UK economic outlook

Activity

Gross Domestic Product growth was stronger than expected over the first quarter, expanding by 0.7%. However, initial data shows a 0.3% contraction during April, driven by a fall in services output. In May, retail sales also contracted sharply, and provisional estimates suggest a monthly payroll reduction of 109,000 employees (-0.9%). Economic data is expected to remain soft throughout the rest of the year. There is pressure on long-dated gilt yields, raising the cost of borrowing and threatening Labour’s already narrow fiscal headroom situation. The government is struggling against its self-imposed fiscal rules. As spending cuts are proving challenging to rally behind, tax increases may be inevitable at the next Autumn Budget.

Inflation

The 12-month change in the Consumer Price Index was 3.4% in May, and it’s expected to remain elevated over the short term. Over the same period, services inflation also came in stickier than ideal at 4.7%. But there is a clear slowdown underway in the labour market, which should help alleviate the pressure. In some positive news, it appears that the impact of shifting global trade policy will be smaller than initially expected.

Policy

The policy rate was held at 4.25% in June in a 6-3 decision. Underlying uncertainty around supply and demand in the economy, and the potential strength of rising input prices, seemed to make the Monetary Policy Committee’s decision more clear-cut than in prior meetings. We still expect two further 25 basis-point cuts to feed through by the end of the year. But if inflationary uncertainty subsides and labour weakness persists, there could be a path to swifter reductions.

Source: Aberdeen, June 2025
Forecasts are a guide only and actual outcomes could be significantly different.

UK real estate market overview

Over the 12 months to May, UK real estate produced an 8.7% total return¹. Returns have been gradually climbing since the start of the year. Capital growth continues to feature in limited quantities, although this is not broad-based and features primarily in the retail and industrial sectors. It’s these sectors that have led 12-month total returns at 11% and 10.5%, respectively, while offices remain the primary laggard at 3.1%. Year-to-date returns for both retail and industrial stand around 3.6%, while all property is slightly lower at 3.2%. Residential was actually the top performer over the first five months of 2025, producing a 4.2% total return.

Income is driving returns, as meaningful yield compression appears off the table for now. While this trend continues, the higher-yielding retail sector is likely to outperform within both the MSCI Monthly and Quarterly Indices. In the latter, data available during the first quarter shows a similar story across the segments, although returns are slightly lower given the lower-yielding profile of assets in the MSCI Quarterly Index.

A subdued investment market and a restrictive monetary policy position will hold back capital values in the interim, but we would expect to see some yield compression when these improve. All property saw 2.7% capital growth in the 12 months to May, with industrials leading at 5.2%. Offices remained a drag on the index at -2.3%, as last year’s capital value declines still fed through.

Investment volumes started the year slowly and have since slowed even more. Preliminary data shows second-quarter investment volumes fell 27% from the same period in 2024². A total of £16 billion was transacted over the first half of 2025, defined by a marked slowdown in cross-border capital. The UK is favoured by international investors, but global macroeconomic uncertainty has held volumes back.

UK real estate market trends

Offices

The main story with the office sector remains centred around polarisation. Sentiment towards offices is becoming clearer as demand for prime office space outpaces the construction pipeline. Indeed, rolling annual take-up in London was nearly 19 million square feet during the first quarter³. While large pre-lets contributed heavily, a lack of prime space will go some way towards convincing occupiers to look at lesser-quality buildings in good locations. This trend could be mirrored in the regional markets. For instance, Bristol and Edinburgh see prime rents approaching £50 per square foot, pressured by a lack of prime stock. Some regional occupiers will be willing to forego paying top rent and accept lesser quality space, although this will be highly location-dependent.

Returns for the sector are unsurprisingly being led by the favoured central London submarkets, as a lack of supply and healthy demand drive competitive tension. The Mid-Town and West End segment saw a 6.2% total return in the 12 months to May1. While this was below All Property’s 8.7%, it was much improved on the -6% return seen over the same period one year prior. At a market level, capital values are improving and recorded flat growth during May. We don’t expect broad-based capital value growth from this point; instead, best-in-class offices and those in superior locations will benefit most from strengthening demand and trickling supply. Poorly located secondary assets will suffer.

Along with the wider market, investment activity has been subdued, down 16% year on year over the first half of 2025². Transactions above £100 million remain more or less off the table. Improving sentiment and clarity in the sector have yet to translate into investor appetite for large lot sizes.

Industrials and logistics

Industrials and logistics are still a favoured sector, but one that is evolving from its prior dominance. Around London and the hotter south-east markets, certain areas are slower to absorb higher vacancy rates and affordability ceilings are pushing occupiers towards more feasible markets. Nationally, occupier consolidation and moderating leasing volumes have resulted in 26 million square feet of negative net absorption over the past 12 months³. A slowdown in construction starts should support the sector overall, although this will be market-specific.

Rental growth is moderating across the sector after years of strong growth. While this has meant double-digit annual rental increases, particularly for prime London stock, there is now a looming affordability ceiling in these same markets. While rents are unlikely to fall significantly, we would expect to see moderation continue into a more normalised annual growth rate. In the Rest of UK markets, where rental growth has been less explosive over recent years, we see more room for growth over the short-to-medium term.

Despite a slowdown in leasing, support for the sector can be found through a reduction in construction starts. On a national scale, these are now at their lowest levels in over a decade and completions should follow this trend heading into 2026³. Certain markets have seen more supply recently and are more exposed to shifting conditions, as a result. Therefore, the sector-wide call is becoming more concentrated on market- and asset-specifics.

While year-on-year investment volumes were down around 16% during the second quarter², merger and acquisition activity made headlines as investors searched for scale. In terms of investor preferences, industrial and logistics remain one of the favoured sectors, even if the outlook is more nuanced than it has been.

Retail

The retail sector is holding steady, while working through various headwinds. Not only have increases in National Insurance Contributions and the National Living Wage fuelled input costs for retailers, but recent global uncertainties have weighed on the consumer too. These headwinds seem to be abating, and consumer confidence rose over the second quarter to stand at -18, – up from -23 in April⁴.

The retail sector recorded a total return of 11% over the 12 months to May1. Shopping centres led the segment, owing to their high income returns. As a result of stalling capital growth, retail warehouse returns declined and recorded just 0.5% over the month (down from 1.4% during January). Rents seem to be falling across the sector as demand weakens. But prime destinations should continue to outperform, supported by a lack of construction starts.

Retail sales were down 0.1% year on year during May, owing to a tough month for food sales⁵. More positive consumer confidence around personal finances bodes well for the sector, though, and real wage growth is still feeding through (1.4% in April). On the one hand, the household savings ratio declined over the first quarter, suggesting consumers are more willing to part with their money. On the other hand, positive trading results show that there are still plenty of value-conscious consumers. This will benefit discounters like Lidl, Aldi, B&M and Home Bargains.

Living

The living sector topped recent investor preference surveys. It isn’t difficult to see why: on a five- and 10-year basis, residential has beaten All Property total returns. Throughout the past 12 months to May, returns have strengthened to 9.5%. Private rents increased 7% over the year to May⁵. Northern regions led the trend as affordability pressures grew in the south. As a percentage of the MSCI Quarterly Index, the living sector now makes up around 10% compared with just 2% four years ago. This highlights the rapid growth in its popularity.

Structural support for the build-to-rent (BtR) sector remains firmly in place. Housing starts over 2024 were nearly a third lower than in 2019, according to the Office for National Statistics. Of homes that are already built, the combination of a high house-price-to-earnings ratio, sizeable deposits and higher mortgage rates supports a growing BtR market. The scope of products is evolving, too, as single-family homes drove around 40% of total BtR investment volumes over 2024².

The purpose-built student accommodation (PBSA) segment is showing a more nuanced picture. Overall applications to UK universities are up 1% for the 2025/26 academic year, with international (excluding EU) applications up 3.1%⁶. However, there are potential headwinds to consider with international cohorts, including shifting government policies and affordability pressures. Due to the current funding model, any slowdown in international fees can result in swift financial headaches, which we are seeing across even some higher-tariff universities. We still see PBSA as a favoured sector, but to ensure continued performance, we have an additional layer of caution around university fundamentals and student demographics.

Outlook for risk and performance

At present, there are still domestic and foreign headwinds that could affect future performance. On a domestic level, anaemic growth and sticky inflation are slowing decisions from both a fiscal and monetary policy perspective. The fiscal headroom headache doesn’t seem to be going away anytime soon and may hurt growth prospects in the short term. International headwinds include the disruption of global trade and the continuation of conflict in the Middle East, facilitated by the US administration. This could pose an additional inflationary risk.

Still, the UK real estate market appears favourable among international investors. Once again, it was the top destination for cross-border capital during 20242. A noticeable trend of disinvestment from the US has been occurring, and the UK and Europe may stand to benefit.

We still see UK real estate performing well, and we are forecasting an annualised 8.4% return over three years. Importantly, we expect sector returns to converge. While this may make outperforming slightly more challenging on a sector-allocation level, it will provide opportunities for asset-specific outperformance. In addition, more consistent returns across All Property may help to provide confidence to the investment market.