UK retail Q3 2022: The storm before the Tempest
This week’s Retail Note references Knight Frank’s Quarterly Retail Monitor, which looks back on a tumultuous Q3 economically, socially and politically, but during which many of the retail metrics remained surprisingly resilient.
8 minutes to read
Key Messages
- Q3 a dramatic quarter economically, socially and politically
- Only some of this unrest percolated into the retail market
- Consumer confidence slumped to record lows (-49 points)
- But retail sales values grew by +4.0% during Q3
- But record (10%+) inflation saw retail sales volumes decline -4.7%
- Consumer picture highly complex rather than unequivocally bad
- Occupier markets relatively stable to date, limited fall-out
- Retail vacancy rates continue to improve (15.4%)
- But most retailers braced for a more challenging environment going forward
- Investment markets have reacted more swiftly to unrest
- All commercial property yields have already moved out by ca. +25bps
- Retail total returns +9.8% in the 12 months to Q3
- But retail total returns declined by -561bps in Q3 to -2.6%
- Retail warehousing by far the best performing retail property sub-sector
- Retail the only CRE category to achieve positive total return in 2022FY (+3.6%)
- Driven by retail warehousing (10.7%) and income return (5.3%) rather than capital growth (-1.5%)
- The worst is yet to come…
That was the quarter that was.
On reflection, it seems barely conceivable that so much could have happened politically, socially and economically in such a short space of time. The political arena descended into little more than farce, the brevity of Liz Truss’ tenure as PM destined to be a pub quiz question for ever more. More tangible was the damage done by the ill-fated mini-budget that the subsequent back-pedaling has only partially redressed. The economic backdrop to all this was, of course, inflation soaring to levels not seen since the early 1980s, when at least the music was way better than anything offered up nowadays. With the threat of an impending recession hanging over us like a guillotine.
Other events were more unfortunate than premeditated. The sad passing of Her Majesty the Queen understandably did little to lift the somber mood of the nation and the extra Bank Holiday to mark her funeral saw most retailers temporarily close their doors out of respect and many lost a day’s trade as a result.
How did the retail sector fare generally during the late Summer/early Autumn of Discontent? The cumulative impacts of these events is evident in some of the figures, but in many, there is also evidence of surprising resilience.
Whisper it, but there is, as yet, limited pain and distress in the retail sector. Are we in denial, merely lagging or is retail comfortably numb in a state of battle-hardened immunity?
A Confused consumer
The consumer narrative has already been written. The cost of living crisis has supposedly completely pulled the rug on retail spending. While there is some evidence of changes in consumption patterns, many of the assumptions around a total collapse in demand are wide of the mark. The consumer situation is far more complex than a straight, universal collapse.
As is frequently the case, Q3 saw a major disconnect between consumer confidence and actual behaviour. Consumer confidence nosedived, with concerns over personal finances tumbling 140bps, according to Gfk. As has been widely (gleefully?) reported in the media, consumer confidence continues to hit record lows. The scale of pessimism is hard to fathom given the misery of multiple lockdowns, but is perhaps a sad reflection of the scale of economic and political chaos unleashed by the short tenure of (now former) PM Liz Truss (44 days, your pub quiz answer).
Seemingly in stark contradiction to this gloom, Q3 retail sales actually remained in positive growth territory. Consumers spent +4.0% more this quarter than last year (values), although purchased -4.7% fewer items (volumes). Sweeping assumptions that consumers solely made cutbacks on discretionary goods simply do not hold true. Several categories witnessed both value and volume growth (e.g. electricals +7.4% / +9.6%).
Compare the relative performances of sister categories chemists and cosmetics. The former, supposedly the epitome of inelastic demand, saw sales fall -19.2% during Q3. The latter, supposedly elastic / far more discretionary, saw sales surge +28.2%. A switch away from large-ticket bulky goods? Then explain the growth in carpets in Q3 (value +20.9%, volumes +12.4%).
The negative effects of inflation are plain to see in the Q3 numbers, but realistically sales values are unlikely to collapse in Q4, even as the well-documented ‘consumer squeeze’ finally takes hold after months of anticipation. As previous recessions show, history is very much on the side of retail spending. For example, back in 1990 when CPI was running high at ca. 8%, retail sales values grew by +7.3% and even volumes were up +1.4%.
It is highly unlikely that volumes will hold up this time around, but expect economic logic to go out of the window as the recession unfolds. Consumers move in mysterious ways and are not the robots economists believe them to be.
For more detail on the complexities and nuances of retail sales, please refer to my earlier Retail Note.
A battle-hardened but braced operator
Despite a multitude of political and economic challenges, occupational markets remained fairly stable in Q3. As unwelcome as inflation may be, it is ‘less bad’ than deflation for retail operators. And significantly more manageable than enforced lockdowns, which saw a complete collapse of retail sales values / volumes (e.g. April 2020, -18.6% /-18.5%).
Generally speaking, the pandemic-induced shakeup of the sector proved the ultimate survival of the fittest. Those retailers left standing are battle-hardened, having shored up their balance sheets and got their house in order generally. As a result, there have been very few casualties this year, with vacancy rates improving for a fourth consecutive quarter to 15.4%.
A lull before a fresh wave of fall-out? That seems to be mood currently, certainly in the retail property investment community. Certainly, most retailers are currently battening down the hatches, hoping for the best, but fearing the worst. But generally, most are in far better shape operationally and financially than they have been for some time and are therefore better-equipped to face whatever challenges will come their way. Compare this with the onset of the GFC in the late 2000s when the retail sector was far more bloated and with considerably less defenses in the face of something far more unexpected and, arguably, far more severe.
Of course, there will be some retail occupier fall-out in the coming months as not all will go the distance. But, as detailed in a previous Retail Note, we expect online-only operators to be at the sharpest end of occupier distress.
A spooked investor
In contrast to previous recessions (where occupier markets have traditionally been the first to spook), investment markets have reacted more swiftly to political unrest and economic crisis. All commercial yields have already moved out by ca. +25 bps, with further easing inevitable in the coming months. But having re-based significantly over the preceding years, retail has been less exposed to sudden and severe corrections in pricing than other property sub-sectors.
In terms of property market performance, recent unrest is apparent only in the very latest monthly figures. Total returns in retail in the 12 months to Q3 were +9.8%, with income return (+5.3%) stronger than capital growth (+4.3%). But in Q3 in isolation retail total returns decreased by -561bps to -2.6%, with a positive income return (+1.3%) only partially offsetting a decline in capital growth (-3.8%). If there is any consolation to be had, it is that correction in retail has been far less dramatic than in other CRE sectors.
Overall, investor demand has been checked rather than completely destabilized. But, realistically, sentiment is likely to remain subdued for the rest of the year. This is already manifest in the numbers. Investment volumes in Q3 fell -70% overall vs. Q2 (£1.21bn vs. £3.98bn), Retail warehousing remained the most resilient retail sub-sector, with investment volumes dipping quarter-on-quarter by just -8.8% (£447.9m). In terms of performance, retail warehousing total returns for the year to Q3 (+20.1%) even eclipsed the performance of Industrial (+17.6%).
On the subject of (admittedly fairly cheap) bragging rights, Retail is the only major commercial real estate sector forecast to achieve a positive total annual return this year - +3.6% vs. Offices (-0.3%), and Industrial (-0.1%). That Retail’s outperformance will be driven purely by retail warehousing (+10.7%) rather than high street shops (-0.6%) or shopping centres (-1.2%) and owes everything to income return (+5.3%) rather than capital growth (-1.5%) are but moot points.
Expectations for Q4
To not duck my original question: are we in denial, merely lagging or is retail comfortably numb in a state of battle-hardened immunity?
Few in the retail sector are in denial. There is no room for complacency and nobody is blind to both current and future challenges. No operator is coming into this with the wool pulled over their eyes.
Are we merely lagging? There is no doubt that the worst is still to come, particularly on the consumer side when the huge energy bills become a reality. But the assumption that all retail is simply on a delayed path to destruction is as trite as it is likely to prove inaccurate.
Comfortably numb in a state of battle-hardened immunity? Maybe immunity is a bridge too far, but retail’s defences this time around are far more robust. Pragmatic, lean, re-based and re-priced – contrast this with the excesses that retail was saddled with going into previous recessions.