Retail Investment: A Game of Two Halves
This week’s Retail Note focusses on Knight Frank’s hot-off-the-press ‘Retail Investment Update Report’ for H2 2022, which reviews events of the past year and tentatively looks forward to 2023.
8 minutes to read
Key Messages
- Retail transaction volumes projected to hit £6.33bn for 2022
- A -14% decline on 2021 levels, -18% below 10 yr average volumes (£7.73bn)
- H1 volumes (£3.58bn) 23% higher than H2 volumes (£2.75bn)
- H1 2022 volumes +11% vs 2021; H2 2022 volumes -33% vs 2021
- Reflects a major shift in sentiment from Q3
- Retail warehousing the trailblazer, projected total returns of 11% in 2022
- Retail warehousing volumes of £2.6bn (41% of retail total)
- Shopping centre volumes of £2.1bn (33% of retail total)
- High street volumes of £901m (14% of retail total)
- Retail warehousing yields moved out by 100bps to 5.75%
- Shopping centre yields moved out by 100bps to 8.50%
- High street yields moved out by 75bps to 7.00%
- Uncharacteristically low volumes for foodstores in Q4 (ca. £50m)
- Expect foodstore yields to settle at 5.00% in the short term
- Past rebasing and repricing has left retail less exposed to base rate increases and rising gilt yields
- Total returns for retail projected to be 3.6% for FY 2022, the only commercial real estate sub-sector to record a positive return
It started so well. It ended less well. If evidence were ever needed of the fickleness of real estate investment markets, it was there in spades in 2022. If we didn’t know before (to be fair, we should have) this year has shown how quickly sentiment can shift on the back of macro-economic and socio-political pressures.
A Game of Two Halves
The buoyancy we witnessed through the first half of 2022 now seems something of a distant memory. In the early part of the year deal volumes and pricing in all of the retail sub-sectors were improving for the first time since 2013. A weight of capital was finding its way into the real estate markets, investors were attracted to the relative discount on offer in retail compared against other sectors and appetite for foodstores and retail warehousing was red hot.
The weather improved, but investor sentiment didn’t. With the arrival of summer, the markets began to cool with concerns over the gradual unwinding of the huge government economic support through the pandemic and rising cost of energy, fuelled by the war in Ukraine. Base Rate increases and rising Gilt yields began to impact the cost of debt, with swap rates moving out from a previously stable 1% and pricing softening to account for this.
What followed was anything but gradual, with a surprise budget sprung by the Truss government unwinding all of this positivity and value recovery in one fell swoop and creating turmoil across all of the investment markets. No sector was left unscathed, with those achieving the keenest pricing (namely logistics, foodstores, long income alternatives and retail warehousing) feeling the greatest effect and contagion spreading through the rest of the market.
Occupationally, the predicted (and widely-reported) “consumer squeeze” has begun to bite into some of the retail sectors, but its impact has been much slower to take hold than anticipated. Indeed, the consumer appeared resilient and keen to continue spending until Q4 but it is clear now that monthly sales volumes are receding from 2021 levels (-6.4% in September and -6.4% in October) and value growth is being driven purely by inflationary pressures. In effect, consumers are buying less but spending more – not ideal, but better than a scenario where they buy and spend less.
Divergence across the retail sub-classes
Retail warehousing stands tall - it is perhaps the only retail sub-sector continuing to show robust underlying occupational tension in most geographies. This, coupled with its excellent performance through the year (by far the strongest performance of any real estate sector) and relative simplicity/flexibility means that any cooling of demand will be short-lived. Having said that, scale continues to deter investors, as evidenced by the withdrawn Boxplus (£300m) and Peacock (£260m) portfolios, which both fell away over the summer.
Whilst unlikely to return to pricing at <5% NIY in the first half of the next year, we expect institutional buyers to return to their pet sector early in the New Year, reversing the outward movement in yields that we have momentarily experienced. Early signs suggest this process is already underway with Purley Cross Retail Park, Croydon believed to be under offer to a UK Fund at ca. £56m / 5.75% NIY.
Quick correction and we go again...
Shopping centres have been discounted yet again, following significant rebasing of rents and values since the GFC, EU Referendum, Brexit, COVID and again at the hands of the now fabled-for-all-the-wrong-reasons “Mini Budget” (with very little value recovery in the meantime). There must now be an argument that well-located, fit-for-purpose investments (namely true convenience or destinational, “day-out” assets) at appropriate yields make an attractive investment case.
We witnessed the return of quasi-institutional equity buyers to the market during the first half of the year, and multiple competitive sales processes, but the recent economic turmoil suggests that they are unlikely to return in early 2023. The continued absence of accretive debt financing will restrict most sales to <£30m and also limit the return of leveraged Private Equity buyers to the market for now. Demand remains regionally diverse with a host of UK and overseas PropCos making countercyclical plays by targeting sellers in distress and properties showing deep discounts to long term value.
One for the brave – but who does fortune favour?...
The factory outlet (FOC) market remains a definite bright spot. The sector has seen reasonable demand from lower cost of capital domestic and overseas buyers this year. The sale of Cheshire Oaks and Swindon to LaSalle at £600m / 6.00% NIY evidenced this and LandSec’s sale of J32, Castleford (£55m / 8.00% NIY) will test this market again, potentially signalling further sales in this space. Leases affording transparency of trade and the ability to cultivate an appropriate tenant mix continue to appeal to these buyers, especially in the face of potential occupational uncertainty in the short term.
More of the same…
In contrast, single and multi-let properties on the high street remain on the sales list for most institutions (as evidenced by the floating of the Argon portfolio from the Shell Pension Fund at £68m / 8.60% NIY) but this does a disservice to their principal appeal - relative simplicity, low management and now elevated yields mean that a host of private and PropCo investors are scouring the market seeking these opportunities. We expect this space to appeal to investors seeking to tentatively increase their retail weightings next year, increasing the share of high street retail investment from £900m, just 14% of total retail deal volumes this year.
The forgotten child starts to find its voice…
Demand for leisure assets, particularly those anchored by cinemas, has cooled due to rising covenant concerns over large parts of the market, particularly in light of the “consumer squeeze”. The ongoing Chapter 11 process at the Cineworld parent company has sparked fears of the financial viability of other debt-laden cinema chains. That said, we do expect better located and well-let leisure investments to continue to appeal (such as Corn Exchange, Manchester, sold at £38m / 8.20% NIY) but others may fall out of fashion if new concepts fail to bed in. Their relative scarcity means that deal volumes, which had been low already, will remain suppressed all the time this occupational uncertainty persists.
Some convincing needed…
A global repricing of real estate assets is now underway, to which all sectors will need to adjust. Those where conviction is strongest and macro-economic trends are most supportive will recalibrate quickly. Others, where there are greater underlying concerns, will take more time to stabilise. With deal volumes for the second half of the year estimated to total £2.75bn (down -33% on H2 2019) we expect the close to the year to be more akin to the end of 2020, where a few cautious investors push deals over the line, but most sit on the side lines waiting for greater clarity over what is to come in 2023.
Outlook
- The after-effects of a disastrous Q4 will be felt into the early New Year, particularly as fears over a protracted recession and “consumer squeeze” play on investors’ minds.
- Winners to be separated from losers once again as discerning shoppers focus on relevant assets, be they those that are omni-channel-enabled or serve a true convenience or experiential purpose.
- Greatest distress to exhibit itself amongst the pure-play/online retailers, with further administration activity expected. Weaker physical retailers will not be immune, with more consolidation or restructuring activity to come next year.
- A swifter stabilisation will occur in the retail warehousing and foodstore markets, due to their stronger underlying occupational dynamics – yields in both sectors could reduce by 50bps by the end of Q1 2023.
- Further discounting in the shopping centre sector is likely – while yields appear to have moved out far enough (yet again), NOI could come under more pressure with further occupational instability.
- The appeal of higher yielding, low management high street assets let to strong covenants will improve through the year if pricing corrects swiftly in keener sectors.
- Elevated debt costs to hold back pricing for secondary assets but availability of debt to improve for better quality assets in the short-medium term.
So much for 2022. COVID uncertainty abating, only to be replaced by a fresh wave of macro-economic uncertainty. Onwards to 2023.
Watch this space for our more detailed predictions for what next year may have in store for the retail sector. Next week, we will publish our ‘Retail Property Market Outlook 2023 Report’ which includes our projections (both quantitative and qualitative) for consumer, occupier and investment markets.
Next week’s Retail Note will summarise the full Report. Spoiler alert: consumer markets will get tougher in 2023 but consumer demand is unlikely to collapse completely. Rising operating and input costs will prove a more bruising pinchpoint for operators than consumer demand. Some occupier fall-out, but a bloodbath is unlikely for a host of reasons. Online pure-players at the sharp end of distress as structural change within e-commerce really starts to play out. The disruptors become the disrupted.
No doubt teased and tantalised by those spoilers, hold these thoughts. And the front page…