UK retail 2023: Riders on the Storm

Written By:

Stephen Springham, Knight Frank

16 Dec 2022

11 minutes to read

Categories: Property Sector Retail

Key Messages

• The worst is yet to come - 2023 will be far tougher than 2022
• But impending recession will be far less damaging to retail than Covid proved
• Retail market will enter 2023 in better shape than previous recessions
• Braced, but battle-hardened – lean rather than bloated
• Consumer demand will hold up better than anticipated
• Ongoing polarisation of retail sales values and volumes
• Values will stay in positive territory (+4%), but volumes will remain negative
• Rising operating costs the main pinchpoint for retail operators
• Some occupier distress, but no bloodbath
• Fall-out more prevalent amongst online pure-players
• Expect acquisitions of online pure-players by multi-channel operators
• Correction of retail real estate will be short and swift as already re-based
• Pricing will quickly stabilise in retail warehousing and strong investor demand will resume 
• But very few big ticket shopping centre transactions at current pricing
• Yields to soften by +50bps in high street assets and shopping centres over the year
• Retail warehousing and foodstore yields to settle at 6.00% and 5.00% respectively
• All Retail forecast to achieve a total return of 3.1% in 2023
• This despite negative capital growth of -1.9%
• Retail warehouses to achieve capital growth of +0.7% and rental growth of +0.4%
• Average annual income returns (5.2%) significant higher than other property classes.

Riders on the Storm

To quote The Doors for our 2023 retail predictions: “Riders on the Storm.”

A tempest is definitely brewing and will fully hit landfall in 2023. So often viewed a lame duck in times of trial and tribulation, retail may actually surprise on the upside this time around, riding the tidal waves more resolutely than other aspects of the economy.

My Radiohead-inspired impassioned plea of “No Alarms and No Surprises. Please” a year ago evidently fell on deaf ears. Domestic and world leaders either didn’t read our predictions for 2022, or just blatantly ignored them. To our chagrin, we didn’t foresee the war in Ukraine, nor that inflation would hit double-digits. These two oversights aside, we would firmly stand by everything we predicted a year ago.

Uncatchy as it may have been, we dubbed 2022 “The Year of the “Re-“” and predicted that the retail landscape would be defined by:

• Rebuilding
• Resolving
• Reengineering
• Reevaluating
• Rebasing
• Repricing
• Redefining
• Repurposing
• Rebalancing
• Renaissance

Despite all geo-political and macro-economic upheaval (both domestically and globally), all these factors have indeed played out across the retail spectrum over the past year. Indeed, most are ongoing and have not fully run their course.

2023 will be defined by another, sadly all-encompassing “re” – recession. But the counterpoint for the retail sector will be another “re” – resolve. This resolve the product of progress on the 10 other “re-s” previously identified.

2023 will undoubtedly be tough, no recession is easy for the retail sector. But consumer demand is unlikely to collapse completely. As previous recessions have shown, shopping may actually prove a haven for the consumer in the eye of the hurricane, people preferring to spend than merely feel sorry for themselves.

Having been through Covid and come out the other side, retail occupiers are battle-hardened in a way they certainly weren’t coming into previous crises. Widespread fall-out is far from a foregone conclusion. Equally, the re-basing and re-pricing of retail property stock leaves it far less exposed to inevitable upward movement in interest rates.

Watch this space on e-commerce in 2023. Having been a disruptor and catalyst for change for many years, the online retail market will be subject to its own structural change in 2023 and beyond and more questions will be asked than ever before.

2023. A year of monumental challenges for retail. But, quite frankly, isn’t every year?

2023 – in numbers

As has been documented to death, the macro-economy will be exceptionally tough next year. Our latest forecasts (informed by Oxford Economic Forecasting) show that the UK economy will contract by -0.9% in 2023. OeF forecasts that short-term interest rates will rise to 4.4% by 2023 year-end, with RPI inflation easing slightly to 10.3% on an annualised basis (vs 11.5% in FY 2022). The realities of inflation are that it has probably already peaked in Q4 2022, but the descent will be slow (CPI not hitting <2% until 2024) on account of tighter fiscal policy being backloaded. In basic terms, inflation will ease, but very slowly.

Macro- and retail economies will be maintained by tight employment markets – we forecast an increase in working population of +0.2%, but labour supply declining by -0.3%, resulting in a moderate rise in the unemployment rate to 4.4%. Average earnings growth of +4.8% will lag inflation and the ‘cost-of-living’ crisis narrative won’t go away anytime soon.

But high inflation will result in a polarised consumer outlook. Nominal consumer spending is forecast to grow +9.3% overall, but dip -0.7% in real terms. We tentatively forecast retail sales value (exc fuel) growth of +4.0% in 2023, above long term (30 year) averages of +3.7% and 10 year averages of +3.4%, but retail sales volumes down -4.0%. Positive growth in retail sales volumes is unlikely much before the end of the year.

In terms of 2023 property prospects, all Retail is forecast to achieve total return of 3.1%, despite negative capital growth of -1.9%. There is likely to be very variable performance between retail sub-sectors, with retail warehouses (+0.7%) and supermarkets (+0.2%) achieving capital gains, but standard shops (-2.7%) and shopping centres (-5.6%) seeing declines. We forecast underlying rental decline of -0.6% across the retail sector; but retail warehouses (+0.4%) maintaining positive growth after several years of re-basing. Supermarkets (-0.1%) and standard shops (-1.6%) to see a further underlying rental decline. Rents in Central London down -0.5%, but a return to growth anticipated by 2024.

There is likely to be wholesale softening of yields across the retail market, in reaction to interest rate rises. Yield movement of 100bps at retail warehouses to 6.00% and 50bps at both prime shops to 6.50% and regional shopping centres to 8.50%. The new interest rate environment to impact foodstores (with RPI increases) softening by 150bps to 5.00%. In reality, much of this re-pricing has already happened.

In terms of longer term prospects, we predict a return to underlying rent growth by 2024, with all retail sub-sectors in positive growth territory by 2025. Underlying retail rents are forecast to grow at an average annual rate of +0.4% between 2023 and 2026. Annual average total returns between 2023 and 2026 are forecast to be 5.4%, with 4 year annual average capital increases of +0.2% . The majority of retail property sub-sectors to deliver positive total returns in 2023, with the exception of shopping centres (0.0%).

In terms of sector bragging rights, retail remains a very solid income play, with annual average income returns between 2023 and 2026 of 5.2%, higher than offices (4.2%) and industrial (3.7%).

Occupier markets

With the first whiff of economic distress, attention naturally defaults to retail occupier markets and the assumption that many operators won’t go the distance. However, we think fall-out may be less severe this time around and what pinchpoints there are may surprise many.

By all accounts, there has been very little retail occupier distress in 2022, for two key reasons. Firstly, for most of the year, the trading environment for retailers has been fairly benign, a period of relative calm bookended by the chaos of Covid/lockdown and the mounting cost of living crisis. Secondly, the wheat has effectively already been separated from the chaff during the pandemic, the weaker players already succumbing to leave a much fitter residual competitor set. The decks have already been cleared, to a certain degree.

The latter is a key factor in our conviction that the degree of occupier fall-out will be less severe in 2023 than in previous recessions. Trading will undoubtedly become far tougher in 2023 than it has been in 2022, particularly in terms of rising operating costs. But most retailers are much fitter than they were coming into previous recessions and while by no means immune to the storm, they at least have stronger defences. There will undoubtedly be casualties, but maybe fewer than the market is anticipating – and no bloodbath.

Be that as it may, we anticipate considerable recourse to our internal Retailer Watch List in the coming weeks and months. The Knight Frank Retailer Watch List is our assessment of occupier health and likelihood of distress Our Watch List focusses on the Top 300 retailers with each operator allocated one of six colour-coded classifications based on a number of criteria.

To quickly summarise the key findings: the outputs of KF’s Watch List are not wholly negative by any means. Just over half of the Top 300 (152, 51%) are rated Green (‘No Risk’). Coupled with the online pure-play Yellows (‘Online Pure-player – No Risk’), a total of 191 (64%) of the Top 300 retailers present no immediate apparent risk of failure.

Our Watch List currently identifies 58 operators ‘at risk’ (19%). Of these, 36 (12%) are multi-channel/store-based (Pink) and 22 (7%) are online-only (Brown). Many of the former fall into the ‘previous distress’ camp, while the latter tend to tick the ‘poor trading performance’ or ‘flaky balance sheet’ boxes (usually both).

“Knight Frank says one in five retailers is at risk of failure” would be the somewhat lazy conclusion to draw from our Watch List analysis. The reality is that not all of these failures will come to pass by any means and this is the absolute worst case scenario. In terms of wider messages, there are two key takeaways. 1. Scale and longevity are important. 2. Being online-only does not provide immunity.

To the first point, no retailer is “too big to fail”. Former market leaders such as MFI, British Shoe Corporation, Sears Group, Woolworths, BHS, C&A and more latterly Debenhams and Arcadia are (non-) living proof that scale is never a guarantee of survival. But our analysis suggests fewer ‘at risk’ operators in the Top 100 versus those ranked 101 – 300. Extrapolating this further, the very smallest operators and independents are going to find 2023 exceptionally tough, hikes in operational costs likely to prove too much for many to bear.

The second point goes against perceived wisdom, that online pure-plays are sufficiently nimble to adapt to any challenge in the market and are effectively bullet-proof. On the contrary, many lack the experience, operational nous and firm financial footing to ride out the impending storm that will undoubtedly unfold during 2023.

Perceived wisdom is about to about to undergo a severe reality check during 2023…

Investment markets

Retail investment markets are covered extensively in the sister publication ‘Retail Investment Update H2 2022’ and were summarized in last week’s Retail Note. Our predictions for 2023 are broadly thus: retail is not immune to industry-wide re-pricing in the wake of the disastrous mini-Budget and ongoing threat of recession, but having been in a downturn for a long period of time and suitably re-based, parts of the market must be attractive for the next cycle of investment. Being out of sync with the rest of the market is actually a good place to be, for once.

After a bit of a wobble in Q4 2022, we expect the retail warehousing market to settle quickly in 2023. Investor demand will return quickly. Despite muted volumes in 2022 on the back of limited supply coming to the market, foodstores remain a very solid, if unexciting, bet. Yields have already moved out by 100bps and off that higher base, they carry significant appeal. The right assets offer very low risk, some modest rental growth and potential for capital recovery.

In contrast, the high street remains the most un-appreciated retail sub-sector. But if investors can buy high quality high street assets and look to aggregate ownership, we feel they will be rewarded with high income return and good capital recovery prospects in the medium term – with relatively low risk and effort along the way.

Sadly, 2023 is likely to be another year of low volumes for shopping centres as there will be few sellers of the best performing prime malls at today’s pricing, at least in the first half of the year. Although there are supposedly plenty of “equity” investors waiting in the wings, they are all looking for the same rare characteristics, are not necessarily the bravest bunch and are usually hampered by having to make decision by committee. But some (e.g. Evolve, the Adhan Group, The Martin Property Group) are making counter-cyclical investments in this space and fortune may well favour the brave.

Final Thoughts

To tie up with some more gems from The Doors:

• These are “Strange Days”. Recessions always are and no two are the same.
• “People are Strange”. Consumers are not robots and rarely behave as economists expect.
• Not “The End” for retail by any means. Although there will inevitably be some casualties.
• But in 2023, it will be one of the key “Riders on the Storm” and its mettle will once again be tested.
• Ultimately, retail will “Break on Through (to the Other Side)”, by virtue of its new-found resilience.
• But “Waiting for the Sun” is not an option just yet…

2022 was a year of re-building for the UK retail sector. All that positive momentum will be checked rather than completely de-stabilised in 2023. 2023 will be an extraordinarily challenging year – but isn’t every year in its own way?

Season’s Greetings from the KF Retail Team. Keep the faith, take the media with a pinch of salt. Go shopping and spend loads.