Fund Finance Insights

Retail sees average capital values hike

6 minute read time

A closer look at the latest data from the commercial property market

Polarisation of the market drives investors to seek alternatives

A defining characteristic of the commercial property market this year is the mismatch between buyers and sellers. There are plenty of willing sellers of retail assets but still few serious buyers, while owners of industrial assets are under siege from an endless queue of eager would-be purchasers. Some investors sense the possibility of a bargain in the office sector given uncertainty around the impact of home-working, but owners who have been successfully collecting rent during the pandemic have seen little need to provide one. Against this backdrop, some investors with cash to deploy are seeking a home in less mainstream parts of the market. Build-to-rent (BTR) continues to attract increasingly diverse capital, while several large deals have completed in the student sector, despite the challenges of the pandemic, and life sciences has emerged as a target for a wide range of investors.

There is, of course, nothing very alternative about residential, but it is nonetheless relatively new as an institutional asset class in this country. Although occupancy rates have dipped during the pandemic, this has done little to dampen the enthusiasm of those investors looking to build scale at pace. In the early years, the typical model was for purpose-built blocks in London and the largest regional cities, and the shortage of suitable stock meant that anyone looking to enter the sector would most likely have to build a portfolio from the ground up. More recently, the range of residential formats attracting interest has become far more diverse, and a highly competitive secondary market for good-quality stabilised assets has emerged. The forerunner of BTR, in many ways, was the student sector – and it was making a strong case for being considered mainstream prior to the pandemic. Investors have been understandably cautious while university life has been so heavily curtailed, but significant deals from the likes of GIC and Lone Star suggest investors are starting to look through the pandemic. As for life sciences, what was a very niche sub-sector has gained prominence as a direct consequence of the events of the past year.

Commercial property returns

  • Investment research firm MSCI reports that commercial property values rose by an average of 0.6% in May. Following a 6.3% decline in 2020, average values have now picked up by 2% so far this year. However, that apparent rebound has been entirely driven by rapid growth in industrial values.
  • Capital values in the industrial sector are up by 7.5% already this year and are now 11% higher than they were at the onset of the pandemic. Growth in this period has been similar across logistics and standard industrial assets, and has been strongest in London (up by 18%).
  • For the first time in more than three years, the retail sector saw a monthly increase in average capital values in May. This turnaround has been driven by early signs of recovery in the retail warehouse market, where values have edged up by 1.6% over the last three months. In contrast, shopping centre and shop values are down by 4.4% and 3.6% respectively, over that same period.
  • At a sector level, offices are now the worst performer, with values off by 0.2% in May and by 1.6% in the year to date (YTD). An exception to that trend has been office parks in the South East, with 2% YTD growth driven almost entirely by science parks in and around Cambridge.
Capital growth chart

Capital growth to end of May 2021 (%)

(Source: MSCI)

Investment market activity

  • Just £2.9bn of investment deals transacted in May, making it the quietest month of the year so far. This was nonetheless more than double the level of investment recorded last May, during the first wave of the pandemic.
  • Union Investment completed the largest transaction of the year so far, with its purchase of the new BT head office in Aldgate. The purchase price, reported to be £468m, represents an initial yield of 4.1% and reflects the brand new 15-year lease with no breaks.
  • The industrial sector remains the most active overall, with more than £1bn of deals completing in May. Blackstone continues to build its exposure, with the acquisition of a £282m portfolio from Westbrook Partners. Meanwhile, the new Jaguar Land Rover facility at Solihull was sold, with a 30-year lease, to US REIT (real estate investment trust) WP Carey for £141m.
  • UK insurer NFU Mutual is seeking to avoid red-hot competition for logistics assets by funding speculative developments. In its latest deal, it has committed £100m to three sites owned by Clowes Developments. Six new units will be built across the sites, five speculatively, comprising a total of more than 1m square feet.
  • The sale of Touchwood shopping centre in Solihull for £90m represents the largest deal in the sector for over a year. The asset was sold by the Lend Lease Retail Partnership, which is being wound down. Despite some competition, and a tenant line-up including John Lewis, Nike and Apple, the price reflected an initial yield of almost 10%. US investor Ardent Companies acquired it for its new UK-focused Strategic Fund 1.
Investment by sector chart

Investment by sector (12m rolling total, £bn)

(Source: Property Data)

Market yields

  • The latest view from Knight Frank on benchmark yields largely reflects the shape of the investment market over the last few years; negative sentiment across most of the retail market contrasting with resolutely positive sentiment and yield compression in the industrial sector.
  • However, a clear change in recent months is investor perceptions of the retail warehouse sub-sector. Demand was initially limited to assets with secure long-term income, or clear alternative use value, yet optimism has now spread across all formats. Benchmark prime and secondary retail park yields, both open and restricted, hardened by 25 basis points (bp) in May, while solus units with long-term income are in by 75bp since March.
  • Insatiable investor demand for industrial assets of all types has seen further hardening of yields for secondary logistics assets, as well as both prime and secondary estates. Yields for prime long-income logistics assets are already at record lows.
  • Despite continuing debate around the future of office working, Knight Frank perceives some hardening of benchmark prime office yields for major regional city centres and South East towns. Regional yields are still 25 – 50bp softer than pre-pandemic levels, but improved sentiment suggests that this gap may narrow again in the coming months.


  • Allsop’s commercial auction in June raised £62m, a very similar level to its May auction, but two and a half times the equivalent auction last year. The auction was notable for a number of bids from tenants, including Majestic who paid £1.03m (6.4%) for its store in suburban Bristol, where it had just two years remaining on the occupational lease.
  • Elsewhere: A mixed-used parade in Haywards Heath, with four shops, 10 flats and potential to increase the residential space, sold for £3.3m (5.3%). A secondary multi-let industrial estate in Knaresborough, with four tenants across 375,000 square feet, sold for £2.86m (7%) after 31 bids.

Market forecasts

  • The latest base case scenario from independent forecaster PMA assumes that Covid restrictions will be lifted, as planned, within the next few weeks. However, it expects that economic recovery will be tempered by a weak labour market and Brexit-related factors.
  • Under this scenario, PMA expects existing market trends to continue, with further double-digit declines for retail, contrasting with robust growth in industrial values. It expects that by the end of 2023 shopping centre values will be 50% down from where they were at the onset of the pandemic, while industrial values will have risen by 30%.
  • The picture for offices is more nuanced, with solid growth in central London and the ‘Big 6‘ regional cities contrasting with some value loss in more fringe locations. PMA expects office parks to underperform, with the Thames Valley markets predicted to be the weakest in the short-term.
  • PMA has also modelled an inflationary growth scenario, the main effect of which would be to make the situation even worse for retail in the short term. In contrast, the office and industrial sectors would be expected to benefit from even stronger growth in 2022 and 2023.

Looking ahead

  • Alternative sectors typically gain popularity when the more mainstream sectors go through extremes of high pricing or low liquidity. However, the mainstream sectors are just that because they are relied upon by a very large and diverse range of tenants, and for most investors, run-of-the-mill office, retail and industrial properties will continue to represent the most sensible targets for their capital. For such investors, rather than turning to completely new sectors that they may have little or no experience of, they could instead seek the corners of more familiar sectors that may for one reason or another be under-appreciated by the market.
  • An obvious, if perhaps somewhat daunting, target for that contrarian bet, is the retail sector. A wide range of investors, notably those who manage institutional capital, seem to have entirely washed their hands of the retail sector and would gladly be rid of their remaining exposure if they can get anything like an acceptable price for it. Convenience retail assets – those that serve a clear local catchment and have the rents to match – still appeal to a wide range of retailers and service operators, while higher up the value chain, retail warehouses can offer a compelling blend of high yields, multichannel relevance and alternative use value. 
  • Outside of retail, which many investors may feel still represents a risk too far, the route to acquiring good quality assets in a competitive market lies in accepting a degree of leasing risk. A very large proportion of capital being deployed in the real estate market today is seeking long-term income. For such buyers, income security is everything and as a result, mediocre assets are being bid up to a remarkable degree. In contrast, good quality assets that have lease expiries or even breaks within the next few years are often being left on the shelf. Given the anticipated economic recovery, and consequently improving odds of retaining or replacing a tenant, this can often resemble a mispricing of risk.

By Tom Sharman

Head of Strategy and Insight, Real Estate Finance