Q2 2023: all quiet on the Retail front

Written By:

Stephen Springham, Knight Frank

04 Aug 2023

7 minutes to read

Categories: Property Sector Retail World Regions UK London

Key Messages

• Relative calm in consumer and occupier markets in Q2
• Investment markets remain more subdued
• Consumer confidence improves by +12 percentage points
• Robust job market reinforcing income security
• Gap narrows between wages growth (+7.4%) and CPI (8.0%)
• Retail sales values grow +7.4% y-o-y, +2.8% q-o-q
• Retail sales volumes decline -1.9% y-o-y, but grow +0.6% q-o-q
• Occupier markets largely resilient and stable
• Very limited occupier fall-out in Q2
• Vacancy rate creeps up q-o-q from 15.2% to 15.3%
• Retail investment volumes of £0.75bn in Q2
• Volumes down -65% on Q1 (£2.13bn)
• Retail Warehousing bucking the general trend
• All retail achieved total returns of +1.9% in Q2
• RW remains the top performing CRE class in Q2 (+2.5%)
• Administration of Wilkos will put retail in negative spotlight in H2
• Unlikely to be a precursor to a fresh wave of occupier fall out
• Retail sales volumes likely to return to positive growth in Q3/early Q4
• Wider/positive implications for the macro-economy + capital markets
• More impetus for inflation to recede, less stimulus for further interest rate rises.

Quiet in consumer and retail occupier markets = good. Quiet in retail property investment markets = less good. Effectively what have seen in Q2 and in the first half of the year as a whole.

In very general terms, the retail sector continues to steer a surprisingly steady course, despite prevailing headwinds. Consumer and occupier markets are leaning into economic challenges with newfound resilience – seemingly adopting a ‘que sera sera’ attitude - tackling challenges head-on with the view that ‘uncertainty’ is now an omnipresent feature, a given. Rather than hide behind ‘uncertainty’ as an all-encompassing excuse, retailers have effectively just got on with the day job. Likewise, consumers have not simply conformed to the way economists say they must behave.

But property investment markets generally remain far more sensitive to macro-economic pressures. Investment markets are undoubtedly where the retail sector remains most challenged, although Retail Warehousing continues to propel the sector forward.

Consumer Markets

The media remain desperate to perpetuate the cost-of-living crisis narrative, yet have actually had precious little to feed on in the Q2/H1 figures. Yes, inflation remains stubbornly high, interest rates continue to rise, but the consumer appears relatively indifferent to this macro-economic backcloth.

In Q2, retail sales increased both YoY and QoQ. Retail sales values in Q2 were up +7.4% YoY. Doomongers could (and did) point to the fact that retail sales volumes declined by -1.9% on the same basis, reflecting the impact of high inflation. But the OoQ figures paint an undeniably positive picture – both retail sales values (+2.8%) and retail sales volumes (+0.6%) were firmly in positive territory, with an improving monthly trend to boot. In simple terms, rather than tightening the purse strings, the UK consumer is buying more and spending more.

Actual spending patterns are supported by (and consistent with) movements in consumer sentiment. Figures from GFK showed that consumer confidence improved by 12 percentage points to hit -24 pts in June, marking the fifth consecutive monthly improvement. Confidence in people’s personal financial situation continues to be far higher than in the general economic situation – in another market, we would probably be talking of a ‘feel–good’ factor, but clearly, that is at odds with the cost-of-living crisis narrative.

Sentiment and spending upticks can be attributed to several quantifiable factors, including a) an increase in householders’ disposable income (ONS showing regular average earnings, excluding bonuses, grew +7.3% in the three months to May) and b) the easing of utility prices, resulting in the diversion of essential spend (down -1.1 ppts) to more discretionary items (+4.9 percentage point increase, according to Deloitte’s Consumer Tracker).

Perhaps less quantifiably, the consumer mood was enhanced in Q2 by the multiple bank holidays, the King’s coronation and the hottest June on record – factors cited in many retailers’ generally upbeat performance updates. Consumers are not robots and they remain far more susceptible to mundane things such as the weather than they do macro-economic pressures.

Retail sales performance over the quarter has been covered in more depth in earlier Retail Notes in May, June and July.

Occupier Markets

As you were amongst retail operators. Quiet, but growing, optimism in retail occupier markets, with retailers steadily ‘plodding on’. Several mainstream operators revealed better-than-anticipated sales - albeit against moderated forecast expectations, but nonetheless supported by solid consumer demand. Easing energy and shipping costs also supported improvements in product margins and profitability. In base terms, there were far more profit upgrades in Q2 than there were profit warnings.

Occupier failure continued to be limited in H1, with the Centre for Retail Research calculating 31 retail businesses failing affecting 523 stores, versus 49 businesses and 6,055 stores in the whole of 2022. Several brands facing distress in Q2 (e.g. Hotter Shoes, Planet Organic) have already been acquired and are set to continue trading. As ever, these figures probably overstate the level of distress in that they include a number of non-retailers (e.g. wholesalers, suppliers and distribution companies). The fate of Wilkos will obviously heavily influence the figures for the second half of the year.

Retail vacancy rates inched up marginally QoQ (by 10bps) to 15.3%, with minor deterioration in High Streets (13.9% vs. 13.8% in Q1). Shopping Centres rates were stable (17.8%) whilst Retail Parks improved to 8.1% from 8.7%. Overall vacancy remains 10bps lower than Q2 2022 (15.4%). In essence a positive YoY trend, but a slight negative QoQ reversal.

Investment Markets

Bittersweet messages within retail property. Retail was the best performing commercial property class in H1, but this accolade failed to translate into transactional volumes. Although the actual figures were disappointing, retail investment markets generally showed growing signs of stability, with demand and liquidity improving across nearly all retail sub-sectors. Sentiment towards retail is becoming increasingly positive, with rents and values appearing to have turned a corner.

Retail total returns in the three months to June (+1.9%) significantly outpaced the Offices sector (-2.8%). Standard Retail lagged (+0.7%), however, whilst Shopping Centres (+1.9%) and Retail Warehousing (+2.5%) led the way, the latter surpassing even Industrial (+2.4%). Going into the second half of the year, Retail Warehousing remains the best performing of all mainstream CRE sectors.

However, in line with wider capital markets, transactional activity remained largely depressed, due to a lack of stock and elevated debt costs. Transaction volumes registered an underwhelming £0.75bn in Q2, marking a substantial -65% decrease on Q1 levels (£2.13bn). Total Retail transactions volumes totalled £2.89bn in H1, but stripping out Foodstores (which were bolstered by a number of portfolio deals), transaction volumes were down -43% versus H1 2022 and -24% versus H2 2022.

For more details, please refer to our Retail Investment Update for H1 2023.

Outlook

A stronger-than-expected Q2, on top of a stronger-than-expected Q1. Not necessarily a case of ‘nothing to see here’, but growing evidence of an over-reaction at the end of 2022 going into 2023, and one that continues to hold back investment markets.

It seems reasonable to expect more of the same in H2. The pending administration of Wilkos will inevitably shine a negative spotlight on the retail sector, but is unlikely to be a precursor for fresh wave of occupier fall-out. It is an isolated instance, rather than the shape of things to come.

The key retail metric to look out for in H2 is a return to positive retail sales volume growth. This has been the one major blot on the consumer copybook YTD, but improving QoQ and MoM trends suggest that it is only a matter of time before the YoY metrics move into positive territory. This will be a landmark moment on a number of counts. 1. It will mark a return to “real’ growth in retail sales on an annualised basis. 2. It will ease some financial and operational pressure on retailers. 3. There will be more impetus for inflation to reduce. 4. And less stimulus for further interest rate rises.

H2 2023: hopefully still all quiet on the consumer and retail occupier front – but hopefully a bit noisier on the retail investment front.