The Retail Note | Retail Warehousing: how soon is now?
8 minutes to read
This week’s Retail Note focuses on Knight Frank’s Q1 Retail Warehousing Dashboard – with RWH emerging as one of the strongest sub-sectors not just within retail, but of all real estate asset classes.
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Key Messages
- RWH forecast to be the best performing of any real estate sector
- Average annual total returns of 9.0% over next five years
- Average annual income return of 6.2% p.a...
- …supported by capital growth of +2.6% p.a.
- Capital values moved into positive growth territory in Q1 (+0.4%)
- But not fully reflected in investment activity and pricing - yet
- RWH investment volumes of £386m in Q1
- Volumes up +12% QoQ, but below rolling 5 qtr ave (£441m)
- Prime stock yields sharpen -25bps, secondary stock stable
- An improving macro-economic backcloth generally
- But erratic retail sales and footfall patterns
- RWH largely insulated from occupier distress to date
- Question marks over the future of Homebase and Carpetright
- Occupier demand remains strong, supply static
- RWH vacancy improves for a 10th consecutive quarter
- Currently 7.5% in unit terms, ca. <4% in floorspace terms
- Rental values grew +0.4% in Q1
- Forecast annual rental growth of +1.4% p.a. over the next 5 years
The stars seldom align – but they are starting to for the retail warehousing market. Against a backcloth of general macro-economic improvement, a largely-rightsized and sensibly re-based market with static supply, low vacancy and strong ongoing occupier demand is quietly going about its business.
Other (every?) real estate sectors may claim to have “solid fundamentals”, but retail warehousing actually walks the walk. Indeed, forecasts suggest that retail parks will deliver the highest total returns over the next five years, the established calling card of high income returns now actually boosted by decent capital growth.
Is this star alignment reflected in investment activity? Only to a certain degree. There is undoubtedly a lot of capital chasing the sector from all sides and retail warehousing is high on many investor shopping lists. But actual volumes are probably not at the level they should be, a shortage of available stock holding back activity. Pricing has yet to move significantly – but it will, particularly when interest rates start to come down in the second half of the year, as they inevitably will.
Buy now, pay less than later?
An improving economic backcloth
The macro-economy is finally starting to play ball. The +0.6% QoQ rise in GDP in Q1 announced this morning was comfortably above both the Bank of England’s and consensus forecasts of +0.4%. It also confirmed that the recession was just a fleeting one which ended at the start of this year and suggests that the recovery will be stronger than most forecasters predict. March in isolation was tangibly stronger than anticipated (+0.4% MoM vs consensus forecast +0.1%).
Encouragingly for retail markets, consumers are proving a key driver behind this economic recovery. According to Gfk, consumer confidence on the outlook for personal finances has reached its highest level since December 2021 (+2), thanks to strong wage growth (+6.0%) and easing Shop Price Inflation (1.3%). Tellingly, consumer confidence in the general economic situation is far lower (-23) than in their personal situations – and this ‘I’m alright Jack’ attitude was reflected in a +0.2% QoQ pick up in consumer spending in Q1.
But was this fully reflected in Q1 retail sales? In fairness, Q1 retail sales were erratic rather than universally positive. Overall retail sales values grew +3.8% YoY in Q1, with volumes returning to positive growth (+0.2%). But category performance was mixed with Sports Equipment & Toys (+3.6%) much stronger than bulky goods (Furniture -5.9% / Carpets -1.0%) and Clothing (-0.8%).
This uneven performance was reflected in retail warehousing footfall trends over the quarter. Footfall was particularly hampered by one of the wettest Februarys on record (-5.8%), but the months either side were both in negative territory too (January -1.8% / March -3.5%). Not as positive as it might be, but retail warehousing generally showed greater resilience than shopping centres and high streets.
Occupier markets – immune to distress?
There was a surprising uptick in retailer distress in Q1, but none of the main protagonists (The Body Shop, Ted Baker, Superdry) have much of a retail warehousing presence. Fresh concerns surfaced as to the future of other key retail warehousing occupiers, such as Homebase and Carpetright. The former has been put up for sale by owners Hilco and the latter has reportedly appointed advisors Teneo to look at multiple cost-saving options, according to The Times. Watch this space.
Be that as it may, occupier demand for retail warehousing generally remains strong. Retail parks were the only retail sub-class to see net growth in occupancy of +0.3% in 2023, outshining shopping centres (-2.5%) and high streets (-3.3%). Fastest growing outlet types included takeaways (+151 units), food-to-go (+131), supermarkets (+40) and petrol stations (+48). Retail warehouse expansion is still being spearheaded by the value operators (B&M, Home Bargains, The Range) but this is not the only source of occupier demand.
The buoyancy of occupier demand saw retail warehousing unit vacancy rates improve for a 10th consecutive quarter in Q1 to reach 7.5% - well below their pandemic peak (11.5% Q2 2021) and pre-COVID rate (8.1% Q4 2019). Note that these figures (from the Local Data Company) refer to units rather than floorspace – our estimates for the latter suggest vacancy levels <4%.
Static supply = rental growth
According to Trevor Wood Associates, there is some 199 million sq ft of retail warehousing stock in the UK. And this figure is largely static – although there are 31 schemes supposedly in the development pipeline (by 2031), the reality is that many of these will not be delivered. A number of schemes have either been withdrawn, put on hold or changed course to other use.
A reflection of increased development costs or an overdue realisation that, as a generic whole, the UK retail market is oversupplied? Either way, we are unlikely to see the needle move significantly on retail warehousing supply in the years to come.
Stable supply + ongoing occupier demand = reducing vacancy + rental growth. After a number of years of rebasing, we are now indeed seeing a degree of rental growth in some retail warehousing markets. Indeed, according to MSCI, overall retail warehousing rents grew +0.4% quarter-on-quarter in Q1.
Nor is this a flash in the pan. Our latest forecasts (produced in conjunction with Real Estate Forecasting) suggest that retail warehousing will achieve rental growth of +1.3% this year, with retail parks (+1.5%) outperforming solus units (+0.4%). The projected annual average rate of rental growth over the next five years will be +1.4%. Solid rather than spectacular. But ultimately sustainable.
Forecasts don’t lie
On the subject of forecasts, look away now if you don’t want to know the score. But retail warehousing is predicted to achieve the highest annual rate of total return over the next five years of any real estate asset class. Average annual total returns for all retail warehousing are forecast to be 9.0% over this period, with retail parks (9.2%) leading the charge over solus units (+8.4%). This compares with 7.8% for all retail, 8.1% for industrial and 5.9% for offices.
Of course, retail warehousing has long been able to hold its own in terms of income return (6.2% vs 5.0% for all property), but the market is now at an inflection point in terms of capital growth. Retail warehousing capital values declined by -4.0% as recently as last year, but are forecast to rebound into positive territory this year (+3.2%) and maintain annual growth of +2.6% over the next five years. This turnaround is already underway, with Q1 figures from MSCI showing capital growth of +0.4%.
High income returns a given, but now supported too by positive capital growth.
Investment – how soon is now?
Capital markets generally remain constrained by the interest rate backdrop, but they too are showing some signs of improvement, in sentiment at least. Globally, the RICS’ Commercial Property Sentiment Index stood at -10pts, the least downbeat reading since Q2 2022. The Investment Sentiment Index also improved to -13pts (vs. -18 pts in Q4).
Testament to the weight of capital chasing the sector, retail warehousing is already bucking some of these trends. Indeed, it was the only retail sub-sector to see a QoQ increase in investment volumes in Q1. Investment volumes improved +12% quarter-on-quarter to £386m. However, this was still below the rolling 5-quarter average (£441m), which perhaps gives a more rounded perspective.
Institutions and Listed PropCos were the dominant purchasers in Q1, acquiring 49.2% and 38.3% of assets by deal volumes respectively. Private buyers made up just 4.2%. Although by no means the only show in town, Realty Income’s dominance of the sector has been undeniably meteoric. From a standing start in 2019, Realty has established itself as the leading RWH investment manager in the UK, with ca. 9.5 million sq ft of retail park space. Others may be weighing up the sector, Realty is putting its money where its mouth is.
The stars are slowly aligning, but is this fully reflected in pricing? Only marginally, as yet. According to the Knight Frank Yield Guide, prime retail warehousing yields sharpened in Q1 by -25bps across both Open A1 and Bulky Goods Parks to 6.00%. Secondary Open A1 and Secondary Bulky Goods were stable at 8.00%.
Interest rates this week remained unchanged at 5.25%. When they start to be cut has become something of a national fixation. In my opinion, the exact month when this happens is actually of little relevance. The point is they will come down at some point in the second half of the year and property yields will inevitably follow suit.
In very basic terms, retail warehousing will be more expensive later in the year than it is now. Exactly when that is is a moot point. How soon is now?
Click here to access the full Q1 Retail Warehousing Dashboard.