Mid-Term Review: Showing Potential, Room for Improvement
COVID-19 Market Update – 06/08/2021
9 minutes to read
Introduction
This is the 48th of a series of weekly notes analysing the state of the UK retail market in the light of the COVID-19 pandemic. This note is a synopsis of our two half yearly reports, the Q2 Retail Monitor and the Q2 Retail Investment Update:
- Retail Monitor: Consumer Bounceback, Occupier Stabilisation
- Retail Investment: Green Shoots Emerging
Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.
Key Messages
- Positive signs of recovery across the retail spectrum
- Consumer confidence surges post-lockdown
- Wages growth substantially above inflation
- But footfall still down -27.6 vs pre-pandemic
- In Q2 retail sales +21.3% y-o-y, +12.2% q-o-q
- Online sales index recedes to <150
- Vacancy rates hit new peak of 15.8%
- But rate of increase slowing considerably
- Retail capital values return to growth for the 1st time since 2018
- Driven largely by Retail Warehouses (+1.98% in Q2)
- Retail investment volumes reach £2.76bn in H1 2021
- Volumes up +80% on H1 2020
- -75bps /-50bps compression in retail warehousing / foodstore yields
- Flood of retail stock expected to come to the market in Q4 2021
- Transaction volumes expected to surpass £6bn in 2021, highest since 2017.
1. Q2 Retail Monitor: Consumer Bounceback, Occupier Stabilisation
The smorgasbord of data, charts and analytics that is the Knight Frank Retail Monitor presents a hugely varied picture of both ongoing COVID-induced pain and recovery, a mixed but very fair reflection of the state of the retail market at the moment. But for the first time in months, the positives are starting to outweigh the negatives.
Q2 was, of course, hugely significant in that it saw the lifting of government imposed lockdown restrictions, with “non-essential” retail operational from 12 April (England, Wales) and 26 April (Scotland). But legal restrictions on social distancing remained in place until ‘Freedom Day’ towards the end of the quarter (21 June). So, a truncated return to something like full capacity over the quarter, rather than a quarter of total unbridled freedom.
The consumer response to the lifting of lockdown has been both immediate and immense. Consumer confidence has surged in recent months. Figures from Gfk show that overall confidence increased from -15 in April to -9 in June. Consumers continue to feel more optimistic about their own personal finances (+11) than they do in the general economic situation (-2). Good news for the retail sector as the former is much more likely to influence purchasing decisions and shopping propensities.
Of course, this confidence flies in the face of many economists’ predictions. Many thought consumer markets would struggle post-pandemic in the face of rising unemployment as furlough schemes unwound. Throw into the mix the other economist hobby horse of rising inflation and you could point to a consumer squeeze that frankly just isn’t there. For what I think it’s worth as a retail metric (shoppers don’t walk round a store calculator in hand), average weekly earnings growth (+8.7%) is way higher than both CPI (2.5%) and RPI (3.9%).
Footfall figures make for more sobering reading. With social distancing restricting store capacity for much of Q2, footfall remained well below pre-pandemic levels (-27.6%). Retail parks (-8.1%) were more resilient than in-town locations (high streets -33.4%, shopping centres -35.8%). But the trends are slowly improving and reopening of indoor hospitality (17 May) provided a boost across all asset types (High Streets +30%, Shopping Centres +31%, Retail Parks +25%).
As ever, very little correlation between footfall and actual retail spending (raising the perennial question as to why the media always attach so much credibility to the former). In Q2, retail sales values were up +21.3% on the previous year (April +38; May +22%; June +9%).and +12.2% quarter-on-quarter.
Admittedly, there were significant skews and spikes in retail sales given soft YoY comparisons against the respective months in 2020. And ‘pre-pandemic’ comparisons are largely spurious in that they gloss over the huge volumes of lost trade over the last 14 months. But there is no denying the fact that the consumer is back and spending freely.
Footfall down significantly, but spending up. Online must be the beneficiary. The limitations of that old chestnut have been dramatically exposed over the last quarter. Online sales have plummeted since physical stores re-opened. The proportion of retail sales made online receded (April 29%; May 28%; June 26%), falling -940 bps from its Q1 peak (February 36%). Pandemic-induced spikes in online grocery demand also continued to normalise (April -11.4%; May -6.9%; June -9.0%), with overall penetration reducing to 10% by quarter-end.
Footfall down, online sales down, but overall spending up. What we are actually seeing is a combination of higher spend visits and possibly also consumers trading up. If this is the case, long may it continue.
Positive as the consumer picture may be, realistically it will take retail occupational markets considerable time to recover from events of the past 18 months. Many of the challenges facing occupiers are ongoing and there are still some far-from-positive numbers in the report. Vacancy rose 40bps to 15.8% to reach the highest rate on record. The fact that this was only half the rate of the same period in 2020 and that we may be past the worst is only of limited comfort.
More positive news in terms of retail property market performance in Q2, albeit highly polarized between the various sub-sectors. A long time coming, but overall retail capital values returned to growth (April -0.1%; May +0.1%, June +0.7%) for the first time since 2018. Cumulative capital value growth of +0.29% for Q2 may be modest, but still represents a significant turning point. The return to capital growth was driven primarily by retail parks which improved +90bps over the quarter (April +0.4%; May +0.6%; June +1.4%). Although the trend is improving, shopping centres saw values slip a further -2.74% in Q2.
In contrast, rental growth remains elusive across the retail sector – hardly surprising given the fact that the rent moratorium has been extended to March 2022. Although still in negative territory, the overall rate of rental decline improved +30bps to -0.1% in Q2. High street rents declined by -0.8%, shopping centres by -0.07%, while retail warehousing registered a very small increase.
Restrictions easing, shoppers slowly returning to the high street but spending a lot more, much of the artificiality in online demand dissipating, occupier shake-out still washing its way through and re-basing in retail property markets bottoming out. Probably the best we can hope for at this still early stage of a very protracted recovery. Mid Term Report: B+
2. Q2 Retail Investment: Green Shoots Emerging
Some of this positivity in consumer markets and occupational markets is already filtering through to retail property investment markets. What a difference 6 months makes. As a general observation, investors have cautiously returned to the retail sector, buoyed by high yields and prospects of counter-cyclical buying opportunities.
In terms of headline statistics, total retail volumes totalled £2.76bn in H1 2021. This marked +80% growth on the £1.54bn in the corresponding period last year.
This growth is being spearheaded by a resurgence of investor appetite for retail warehouses. Volumes of £1,040m in H1 were +76% ahead of last year and accounted for 38% of all retail investment in the first half of the year. Strongest demand is for re-based, discount-led bulky parks and solus units. In contrast, fashion parks are still perceived to offer far higher risk. Encouragingly, selective UK funds are back in the market.
Having reinforced their sound investment credentials throughout the pandemic, foodstores remain in high demand. Some £790m (+11%) was transacted in foodstores alone in H1 2021, accounting for 28% of all retail volumes. Investors remain attracted to longer leases (often index linked) coupled with strong covenants. UK Institutions, REITs and overseas investors are all active in the market.
Strong demand for out-of-town assets has seen significant yield compression in both retail warehousing and foodstores. Prime retail warehousing yields have hardened by -75bps since the beginning of the year and are now around 5.75%. Foodstores have compressed by -50bps over this year to record lows of 3.50%. Current deals may even complete below this figure.
Polarisation maybe, but the in-town market is also showing encouraging signs of life. Some £429m was transacted in high street units in H1 2021, more than double the figure in the corresponding period last year. Perhaps unsurprisingly, demand is strongest for historic prime asset let to secure, rent-paying tenants. Most active high street investors include HNW Private Investors and PropCos.
Shopping centre volumes of £511m in H1 2021 were infinitely higher than in the same period last year. Pricing for relevant schemes – prime experiential and local convenience – is starting to stabilize. At the same time, dramatic valuation declines have caused debt covenants to be breached, which has led to a number of bank-led sales processes. Administrators and banks taking on secondary portfolios are likely to prompt a flood of shopping centre stock hitting the market as the year progresses.
Valuation write-downs continue to open the door for “re-purposers”. With retail historically being the highest value use, the opportunity to convert space to alternative uses only existed in certain markets. However, the crash in values (often -50%+) has broadened the playing field for “re-purposers” looking for development opportunities. With numerous assets trading at <£100/sq ft, conversions are becoming more viable in locations where this was not previously possible.
Looking forward, we expect to see an increasing number of investors for retail emerge as the year progresses, although many counter-cyclical opportunities in retail warehousing have already passed. We expect a further 25-50bps of compression in retail warehousing by the year-end, which would mean 100-125bps of inward yield shift over the course of 2021.
We anticipate that significant stock will come to the market in Q4 2021. There are concerns that this supply could overwhelm demand in some areas of the in-town market and pricing could be impacted. Despite a risk of oversupply, we expect retail transaction volumes to surpass £6m in 2021, a level not seen since 2017.
Although this is an objective, Research-led Note, it would be remiss of me not mention the fact that Knight Frank have closed over £1bn of retail transactions in the last 12 months. Mid Term Report; Retail Investment Market B+. Knight Frank Investment Agents: A* (much as I would like to say “Poor. See Me.”)…
Stephen Springham
Partner – Head of Retail Research
+44 20 7861 1236
stephen.springham@knightfrank.com