2022: No alarms and no surprises. Please.

Written By:

Stephen Springham, Knight Frank

17 Dec 2021

9 minutes to read

Categories: Property Sector Retail

Key Messages

• 2022 – a tangibly better year than 2021 despite ongoing uncertainty
• Increased stabilization in retail occupier markets
• Supply chain issues specific to certain items rather than blanket
• Lifting of moratorium in March unlikely to result in bloodbath
• Most landlords and occupiers have already resolved arrears
• Fewer CVAs – isolated instances rather than a constant flow
• Necessary deep reform of business rates unlikely to be forthcoming
• Recovery in retail investment markets, but polarized performance
• Lazarus recovery in retail warehousing set to continue
• All retail classes likely to see yield compression
• -100bps in retail warehousing, -50bps in high street and shopping centres
• All Retail forecast to achieve total return of 7.2% in 2022
• Second consecutive year of capital growth (+1.9%)
• All Retail to see underlying rental decline of -0.7% in 2022
• But retail warehousing (+0.5%) and foodstores (+0.4%) back in positive growth
• All Retail to return to positive underlying rental growth from 2023
• Average annual total returns of 6.4% over the next 5 years
• Average annual income returns (5.1%) significant higher than other property classes.

No alarms and no surprises. Please.

To quote Radiohead from one of their most ambiguous endeavours. Is ‘No Surprises’ a song of hope or a lullaby of despair?: The juxtaposition of bleak, weather-worn lyrics set against a bright, lilting melody evokes a sense of fear and optimism in almost equal measure. Or just an ultimate ode to defiance in the face of intolerable adversity?

Do I need to spell out the parallels with the retail sector as we approach 2022? Left to its own devices, the retail sector would continue on its long road to recovery next year and the positive momentum that has built up in the second half of 2021 would accelerate. Not without significant residual / structural challenges, but at least on a more even keel. But there are always nagging doubts that retail won’t be “left to its own devices”, COVID concerns will resurface and government intervention will again come to pass. These nagging doubts are clearly amplifying by the day.

A less than opportune time to be releasing a report detailing our expectations and projections for the retail market for coming year. But alarms and surprises notwithstanding, we remain confident that 2022 will prove a more benign and therefore better year for UK retail than the two that preceded it.

The year of the “re-“

Admittedly not the snappiest of monikers, but 2022 will be the “year of the re-“. If 2021 was all about re-opening, the retail landscape in 2022 will be defined by 10 other “re-s”:

1. Rebuilding: in almost every sense imaginable, but particularly true amongst retail occupiers in terms of the tangible (repairing battered balance sheets on the back of improving cashflow) and the intangible (reconnecting with their customer base).

2. Resolving: the thorny issue of rent arrears ahead of the lifting of the moratorium on forfeiture in March. Appropriate compromise solutions reached between landlords and tenants, with limited recourse to arbitration. A foundation for a more collaborative relationship going forward.

3. Re-engineering: supply chain practices to counteract both short-term issues (e.g. rising prices, stock shortages, lack of HGV drivers) and far deeper long-term challenges (e.g. consumer demand for ever shorter online lead times versus product provenance and wider ESG concerns).

4. Re-evaluating: floorspace need and affordability. The ongoing process of rightsizing store portfolios and achieving a more sustainable rental base. Greater understanding of the dynamics of multi-channel retailing and the co-dependencies of online and store-based retailing.

5. Rebasing: 2022 will see a bottoming out of significant rent and capital value corrections of recent years to create 1. a more sustainable retail market 2. a more compelling investment case for the right retail stock.

6. Repricing: drastic price revision has made retail increasingly good value versus other property investment classes. Yields have already started to compress in retail warehouses and foodstores, better quality high street and shopping centre stock will follow suit in 2022.

7. Redefining: the role of the high street and reinvigorating our town centres, on the basis that every location is different, has its own story to tell and will require bespoke solutions. More coordinated strategies involving all relevant stakeholders (local authorities, landlords, developers) and appropriate investment.

8. Repurposing: of surplus retail stock to other uses, less a knee-jerk reaction to COVID-driven fall-out, more as long-term regeneration projects designed to redress property uses within a town centre (with retail sometimes reducing to a supporting rather dominant role).

9. Rebalancing: sentiment towards the retail sector, which is both unequivocally and disproportionately negative. The notion that retail is either ‘boom or bust’ is a perennial barrier to meaningful but necessary change.

10. Renaissance: 2022 will definitely be a more stable year for the retail sector, but “back to pre-pandemic levels” narrative falsely assumes a return to a normality that doesn’t exist. The high street is not dead, but it will continue to evolve. Unwelcome as it was, COVID was (is?) no more than a stage of this evolution process.

2022 – in numbers

So much for general trends, what of actual forecasts? Macro-economics are currently a constantly shifting target, but we broadly expect the UK economy to grow by +5.7% next year, with RPI inflation hitting 5.0% on an annualised basis. Short-term interest rates rising to 0.5% by 2022 year-end – if not, perhaps, sooner. None of this necessarily as damaging to the high street as the economic community would have us believe.

For all the doom and gloom and supposed uncertainty, both macro- and retail economies will be buoyed by strong employment markets – an increase in working population of +0.2%, labour supply rising by +1.6% and a moderate unemployment rate of 4.5% and average earnings growth of +3.2%.

A full year unencumbered by lockdown (fingers well and truly crossed) will also prompt accelerated release of pent-up consumer demand. Consumer spending is forecast to grow +7.5%. In terms of retail sales, after something of a spike in 2021 (our prediction a year ago of +5% increasingly looking a good bet), a return to more “normalised” growth in 2022. We expect retail sales values (exc fuel) to grow by +3.5%, in line with long term (30 year) averages of +3.6% and above 10 year averages of +3.1%.

In terms of property prospects, All Retail is forecast to achieve total returns of 7.2% in 2022, with a second consecutive year of capital growth of +1.9%. But there will be very polarised performance between retail sub-sectors, with supermarkets (+6.5%), retail warehouses (+4.8%) and standard shops (+0.9%) achieving capital gains, but shopping centres (-2.4%) still seeing declines.

We forecast an underlying rental decline of -0.7% across the retail sector in 2022; but retail warehouses (+0.5%) and supermarkets (+0.4%) are likely to return to positive growth after respectively 4 and 7 years of re-basing. Standard shops are forecast to see a further underlying rental decline of -2.0%, with Central London down -0.4% despite a return to positive growth during H2 2022.

In terms of investment, we predict hardening of yields across the retail market. We anticipate yield compression of -100bps at retail warehouses to 5.50% and -50bps at both prime shops to 6.00% and regional shopping centres to 8.00%. Already keen pricing on foodstores (with RPI increases) expected to sharpen by -25bps to 3.50%.

In terms of longer term prospects, we predict a return to underlying rent growth in 2023, with all retail sub-sectors in positive growth territory. Underlying retail rents are forecast to grow at an average annual rate of +0.6% between 2022 and 2026. Annual average total returns between 2022 and 2026 are forecast to be 6.4%, with 5 year annual average capital increases of +1.2% . All retail property sub-sectors to deliver positive total returns from 2022, including shopping centres (2.3%).

In terms of industry “bragging rights”, Retail remains a very solid income play, with annual average income returns between 2022 and 2026 of 5.1%, higher than both offices (4.1%) and industrial (3.6%)…

Occupier and Investment Markets

Much more narrative in the Report itself on our expectations for retail occupier and investment markets. By way of teaser, we remain cautiously optimistic on both counts, although acknowledge both ongoing and fresh challenges and variance in performance.

Retail occupier markets will be dominated by two headlines: supply chain issues and rent collection. The former are likely to be item specific, but no doubt some retailers will use them as an excuse for their own operational shortcomings. Rent collection and the end of the moratorium on 25 March 2022 will not be the cliff edge many are predicting – the reality is that most owners and occupiers have already found resolution on Covid arrears. No bloodbath, but inevitably some landlord and tenant disputes escalating to full arbitration. But only as a last resort and the exception rather than the rule. Less positively, no reform on business rates that will impact the high street in a meaningful and constructive way, as the government continues to fudge something it doesn’t understand.

Retail investment markets are covered extensively in the sister publication ‘Retail Investment Update Q4 2021’ and were summarized in last week’s Retail Note. Our predictions for 2022 are broadly thus: the Lazurus style recovery in Retail Warehousing set to continue in 2020, with further yield compression of -100bps. A similar story in foodstores (-25bps). Factory outlets also very much in favour, with the prospect of double-digit returns. A more nuanced picture on the high street on the back of a general lack of trust. Much more appetite for value-add plays with underused upper parts, particularly in London and the South East.

And shopping centres…where the picture couldn’t be more mixed and / or polarized. And stock selection is absolutely paramount. Operating off notably lower income streams and off record high yields, a relevant scheme should now start to offer strong performance. Recent sales have generally attracted multiple bids and the strong prospects have achieved pricing ahead of initial expectations. The metrics for overall shopping centre performance are likely to remain poor in 2022, but this masks significant separation of the wheat from the chaff.

Final Thoughts

2021 was hugely challenging for the UK retail sector, but it responded. And 2021 was definitely better than 2020. Forget all the lazy, largely nonsensical “vs pre-pandemic comparisons” – the fact is that 2022 will be better still for the retail sector – a certainty despite all ongoing uncertainty.

And in a year’s time I hope to be drawing more on the nuances and ambiguities of Radiohead’s “Fitter Happier”, “Everything in its Right Place” or “Optimistic” than “Nice Dream” or “Let Down”…

Season’s Greetings from the KF Retail Team. Keep the faith and spend loads.