UK retail Q1 2023: a better quarter than anyone dared hope
This week’s Retail Note focuses on Knight Frank’s UK Retail Monitor for Q1 2023. While the metrics are not universally positive, the outcome for the retail sector was infinitely better than virtually anyone was predicting coming into the quarter.
7 minutes to read
Key Messages
- Consumer and occupier markets refreshingly benign in Q1
- Investment market more subdued
- Significant inflection point in retail property market performance in Q1
- Consumer confidence improves by +9 percentage points
- Robust job market reinforcing income security
- Although wages growth (+6.5%) lags CPI (10.1%)
- Retail sales values grow +5.6% y-o-y, +1.7% q-o-q
- Retail sales volumes decline -3.8% y-o-y, but grow +0.7% q-o-q
- Occupier markets resilient and stable
- Very limited occupier fall-out in Q1
- Vacancy rate recedes very slowly to 15.2%
- Online penetration plateauing at ca. 25%
- Retail investment volumes of £1.8bn in Q1
- Below the 5 yr quarterly average of £2.1bn
- Retail Warehousing a positive outlier
- RW volumes of £659m (+31% ahead of Q4 2022)
- Retail the top performing CRE class in Q1
- Total returns of 1.04% vs 0.15% for All Property
- Outperformance spearheaded by Retail Warehousing (2.37%)
- RW only CRE sub-sector to register positive capital growth in Q1 (0.78%)
- Optimism slowly growing for the rest of the year.
Consumer markets far more resilient than expected, occupier markets defiantly withstanding cost inflation pressures, a positive inflection point in retail property market performance, but investment markets (with the exception of retail warehousing) slightly subdued. Q1 2023 in a nutshell.
Our long-standing, Radiohead-inspired plea of ‘No Alarms and No Surprises. Please’ was finally heeded in Q1. With no major alarms or surprises, the retail sector was able to regain its footing and actually build confidence, rather than succumb to external economic forces, as the doom-mongers were predicting. Consumer demand held up surprisingly well, with sentiment appearing to have turned a corner. Occupational markets were also stable, with retailers even cautiously optimistic for the year ahead.
Retail property defied all expectations as the top-performing Commercial Real Estate (CRE) sub-sector, an accolade not fully reflected in investment activity. Retail investment markets remained muted, with demand for Retail Warehousing principally driving the sector forward. Investor sentiment perhaps lagging the more fundamental metrics.
Above all, a growing feeling that ‘thing’s might not be as bad as all that.’
Consumer Markets
That sentiment certainly pervaded the consumer. The mood of consumers definitely improved across the quarter, with confidence increasing by +9 percentage points overall in Gfk’s sentiment tracker. This was driven primarily by an improved outlook on the general economy, with the news that high inflation is expected to ease considerably later this year. Yet to become a reality maybe, but enough to lift the national psyche.
The mood toward personal finances (as opposed to the general economy) remains significantly elevated, as it was for much of 2022. Although wage growth (+6.9%) inevitably lags inflation (RPI 13.5%, CPI 10.1%), the majority of the population still enjoy a high degree of income security, with unemployment at historic lows. Record rates of workers exiting the workforce entirely also signal a level of personal financial confidence.
Curious that the economic community seemed to put far more weight on consumer confidence trends than they did on the actual retail sales figures for Q1. Tantamount to looking for proof in the pudding but ignoring the dessert trolley before your very eyes.
Retail sales continued on a growth streak in Q1, with sales values (amount spent) increasing +5.6% year-on-year. Year-on-year volumes (number of items purchased) were inevitably impacted by inflation (-3.8%), but to a lesser degree than previous quarters (Q4 2022: -6.3% / Q3 2022: -5.2%). Expect an inch back towards positive growth as the year unfolds.
The less relevant (but more favoured) quarter-on-quarter comparisons painted a more favourable picture still, with both values (+1.8%) and volumes (+0.7%) in positive growth territory.
In defiance of supposed economic logic, demand for many discretionary and large-ticket items remains strong (e.g. clothing +13.3% / cosmetics +26.6% / furniture +5.2%) with consumers spending and buying more on these categories. An appetite for the store experience prevails and there was a discernible shift away from online in Q1. According to ONS, online sales penetration is plateauing at ca. 25%, somewhat higher than Knight Frank’s own calculation of ca. 22%.
Retail sales performance over the quarter has been covered in more depth in earlier Retail Notes in February, March and April.
Occupier Markets
As covered extensively in last week’s Retail Note, there has been very little occupier fallout in the year to date, with the occupational market far more benign than predicted.
The only major household retailers to go into administration (Paperchase, M&Co) are both ‘repeat offenders’ with chequered histories of private equity ownership and a track record of previous administrations. Less a barometer of general economic malaise, and more operational shortcomings particular to those operators.
Although distress has thankfully been minimal, the retail market remains a tough place to be at the moment, with cost inflation still a very real issue for operators. Whilst some have inevitably seen a hit to their profits, the majority have upgraded guidance rather than issue warnings. Retailers knew what was coming and have prepared and communicated accordingly.
Against this backdrop, retail vacancy rates continue to recede, albeit very slowly. And this is the shape of things to come for a considerable time. Encouragingly, over the quarter a number of retailers have announced plans to open new stores. By and large, these expansion targets are modest rather than aggressive, a reflection of a new-found sense of pragmatism amongst retail operators.
More tellingly, it is refreshing to see retailers re-investing in their store estates. While much of the ‘death of the high street’ narrative has majored on the supposedly inexorable rise of online, the real detriment to physical channels (i.e. stores) has often been lack investment as capital has been pumped into multi-channel capability. Retailers are now taking a more balanced view and deploying capex more broadly.
Investment Markets
A quiet start to the year, with investment activity generally muted. But after the ‘Sturm und Drang’ of Q4, relatively few after-shocks. Sentiment across capital markets improved only marginally – the RICS Commercial Property Sentiment Index seeing a marginal uptick in Q1 (-11 pts. vs. -15 pts in Q4). The quarter did benefit from a spill-over of deals which did not complete by 2022 year-end. However, overall retail deal volumes were relatively restrained at £1.8bn, registering below the 5-year quarterly average (£2.1bn).
A positive outlier to this was Retail Warehousing. Although stock flow was fairly limited relative to the weight of capital chasing, deal volumes of £659m were 31% ahead of Q4 2022 and significantly above quarterly five-year averages of ca. £510m. For more detail on the Retail Warehousing market, please refer to our Q1 2023 Retail Warehouse Dashboard.
In general terms, stock availability and cost of debt will be key challenges to investment markets over the next few quarters, as vendors’ concerns over the ability of buyers to raise debt to support bid pricing remain front and centre.
Perhaps the most positive newsflow of all in Q1 flew under the radar somewhat. On the one hand, Retail retained its unlikely status as the top-performing CRE sector in Q1. On the other hand, there were key turning points in a number of the metrics that underpin this headline performance that transcend pure bragging rights.
According to MSCI, Retail delivered a total return of 1.04% in Q1, higher than All Property (0.15%), Industrial (0.66%) and Offices (-1.58%). Retail Warehousing (2.37%) was the key driver behind this out-performance, with Shopping Centres registering a more modest total return of 0.95%.
More significant were the underlying components of this return, with Retail Warehousing reporting capital growth (0.78%) to support more established and predictable income return (1.58%). In fact, Retail Warehousing was the only CRE sector to achieve capital growth in Q1 (All Property reporting a -1.04% decline).
Some positive signs also in Shopping Centres. Not only did they achieve the highest income returns of all CRE sectors in Q1 (1.63% vs. All Property 1.19%), there were even monthly flirtations with capital growth (e.g. 0.06% in January).
And – whisper it – even a glimmer of rental growth (remember that?). Just +0.2% (and driven by +0.9% growth in retail warehousing), but something that has been a long time coming nonetheless.
Outlook
A quarter that anyone would have taken at the tail end of last year. And the notion of a “last hurrah” increasingly receding in favour of an acknowledgement that this enduring resilience is actually a shape of things to come.
No alarms and no surprises. Other than on the upside?