United Kingdom Real Estate Report Q1 2013

This United Kingdom Real Estate report examines the commercial office, retail, industrial andconstruction segments. With a focus on the principal cities of London, Manchester and Glasgow, thereport covers the rental market performance in terms of rates and yields over the past 18 months andexamines how best to maximise returns in the commercial real estate market, while minimisinginvestment risk and exploring the impact of a variety of factors weighing heavily on the UK's real estatemarket.

The commercial sector is under pressure as a result of the country's economic woes, though it has beenmore stable than expected. Activity in commercial property has been very slow as businesses andlandlords watch and wait for signs of economic recovery. The office space sub-sector is a stable elementof the segment, with office space in central London experiencing a healthy run of growth. This now looksto be slowing, but we expect growth to remain positive, as the capital has limited scope for newdevelopment and demand has moved faster than new supply. New retail developments (larger shoppingmalls) and fierce competition for high-end retail space in central London are the key growth areas, withother retail spaces as well as industrial and office spaces showing slower growth rates in the face ofbroader economic weakness in the UK.

High-end retail in the London market is the clear outperformer in the UK real estate sector as a constantflow of foreign shoppers and tourists support this segment despite weak macroeconomic fundamentals.Outside central London, large shopping centres continue to open across the UK, creating new supply andattracting tenants and footfall, although 'high street' retail will suffer as a result. The office and industrialsegments, however, will remain under pressure, despite some high-profile deal making, as a result ofweak economic growth, tight credit and job losses in the private and public sectors undercutting demandfor new business rental space.

Key Points

Data for the second quarter suggest that the UK economy is back in recession. However, there isa growing disconnect between the headline GDP data and the relatively more robust servicesector and improving employment outlook. Although we are somewhat sceptical about the data,it is clear that the economy is at best treading water and remains extremely vulnerable to externalshocks, particularly in the nearby eurozone.

We remain bearish on the European building materials market as conditions for firms continue todeteriorate in light of ongoing eurozone austerity. The sovereign debt crisis, lower domesticdemand from peripheral countries, and tighter financing conditions are constraining ourconstruction outlook for the region, and will continue to limit growth for the foreseeable future.

Overcapacity, increasing production costs, and falling sales volumes have hit the bottom lines ofproducers since 2009, and we see no immediate end to these phenomena. Notable exceptions tothis trend are Russia and, to a lesser extent, Turkey and we expect these outperforming marketsto sustain high levels of demand over the medium term.