Out of the COVID frying pan into the inflation fire?
This week’s Retail Note references Knight Frank’s latest Quarterly Retail Monitor. Q1 proved an intriguing quarter, a genuine retail market recovery overshadowed by the “cost of living crisis” and huge global political and economic unrest.
6 minutes to read
Key Messages
- Q1 a period of considerable recovery for the retail market.
- Despite deafening “inflation/cost of living crisis” narrative.
- Consumer confidence falls to lowest level since October 2020.
- But not reflected in retail sales performance as consumers still spend.
- Q1 retail sales values grow +10.1% y-o-y, +0.3% q-o-q.
- Online spend index (120.4) lowest since April 2020.
- Footfall still down, but more robust at Retail Warehouses than in-town.
- Vacancy rate recedes to 15.5%.
- Occupiers face new cost headwinds inc. +6.6% NLW increase.
- All retail capital values grow +2.9% in March.
- Q1 saw Shopping Centres return to positive capital growth for first time since 2016.
- First return to retail rental growth since 2018 (+0.2% in March).
- Rental growth driven by Retail Warehouses (+0.4% in March)
- Solus retail warehousing yields compress by -25bps to 4.75%.
- Pricing movement too in Regional Shopping Centres (-100bps to 7.50%).
- Some £1.59bn transacted in retail real estate in Q1.
- £600m generated from two designer outlets deal (Cheshire Oaks and Swindon).
- Retail investment sentiment tangibly improving.
What should have been a quarter of unbridled recovery was sadly overshadowed by domestic and global events. Q1 was when the UK finally made the transition away from ongoing restrictions to a state ‘of living with Covid’. But one crisis simply gave way to multiple others, an impending consumer squeeze and massive global political upheaval chief amongst them.
While much of the narrative may have been grim, many of the actual retail market metrics have been far less so. Despite the negative backdrop, the UK consumer continues to spend freely and retail sales have recovered strongly. Equally, there are encouraging signs of stabilization in retail occupier markets, although new headwinds are coming thick and fast. And retail real estate markets have definitely turned the corner, with improving performance filtering through to transactional activity.
Considerable market positivity, albeit buried under a deluge of negative narrative.
The consumer – still in post-lockdown mood
Given domestic and global events, consumer confidence unsurprisingly took a tumble in Q1 - and with ongoing headlines of record food and fuel inflation it is unlikely to recover anytime soon. But it is worth stressing that the Gfk index has not tracked positively since March 2016. Confidence fell -12pts across Q1 to reach -31pts, the lowest level since October 2020. Although far from positive, negative sentiment surrounding personal finances was more subdued (-26pts, March) than that of the wider economy (-55pts, March).
But lack of consumer confidence did not filter through to constrained spend – as we have seen so many times in the past, there is often a huge disconnect between sentiment and actual consumer behaviour. In Q1, retail sales values (exc fuel) grew +10.1% year-on-year (+13.8% inc fuel), while volumes were ahead by +3.5% (+5.4% inc fuel). Quarter-on-quarter, retail sales values were ahead +0.3%.
Current trends in retail sales were explored in greater depth in last week’s Retail Note. For now, the consumer is still in a buoyant, post lockdown mood and this is outweighing any concerns about the well-documented “cost of living crisis”. With inflation now peaking at 7%+, at worst we are seeing a slight drop off in volumes (i.e. people are buying slightly less than they were) but values are still showing strong growth. Prices have risen, but consumers generally are willing and able to pay for the privilege, for now at least.
Occupiers – stabilisation but fresh challenges
Most of the indicators point to greater stabilisation in occupier markets. Vacancy rates had already plateaued towards the end of last year and actually started to recede during Q1 through renewed occupier acquisition activity, a reduction in overall retail floorspace, and some repurposing to alternative uses. Although tangibly higher than pre-pandemic levels (13.3%), the current direction of travel is both positive and sustainable.
Footfall is still firmly in negative territory, although Retail Parks (-4.2%) are faring much better than their in-town counterparts (High Street -17.4%, Shopping Centres -21.3%). As with consumer confidence, too much weight is attached to footfall in assessing the relative health of the retail market. Footfall is perennially down, the proof in the pudding is what is actually happening with retail sales and the read there is far more positive.
As also detailed in last week’s note, many of the artificial spikes in online penetration witnessed during the pandemic are now being redressed. In March, the ONS Online Index was 120.4, well below the 168.9 reported in December and the lowest figure since April 2020 (113.8). Online penetration will never recede to pre-pandemic levels, but it is slowly returning to a more normalized growth trajectory after so much artificiality.
The mood music amongst retailers has generally been cautiously optimistic, despite well-documented headwinds. Retailers gained greater control over staffing levels in March with the dismantling of legal requirements around self-isolation rules. But staffing headaches were / are far from over. Cost pressures are very real, with a +6.6% increase in the National Living Wage effective from April. Plus, pressure has mounted to attract footloose workers to plug vacancy gaps with higher salaries, as earnings lag CPI and RPI rises.
Inflation is obviously a major headwind for retailers in terms of higher operating costs and rising input prices. A number of the major operators have already warned on profits for the coming year. But some perspective is lacking in the media: inflation is far better for the retail sector than deflation and could actually prove a force for good if it prompts a return to more ‘honest’ pricing and EDLP (as opposed to relentless promotions and discounts).
Inflation may be a headache for retailers, but it is at least a manageable one – unlike unenforced lockdown.
Retail real estate – more than a few green shoots
It may have flown under the radar, but retail real estate markets hit the bottom of the market during the pandemic and are now on an upward cycle, albeit a very gradual one.
Growth in retail capital values accelerated over the quarter (January +0.6%, February +0.9%, March +2.9%). All retail asset classes are now in positive growth territory, including Shopping Centres (for the first time since January 2016). Clearly, they will not recover the value lost in the interim anytime soon, but at least the direction of travel is positive.
There are also tentative signs of a return to rental growth (remember that?) In February, all retail rents entered positive territory (+0.0%) for the first time since 2018. By March, rental growth had strengthened to +0.2%. This was predominately led by growth in Retail Warehousing (+0.4%) but there are also encouraging signs of stabilisation at both High Streets and Shopping Centres.
In terms of deals, a robust £1.59bn was transacted in Q1, ca. -25% below the 5-year quarterly average. Shopping Centres enjoyed a renaissance amongst investors with £736m transacted, nearly half of the quarter’s total volume. Some £600m of this originated from the portfolio sale of just two designer outlets, Cheshire Oaks and Swindon, reinforcing and buoying confidence in the turnover-based factory outlet model.
Pricing is also starting to move. Continuing the trend of last year, retail warehousing yields tightened by a further -25bps in Q1, with solus stock now around 4.75%. Regional shopping centres have also compressed by around -100bps to 7.50%.
A far cry from the glory days maybe and a long way from being ‘back to normal’. But a quarter of considerable recovery nonetheless for the retail sector, if you can block out all the excessive “cost of living crisis” noise.