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Perhaps somewhat contrary to the sentiment out there, the retail sector has been a standout performer recently. In fact, according to MSCI, the total return of the sector in the UK was 7.8% in 2024, practically on par with the industrial sector (7.9%) and outperforming the all-property segment (5.1%) for the third year in a row. While income return has been the key driver of total return, yield compression has been evident, driven by the dual forces of asset repricing and improved access to credit. Indeed, investors have benefited from more favorable credit access – thanks to high income yields compared to debt costs – which has translated into lower effective yields on prime retail properties. The positive leverage impact means that, despite challenges in consumer spending, prime retail assets might continue to offer robust, attractive outcomes when viewed through a risk-adjusted lens.

In parallel, the industrial segment has seen pressure on yields in response to continued robust income growth, with NOI growing 4.2% in 2024, comfortably above the 20-year average of 1.7%. Industrial properties, particularly logistics and warehousing assets, have benefitted from strong rental performance driven by sustained demand from e-commerce and supply chain modernization trends. The upcoming pressure from the defense industry will also support this growth. This healthy income increase, delivering its historically outsized share of total return, has allowed investors to accept lower yields in exchange for growing cash flows. The yield drop here is less about capital value correction, as in the case of the retail sector, and more about a solid fundamentals story that is resonating well with institutional and private investors alike.

Meanwhile, the prime office market has maintained a relatively stable yield environment. Secondary offices are a different story. But for prime offices, there is downward pressure on yields from strong repricing upwards when it comes to rents in key locations, due to the relative shortage of prime assets in areas where tenants want to be. At the same time, the sector is held back by significant headwinds such as high obsolescence risk and a noticeable lack of investor interest.

Many older office assets are now facing scrutiny due to their outdated design and limited adaptability, making investors hesitant despite potential short-term rental growth in prime segments. This highlights the need to distinguish clearly between prime and non-prime offices, and the challenges the sector faces in adapting to a rapidly changing work environment.

Finally, the residential sector (student housing included) has shown stable yields since spring last year. Notably, the prime segment of this sector experienced the smallest increase in yields compared to the other sectors discussed. This is primarily due to the high demand for rental properties caused by the housing shortage in the UK. In fact, the market rental growth in the residential sector was 5.3% in 2024, on par with the industrial sector.

Figure 1 – UK commercial real estate: prime yields, key sectors

The driving forces behind these trends are the prevailing interest rate environment, intertwined with the complexities of supply and demand in different markets and even individual assets.

The current interest rate environment has been shaped by the Bank of England’s cautious approach where rates have been kept high enough to steer inflation towards its target while also being low enough to support credit market stability. Real estate investors are acutely aware that further significant rate increases, e.g. due to negative price impacts from tariff uncertainties, could negatively impact debt sustainability and asset prices, necessitating careful application of leverage.

In this context, it is crucial that interest rates do not spike unexpectedly. Nobody wants to see a repeat of autumn 2022, when 10-year gilt rates rose more than 2 percentage points due to inflation and fiscal budget mismanagement. Although macroeconomic pressures remain in play, with the 10-year gilt rate now back at levels it was last seen around the beginning of this year, the risk of higher rates remains if inflation is higher than expected. This could push property yields higher, particularly for assets that lack operationally security. Stability in rates will be the lynchpin for sustaining improved market sentiment across segments.

Looking ahead, the outlook for UK commercial real estate yields appears stable, driven by income and income growth. We do not expect any major yield movements but continuing access to credit and effective asset repricing have laid a foundation for small but sustained yield compression in both the retail and industrial segments. For the office sector, however, the narrative remains more complex. Stability is currently maintained, but investors must remain alert to the risks posed by aging building stock and evolving tenant requirements. As the market evolves, ongoing investment in modernization and strategic asset upgrading will be pivotal if landlords are to stave off obsolescence and attract quality tenants over the long term.

Another key factor that will determine success in this varied landscape is asset selection. Choosing the right assets is crucial to generating attractive, risk-adjusted returns, driven in no small part by yield compression on the asset level even if the market as a whole does not see a similar drop in yields. MSCI, which benchmarks many properties’ performance against their benchmarks, has pointed out that can account for ca. two-thirds of the tracking error in returns compared to the benchmark. This is especially important at times of stress. Investors who are discerning in their asset allocation and focus on quality – and not simply on headline yields – are best positioned to weather market fluctuations and capitalize on emerging trends.

While the market retains an overall slightly positive momentum, ongoing vigilance will be essential. A stable interest rate environment, coupled with careful underwriting and innovative asset management, will determine which assets ultimately thrive in the current opportunistic landscape.