As total returns come off their recent peak, while yield compression tails away, performance over the next few years will rely far more heavily on rental growth. But just how much support will this supply?
Annual rental growth reached 4.0% in the final quarter of 2015, not far short of its high water mark this century, the 4.5% recorded in 2007. But in real terms the current rate is much more impressive given the virtually flat level of CPI inflation last year; in contrast, CPI in 2007 averaged around 2.3% and RPI 4.3%.
Prospects for further rental growth this year are still decent, if not quite expected to match last year's. But growth has been far from evenly spread. Our recent UK Property Handbook shows that the office sector has largely driven the improvement over the last couple of years, while the recovery in retail rents has been limited to certain niche segments. The industrial sector, on the other hand, has produced a surprisingly strong recent run of growth.
Offices
As usual in an upswing, central London offices have led the pack, with rental values rising by close to 12% last year. But the number of submarkets that have produced growth far ahead of the core business areas has been a testament both to the capital's continued attraction to businesses and to the increased willingness of occupiers to consider a wider range of locations. The eastern and northern fringes of the City, Belgravia & Knightsbridge, North of Oxford St and Camden all saw office rental growth of between 15% and 20% last year. Outside London, the cities with the strongest growth included Cambridge, Bristol, Birmingham and York.
Retail
The pattern of rental growth in the retail sector highlights the divergent forces currently at play in the industry. While London's West End has seen a frenzy of both investor and occupier interest and rents have risen sharply, elsewhere the consistent run of healthy annual retail sales volumes has not brought rental growth back to pre-financial crisis levels. The growth of online shopping continues to erode sales per sq ft figures for large parts of the retail stock.
On the high street, rental growth is closely linked to asset quality: the top quartile measured by yield (a proxy for quality of asset) saw values rise by 7.3% in 2015, compared with 1.3% for the mid-tier and 0.2% for the bottom quartile. Outside the south east and eastern regions, rents on standard units continued to fall last year.
For shopping centres, out of town schemes have performed more strongly than town centre schemes, but again quality is the key. Over the last four years, prime schemes have seen cumulative rental growth of over 20%, while rental levels in secondary/tertiary centres have consistently fallen.
Industrial
For most large retailers it has become increasingly important to achieve a more flexible warehousing strategy to meet the heightened expectations of online consumers. Competition for industrial property has become fierce in places – in particular smaller buildings that allow retailers to reach key areas of demand. This in turn has driven some impressive rental growth in the sector.
Across the whole sector, rental values rose by 4.6% last year, up from 2.5% the year before. Property in London, however, saw an annual increase of 7.9%.
Over the next couple of years, the consensus outlook expects rental growth in the industrial sector to pull ahead of offices, and for growth in the retail sector to catch up somewhat. In broad terms, all sectors are forecast to see a slowing - but still positive - rental picture, which will feed through into total return prospects.
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