Retail vs reality: a mass of contradictions

Written By:

Stephen Springham, Knight Frank

05 Aug 2022

7 minutes to read

Categories: Property Sector Retail World Regions UK London

Key Messages

• Huge mismatch between retail metrics and wider narrative.
• Retail sales steady, occupier markets strengthening, investment buoyant.
• Contradictory and counter-intuitive trends.
• Consumer confidence hits lowest ebb (-41pts)…
• …but consumers continue to spend fairly freely.
• Retail sales in Q2 +1.5% (food +1.3%, non-food +3.8%).
• Tight employment market still a significant cushion.
• Unemployment rate (3.7%) lowest since the 1970s.
• Zero retail occupier fall-out/administrations/CVAs in Q2.
• Some distress amongst online pre-plays as pandemic trends unwind.
• Vacancy rates (15.2%) recede for 3rd consecutive quarter.
• Retail Property achieves total returns of 3.0% in Q2.
• Retail Property outperforms All Property (2.9%).
• Retail Warehousing star performer (total return of 4.9%).
• Retail Warehousing delivers higher return than Industrial (4.5%).
• Retail Warehousing yields harden by -50bps in Q2.
• £4.18bn of retail-related assets traded in Q2.
• Significant surge q-o-q (+157%) and y-o-y (+101%)
• But some cooling at the end of Q2/currently as investor sentiment dampens.
• Economic conditions will inevitably worsen in H2 2022.
• Re-based and battle-hardened, retail will continue to prove resilient.

Retail seems to perennially live in a parallel universe, not just in real estate, but in almost every dimension of the macro-economy. Historically, the retail parallel universe was often an infinitely happier place, but in recent years, the reverse has been true. In very recent (Q2 2022) and current times, retail again finds itself singularly detached from the world at large, in many regards curiously sheltered from the storm.

Nowhere is this more apparent than the smorgasbord that is the Knight Frank Quarterly Retail Monitor. Impending recession. Skyrocketing inflation. Interest rate hikes. Consumer squeeze. Cost of living crisis. Political unrest. Ongoing war in Ukraine. The general narrative could scarcely be more bleak. Juxtapose this with the key reads on the retail market: consumers continuing to spend relatively freely, retail sales holding up. Retail occupier markets showing increasing signs of life, vacancy rates slowly receding. A rebound in retail investment activity, pricing holding firm or even tightening.

A market in denial, a market simply lagging reality or a market that is battle-hardened to the extent that it is plotting its own course? Others may argue the former two, my money is definitely on the third.

The consumer – saying one thing, doing another

The biggest contradictions are arguably on the consumer side. According to Gfk, consumer confidence hit a new record low in Q2 2022 (-41pts), with the state of the wider economy (-57pts) weighing more on consumers’ minds more than personal finances (-28pts). That consumer confidence is lower now than it was during COVID absolutely beggars belief – are big energy bills really more worrying than a life-threatening global pandemic?

But this negative sentiment is not filtering through to actual behaviour. As detailed in the last Retail Note, retail sales figures are actually holding up fairly well, challenged as much by mathematics in the shape of very tough y-o-y comparisons than wider economic pressures. Overall retail sales in Q2 were firmly in positive territory (+1.5%), with food sales up +1.3% and non-food higher at +3.8%.

The spectre of inflation is very much in evidence (with retail sales volumes down -6.1% y-o-y), providing an underlying picture of consumers buying less, but still able/willing to pay more. Shop price inflation (June 7.6%) tracked lower than CPI (9.4%) with inflation varying across categories (e.g. food 8.3% vs. electricals 0.1%). Inflation is a very real factor, but it hasn’t undermined retail spending as yet.

All narrative blinkered on a consumer squeeze has deflected attention away from a tight jobs market. Employment levels remained high, whilst unemployment reached its lowest rate (3.7%) since the 1970s. Job vacancies and average weekly earnings growth also accelerated, whilst redundancies fell.

In short: consumer sentiment has dampened, but appetite to spend hasn’t.

Occupier markets – ongoing recovery

Any predictions of an occupier bloodbath have thankfully proved ridiculously wide of the mark. To the chagrin of the doom mongers, there was not a single multiple retailer failure, administration or CVA in Q2 2020. Repeat, not one. Zero. Zilch. In fact, in the first six months of the year, the only real casualties of any scale were the c-store chain McColl’s (largely a debt issue and subsequently acquired by Morrison’s) and aptly-named online pure-player Missguided (subsequently acquired by Frasers Group).

If there is any distress in retail occupier markets, it is much more in evidence in the online market than amongst multi-channel operators. Our Retail Monitor shows that online sales were the major drag on retail sales performance in Q2, as the inevitable unwinding of artificial peaks achieved during the pandemic continued. Online’s share of retail spend declined to 25.3%, a -300bps decline since January (28.3%). The anticipated bottoming out has yet to materialize: E-commerce sales failed to achieve one single positive metric in June (food -13.4%, non-food -9.4%) with ‘pure-players’ (-9.1%) taking a bigger hit than multi-channel retailers (-7.4%).

Of course, this is by no means ‘the beginning of the end’ for online, far from it. But what we are seeing now (and are going to see an acceleration of going forward) is a generation of online pure-players having to face up to a far more challenging period in their evolutionary process. Those that blindly believed their own hype during exceptional COVID-induced circumstances are going to be found out. Those that have grown rapidly in the last few years but haven’t achieved sustainable levels of profitability have a lot of soul-searching to do. I expect considerable consolidation amongst online pure-plays and some inevitable fall-out.

In contrast, most store-based and multi-channel operators have rebased and right-sized during the pandemic, merely as a survival mechanism. Most are now beyond the feet-refinding process and many are now selectively acquiring again. This is manifest in vacancy rates, which registered a third consecutive quarter of improvement in Q2, though rates remain 2 percentage points higher than pre-pandemic leveld. A significant North-South divide still exists, with shopping centres also lagging behind high streets and retail parks. Indicative of the sustained recovery, vacancy is forecast to improve further as redevelopment activity takes hold.

Occupier stabilization and now baby steps. All we can hope for and something for which we should be grateful.

Retail property – improving performance and investment recovery

Retail property metrics also showed improvement, albeit stronger at the beginning of the quarter than at the end. All Retail registered total returns of 3.04% in Q2, even beating the wider market average (All Property 2.93%), with capital values and income return up 1.74% and 1.28% respectively. Retail Warehousing returns led the pack (4.93%), even surpassing Industrial returns (4.51%) with robust capital growth (3.52%) and income return (1.38%). RW yields were the only retail sub-class to harden (-50bps) over the quarter. A retail sub-sector out-performing industrial sheds, who’d have thought?

£4.18bn worth of retail-related assets were transacted in Q2, representing a massive surge q-o-q (+157%) and y-o-y (+101%). Investment flooded into all categories with q-o-q uplifts across High Streets (+40%), Shopping Centres (+16%) and Retail Warehousing (+87%). Notable transactions included several large deals to councils: Guildhall, Exeter (£41.5m), Newhall Walk, Sutton Coldfield (£15.6m), and Brunel Centre, Bletchley (£4.4m).

But an obvious note of caution that this buoyancy is largely lagging market reality. Some of the Q2 heat has already dissipated as sentiment takes another reality check of local and global events. Retail investment markets have not evaporated completely, but they have turned quickly. Buyers are still there, although maybe not in the same numbers as in Q2. But surely re-based and fairly priced retail stock will prove increasingly attractive relative to other sub-sectors as interest rates rise further?

Where now?

Retail: an unlikely oasis of calm in the eye of a storm. Surely this cannot continue indefinitely and it is only a matter of time before it succumbs to the inevitable?

Let’s not pretend the macro-environment is going to get any easier in the second half of the year. It won’t. Further interest rate rises are inevitable, inflation is not going to go away anytime soon and higher energy costs will become much more of a reality as Autumn and Winter kick in.

Does this necessarily mean retail markets are poised for (another) precipitous fall? It may not always seem this way, but retail markets are a lot more resilient than they are given credit for. For all the “non-negativity” in the Knight Frank Retail Monitor, no one should assume that retail markets are riding on the crest of a wave. Nor, on the other hand, are they desperately clinging to a life-raft in the midst of an ocean storm. If they are doing anything metaphorical, they are rising and falling with the tide and weathering any conditions and challenges that either come their way or are thrown at them.

The realities of life in a parallel universe.