4.6% – its highest level in nearly four years. Consequently, market participants assign a 75% probability to another 25-basis point rate cut at the next MPC meeting on the 7th of August.
UK real estate market
Capital values and rents continue to recover
Against this mixed economic backdrop, appraised UK real estate capital values have continued to recover since summer 2024, driven by a combination of modest rental growth and yield compression. All property capital values recorded in the MSCI UK Monthly Index for May 2025 are now 2.7% higher than a year ago, underscoring our view that following the significant correction of 25% between mid-2022 to mid-2024, a cyclical recovery in values is expected. We continue to project returns of 7-8% this year and approximately 8% per annum over the next five years, above the long-run average.
In the short term, elevated economic uncertainty is expected to weigh on occupier sentiment, leading to subdued business spending and some firms postponing decision-making. At the same time, however, there remains a scarcity of modern, high-quality space, and elevated construction costs will likely curtail new supply further, which in turn should support rental levels and future rental growth.
Investment outlook
Sector views: Industrial, retail and office
Across sectors, we continue to favour industrial estates (including outdoor storage facilities), cross-dock warehouses, and urban logistics assets benefitting from e-commerce and urbanisation trends. We believe that the shifts in trade policy are likely to accelerate nearshoring dynamics and lead to occupiers holding higher inventories where financially viable, even if tariffs might ultimately prove to be short lived. There is also a growing threat of obsolescence in the sector, with over 50% of UK stock more than 10 years old, according to JLL, and many major occupiers having introduced carbon reduction targets, which supports demand for new and refurbished space going forward.
The retail sector appears to have stabilised, however ongoing headwinds to consumer spending and persistent margin pressures mean our preference remains for retail parks with minimal exposure to fashion, particularly those attracting discount and mid-market retailers, as well as convenience formats such as supermarkets.
In the office sector, we maintain a selective approach, focusing on well-located, high-quality offices with sustainability certifications1 in London, major regional centres and knowledge-driven cities. Recent announcements from major corporations indicate an increased return to the office, albeit we remain confident that hybrid working arrangements will be a permanent feature of the market. As a result, occupiers are expected to continue to seek high-quality space to attract and retain talent, encourage attendance and foster collaboration.
Modern office space is already scarce across all major central business districts (CBDs), and we anticipate that the imbalance between constrained future supply and rising demand for best-in-class will intensify. We see potentially mis-priced opportunities to execute upgrades and refurbishments of well-located workspaces.
Sector views: Self-storage and ‘living’ segments
UK real estate portfolio allocations are evolving to include more operationally intensive real estate segments able to provide, at a minimum, inflation-linked cashflows. These can be delivered both directly and indirectly, with outsized income growth potential aligned to the success of the business activities taking place within the properties.
This includes self-storage, which is benefitting from the growth in household formation and e-commerce, as well as representing an attractive consolidation opportunity. We see notable opportunities to create these formats by converting and repurposing existing assets into higher-value alternative use.
Living and ‘social infrastructure’2 segments such as doctors’ surgeries are providing long-term resilient cashflows and are to a certain extent driven by longer-term demographic trends and less by economic cycles.
We are observing an ever-increasing opportunity for private capital to fund the development of affordable and social housing3 formats that can subsequently provide contractual inflation-linked income and positive impact attributes. This strategy is set to benefit from strong government policy support and could potentially see a further increase in demand if a prolonged period of economic weakness starts to affect more households.