The Retail Note | Q1 Retail: you can’t start a fire without a spark
8 minutes to read
This week’s Retail Note showcases Knight Frank’s Q1 Retail Monitor – a temperature check on all aspects of the retail market, the signs are increasingly positive, yet the investment market in particular has yet to fully spring into life.
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Key Messages
- Improving narrative and sentiment in Q1…
- …but yet to fully filter through to investment activity in particular
- Consumer confidence definitely rising
- Perceptions of personal finance at highest levels since Dec 2021
- But retail sales performance very erratic in Q1
- Retail sales values +3.8%, volumes +0.2%
- Some concerns over clothing demand (vals -0.8% / vols -5.7%)
- Shop price inflation declines to just +1.3% in April
- Lowest rate since 2021
- Wage growth remains strong (+6.0%)
- Retail & Leisure vacancy stable at 14%
- Shopping centre vacancy improves -30bps to 17.4%
- But apparent uptick in retail ‘distress’ in Q1
- 308 stores affected by CVA/administration in Q1 (vs 971 2023 FY)
- But a modicum (+0.6%) of rental growth nonetheless
- Subdued investment volumes of ca. £1.1bn in Q1
- Below Q4 (£1.3bn) and 5-yr (£1.5bn) and 10-yr (£1.8bn) averages
- Retail warehousing remains a bright spot (QoQ vols +12%)
- All retail forecast to deliver total returns of 7.9% p.a. over next five years
- Retail parks forecast to be the best performing of any real estate sector (+9.4% p.a.)
You can’t start a fire without a spark. A line, as most will (and everybody should) know from Bruce Springsteen’s classic ‘Dancing in Dark’. An apposite parallel for the UK retail market in the first quarter of this year?
The portents are almost overwhelmingly good. Sentiment is increasingly positive, a by-product of an improving macro-economic backcloth. Economic indicators are definitely moving in the right direction. In April, according to the BRC, Shop Price Inflation hit its lowest rate since 2021 at 1.3%, with strong wage growth of 6.0% enhancing both consumer and retailer confidence.
However, this hasn’t been fully reflected in either retail sales or capital market data - yet. Recovery in retail sales volumes remains uneven, with some sectors even showing signs of softening demand. Despite quiet capital market activity, stabilising yields suggest we may be approaching (or even be past) the low point in the cycle.
Improvement on all counts – but somehow that certain spark seems to be lacking to really kick-start the market.
Consumer markets – no massive rebound, nor ‘straight line’ recovery
The consumer narrative has changed – perhaps a bit too prematurely. Whereas the ‘cost-of-living’ crisis predominated for most of last year, economists are now looking at the consumer as the driving force behind wider economic recovery in 2024. Way too simplistic, dangerously so, in fact. Consumer demand actually held up fairly well last year, despite everything conspiring against it. So, it can’t exactly rebound if it didn’t really go away in the first place. And the consumer trends emerging in Q1 2024 were nuanced, rather than universally strong.
On the one hand, consumer sentiment is definitely improving. Consumer confidence has been on the rise, improving from -36 points in Q1 2023 to -21 points in Q1 2024. Despite fluctuations during the quarter (-19 pts points in January, -21 points in both February and March) due to concerns about the broader economy (-23 points in March), perceptions of personal finances improved to +2 points, the highest level since December 2021.
But the perennial question is the extent to which this filters through to actual spend – there is often a curious disconnect between how consumers feel and how they behave. And this is what we have seen in retail sales figures year-to-date. Despite some narrative to the contrary, Q1 retail sales were actually fairly lacklustre, covering the traditionally quiet months of January and February. However, year-on-year sales values grew by +3.8%, and volumes encouragingly returned to positive territory (+0.2%). Monthly YoY trends were erratic however, with volume recovery showing considerable inconsistencies (January +0.4%, February -0.4%, March +0.4%).
Category demand was mixed, with a few worrying trends emerging. On the positive side, Non-Food sales rose by +2.5% (values) and +0.5% (volumes), the first positive volume increase in seven quarters. But clothing demand experienced a significant slump (-0.8% /-5.7%). This marked a first quarter of negative value growth since 2021, and a continued decline in volumes.
Meanwhile, Food sales growth slowed to +5.3%, the lowest in six quarters, although this in part reflected declining inflation. Nevertheless, food volumes decreased by a disappointing -0.3% in Q1, despite a number of the large operators (e.g. Tesco, Sainsbury’s) reporting positive volume growth.
For more detail on monthly retail sales, please refer to earlier Retail Notes.
Occupier markets – an uptick in distress?
Occupational markets have shown increasing levels of stability for some time. Indeed, most retailers maintained steady trading performance in Q1. This stability supported modest and targeted expansion, with retailers continuing to take advantage of newly-available vacant units and rebased rents. According to LDC, Retail & Leisure vacancy was stable at 14.0%, with Shopping Centres witnessing a -30bps improvement to 17.4%. Retail Parks improved -10bps to 7.5% and are now 80bps below the pre-pandemic rate (8.3%).
Contrary to overblown ‘cost-of-living crisis’ expectation, there was actually very limited occupier distress in 2023. Stores affected by CVA/administration were at their lowest level since 2015 and taking the demise of Wilkos out of the equation, retail distress was at its lowest level on record.
Despite the improving narrative, there has actually been more fall-out in 2024 YTD than there was in the whole of 2023. A spate of distress amongst high-profile players (e.g. Lloyds Pharmacy, Ted Baker) triggered a rise in stores affected by administration/CVA in Q1 (308) following a record-low year of fallout in 2023 (971 stores). Distress will inevitably be higher in 2024, aligning more closely with historical averages and primarily affecting those operators with internal or structural issues (i.e. non-retail ownership - The Body Shop / historic over-expansion – Superdry).
For more detail on occupier distress, please refer to this Retail Note.
Whisper it, but we are even seeing some rental growth, particularly for retail warehousing (2023 FY +1.5% versus +0.8% for all retail). Of course, rental growth is not universal, but expectations are now improving for well-positioned locations. As evidence of this, Hammerson revised its ERV for its core portfolio by +1.7%, the first time in six years. Similarly, British Land reported its retail parks delivered a higher gain in ERV than any other asset type, at +4.0%. Our latest forecasts now suggest retail rental growth will average +0.9% per annum for the next five years.
Rampant rental growth this may not be, but in the context of many years of decline, a very positive direction of travel.
Investment markets – still waiting
Retail capital markets – definitely where the figurative spark is missing most.
The restrictive interest rate backdrop continued to challenge capital markets in Q1. Ca. £1.1bn worth of retail assets transacted in the first quarter of the year, marking a deceleration on Q4 2023 levels (£1.3bn). This was also below both the 5-yr (£1.5bn) and 10-yr averages (£1.8bn). Retail Warehousing was the only sub-sector to see an uptick in QoQ volumes (+12%), and the sector continues to run hot amongst institutional investors (especially Realty), attracted to the sector’s fundamentals of affordability, adaptability and accessibility.
Whilst transactional activity may be subdued, yield stability was the overarching theme in Q1, with a notable exception being Regionally Dominant Shopping Centres, which experienced a slight increase of +25bps, pushing yields up to 8.25%. But overall market sentiment is showing signs of improvement, with RICS’ latest survey revealing a significant 35% of respondents now believing that markets have bottomed out, marking a potential key turning point.
Forecast data makes a renewed investment case for retail. Total returns are forecast to average 7.9% per annum over the next five years, higher than offices (7.7%) and competitive with the golden child that is industrial (8.4%). And retail parks are expected to deliver the highest annual return (9.4%) of any real estate sub-sector over that period.
Hold that thought. Or better still, start acting upon it now.
Where do we go from here?
At the moment, it’s difficult to see where the elusive spark will come from. Inflation has been the bane of market for so long, but its descent to acceptable levels is hardly a tinderbox for wider activity. Likewise, long-awaited reductions in interest rates will reduce some of the straitjackets on capital markets, but again, this is unlikely to trigger an immediate and decisive spark of energy.
Ultimately, the spark may come simply from all the stars aligning – if not perfectly, but at least favourably. And, on the evidence of Q1, we are firmly on the path towards this.
To a certain degree, we are still dancing in the dark. We are dyin’ for some action. But the messages keep gettin’ clearer. There will be somethin' happenin' somewhere. Baby, I just know that there will be (to paraphrase Bruce a little bit).
Click here to access the full Q1 Retail Monitor.