Retail poised to ride the wave after tide turns

The UK retail market started the year with a renewed sense of optimism. While initial signs were encouraging, with economic growth, retail sales and consumer confidence all in positive territory, recent indicators have been more mixed, and investment volumes remain below trend. However, as we approach the final quarter, there are real signs that an inflexion point has been reached. Inflation is at the Bank of England’s 2% target (albeit upward pressures remain), interest rates are on a downward curve, cost-of-living pressures are moderating, confidence levels recovered post-election, and consumer demand looks set to rebound. The improving consumer backdrop is positive for occupiers and investors, and should stimulate the retail market in the months ahead. Below, we briefly review the year-to-date, and look forward to what’s in store in Q4 and beyond.

2024 – the year-to-date

Slowly strengthening economy and consumer sentiment. The economy has experienced better-than-expected gains so far in 2024, signalling that the new Labour government has taken over a strengthening economy (the OECD has ranked the UK joint second among the G7 countries in its latest world economic outlook). And, while there is little consistency to the latest indicators, it is also possible to discern a gradual improvement in consumer sentiment. According GfK’s data, there was a strong lift in consumer confidence in August, driven by an uptick in the Major Purchase Index, with consumers appearing more willing to buy big-ticket items. This more positive outlook was likely due to the recent mortgage-friendly interest rate cut, and the expectation of more to come. While September saw a pre-budget reversal in confidence levels as tax-hike fears hit the consumer mood, it is expected to rebound again as economic fundamentals continue to drive improving sentiment.

Retail sales inconsistent but on a slow upward curve. The official retail sales series from ONS is notoriously volatile, and recent data has been particularly inconsistent. UK retail sales rebounded in July and August after a poor June, driven by an upturn in spending in department stores. However, cutting through the monthly noise, there are definite signs of a progressive improvement in sales over the past year. And more broadly, across the major consumer indicators, the latest numbers are significantly more encouraging than they were 12 and 24 months ago.

Solid economic growth, driven by consumer activity. GDP growth is forecast to be solid but unspectacular, with Oxford Economics expecting growth of 1.1% this year and 1.8% next year. Healthy real income growth and rising confidence indicate that much of the growth will be driven by a consumer-led pick-up in activity in the coming months and years.

There will be two key drags on disposable income growth and household spending power, however. With tax rises predicted in October’s Budget, the impact of tighter fiscal policy will continue to bite. Meanwhile, the lagged impact of past interest rate rises will continue to emerge, particularly for fixed-rate borrowers. Barring strong evidence that inflation pressures are abating more quickly than anticipated, further rate cuts are expected this year.

Real household income growth supports sales volume growth. Recent survey data suggests the consumer mood is improving – if this positive shift continues (and assuming September’s dip is a temporary one) we should see a period where consumer spending grows faster than real incomes. So, while tighter fiscal policy and the lagged impact of past interest rate rises will act as a drag on spending power, the consumer outlook remains relatively upbeat. Sustained real wage gains should boost real household income growth and, provided inflation remains under control, there are concrete reasons to believe that retail sales will strengthen further in Q4 and beyond. At an EU level, UK sales volumes are forecast to grow at an average of 1.9% from 2024-28. This is above Spain and Italy, and above Eurozone average levels, but marginally below Germany and France.

2024 – year-to-date

Stabilisation and growth in store for retailers. After a lengthy period of rent rebasing and portfolio rightsizing, retail occupier markets have stabilised and are now in a growth period, with demand resilient and broad-based. Many retailers are now well-positioned to benefit from sales growth, and are back on the expansion trail, albeit selectively. As a result, all retail vacancy rates have also stabilised and are trending marginally downwards (14% at H1 2024, down from 14.5% in 2021, driven by OOT which is now at 7.1%).

Further evidence of the market stability is a decline in occupier distress. Data from the Centre for Retail Research shows the number of operators and stores impacted by CVA and administration was 61 and 971 respectively in 2023 (the lowest level of store closures since 2015). This year to end-August, the numbers look broadly similar (24 and 759, including The Body Shop, Ted Baker and Lloyds Pharmacy), indicating a degree of market stabilisation post-COVID. A significant proportion of the distress is now in the online pureplay market, where operators are ‘paying the price’ for long-term unprofitability. All this is reflective of the general improvement in occupier markets, and a clear indication that the majority of retailers have made the right strategic moves with regards to cost-control and channel strategy.

Slowing ecommerce growth boosts occupier market. Monthly data remains erratic, but the broad direction of travel is one of slowing e-commerce growth. The amount spent online fell by 2.7% during June 2024, then grew by 2.5% in July (ONS data). This low /no growth scenario is reflected in CACI’s latest data – they forecast flat online sales growth and physical sales growth of 5% in 2024, which would result in the online penetration rate declining from 23.4% of total sales in 2023 to 22.4% this year. This would be the first time the upward trajectory of online has been reversed. While there is further online sales growth to come, the extent of online disruption is now becoming more evident (and less severe than many expected). In addition, recent research from Retail Economics shows that half of all online sales rely on physical touchpoints along the customer journey from pre-purchase to returns. All of this evidence is providing clarity and certainty to the retail occupier market.

Prime ‘outperforms’ as winning locations become clear. As a result of resilient occupier demand, we are seeing rental growth returning to the market – albeit outperformance (against rebased ERVs) is primarily limited to prime locations. Anecdotally, vacancy levels are also reducing for prime (at a quicker rate than the market) as occupier competition intensifies, while incentives are also broadly reducing. And while footfall remains marginally below pre-COVID levels at an aggregate level, many prime locations are reporting growth as the post-pandemic return to the store continues to gather momentum. So what we are seeing is a polarisation of demand, footfall and spend, with winning ‘prime’ locations becoming clearer, to include top 30 shopping centre schemes, key retail parks, and heritage towns and cities.

Generally positive outlook for occupational markets. The retail outlook remains challenging and nuanced, but all ingredients are in place for the retail recovery to continue through this year and into 2025. The sector’s overall vacancy rate is expected to remain stable (although no forecasts exist). The retailer/landlord relationship - at least for prime - has been reset, and upward rental pressure is forecast to continue for the biggest and best retail locations. This is due primarily to rising occupier demand, but also lower availability of suitable stock, due in part to more department stores being re-let. It should be noted that rental increases are certainly not forecast for secondary/weaker locations - if anything the gulf between prime and secondary locations will become more pronounced with certain secondary locations needing significant repurposing to alternative uses over the medium-term.

Select locations will attract strongest occupier demand. Select locations will ‘outperform’ the market, including Central London, which has been reasserting its position as the strongest retail destination in one of the world’s few global cities. Occupier sentiment remains positive with availability of good quality space on the West End’s key streets heavily constrained. However, the recovery will be uneven, with diverging performances between individual streets demonstrating that success will be contingent on investment and innovation to drive growth. Elsewhere on the high street, heritage towns and cities will continue to prove attractive destinations for retailers and leisure operators alike.

Retail parks are proving particularly popular as retailers close down unperforming stores in unattractive high streets and re-open in busier retail parks. There will be ongoing demand for more space from retailers who recognise they can use stores to attract customers using click and collect and free in store returns (85% of B&Q’s online sales are fulfilled from their store network), and the stronger margins on offer from having a physical space. And prime shopping centres will continue to ‘outperform’, benefitting from healthy occupier demand from existing operators and new entrants to the market.

Retailer success will be defined by common strategies. Investing in physical stores by opening in strategic areas, rationalising store estates, and enhancing the in-store experience are likely to define retailer success. In addition, retailers can secure both short-term growth and long-term success in a rapidly evolving retail landscape by employing a number of strategies that put the customer at the heart of everything they do. Notably, the cautious, price-conscious consumer looks here to stay, and retailers using promotions to generate trust in pricing will benefit. Consumers will still spend, but will be very selective about how, when and what they purchase.

There is a lot of talk about sustainability, but it is yet to fully emerge as a successful strategy for retailers. Sustainability is ‘winning’ where eco-conscious consumers are prioritising repairs over replacements, or reconditioned over new, whether this is in clothing, electronics or furniture. In addition, it is now clear that consumers demand seamless commerce - retailers should no longer treat online and offline as separate channels, and instead create a seamless experience for customers across all touchpoints. Multi-channel retailers are clearly well placed here to exploit the revival of ‘bricks and mortar’ shopping, as well as the continued growth in online shopping.

2024 - year-to-date

Aggregate volumes remain subdued (but still highest in Europe). At an aggregate level, UK retail transaction volumes remained below average in H1, with higher interest rates weighing on real estate market activity. Retail made up for an 18% share of UK total investment, with volumes of £2.9bn, a 2% decrease compared to 2023, and 20% below the 10-year H1 average of £3.6bn. However, the UK remained Europe’s largest retail investment market, accounting for 26% of total volumes (ahead of Germany and Spain). 

The first half of the year was particularly positive for the shopping centre market, with transaction volumes totalling £960m in comparison to £810m in the same period in 2023. And high street volumes almost topped £1bn in H1, and have already exceeded 2023 total volumes.

Shortage of stock constrains the market. The consistent theme across the retail market is a shortage of quality stock, with improving occupational dynamics and the expectation of stronger pricing discouraging some owners from selling. The exception being the high street market, where Q1 saw vendors seemingly accepting new pricing dynamics after a challenging 2023, which then sparked a flurry of properties being brought to market.

This lack of supply has generated competitive bidding on the majority of sales this year, across all the main retail subsectors. This resulted in yield compression over H1 in the out-of-town market, which will likely be replicated in the other subsectors in the coming months. Yields continue to trend stronger on the high street as the market picks up, and for shopping centres, while yields remain stable, Dominant Regional schemes are also trending stronger as we await transparency over benchmark deals in the market.

Recent signs of market improvement. There are a varied group of buyers reviewing opportunities in the market, and with interest rates starting to reduce, mainstream finance is becoming selectively available (UK clearing banks are lending on retail again and at very competitive margins for the best stock). While some buyers may continue hold out until lending rates are more appealing, there are definite signs that the market has turned.

JLL has acted on several transactions in the last couple of months that reflect these improving market dynamics. Notably, there have been a number of positive results on the high street, where properties have been sold at keen yields ahead of asking-price in prime locations (for example The White Company on Queen Street in Oxford - 5.95% yield). And one of the most instructive shopping centre deals over the summer was JLL’s sale of Cross Ocean Partners’ 50% stake in Cribbs Causeway to JV partner, M&G (c. £110m). Albeit not an arm’s length transaction, the entire deal was completed in under five weeks, highlighting the importance of capitalising on short liquidity windows in the current market, plus the ongoing appeal of quality assets.

Investment activity will increase as the tide turns. Investment activity will increase gradually as more investors seek to reposition portfolios and deploy capital to take advantage of the rebasing of real estate prices. There is debt available in all sectors for high-quality assets, and investor sentiment is expected to remain relatively positive in Q4 and into 2025. Reduced finance costs could see further pricing improvements and more stock becoming available in certain retail sub-sectors. Occupiers now have a much better understanding of the value of their space, providing investors with added clarity and certainty. And there is a wall of money seeking investment in resilient UK retail assets. The tide is definitely turning for UK Retail and, for the first time in a long time, the resurgence will be driven by a lack of supply rather than a lack of buyers. There are also signs of the secondary market picking up.

Sector ‘hotspots’ emerge, with prime to the fore. While overall market conditions will improve, there will be investment ‘hotspots’. Investor confidence in Central London retail, for instance, has been improving in 2024, reflected by the recent Blackstone deal on Bond Street. And with recent deals signed on Oxford Street and Conduit Street, transaction volumes look set to exceed last year’s £1.2bn. The robust investor appetite and an acceleration in activity is leading to downward pressure on yields. Elsewhere on the high street, prime yields are now trending below 7%, and we will see further downward pressure due to competitive bid processes.

Retail Warehousing will continue to benefit from strong demand across the board. Most UK institutions have active requirements, and pricing continues to be under downward pressure as competition remains fierce, particularly for prime assets. While low availability of stock has held back deal volumes (c.£600m in H1), moving forward into Q4, as more assets come to market, we expect yields will continue to tighten towards the end of the year, particularly given the weight of capital looking for opportunities. There is also broad demand for foodstores, albeit there is divergent pricing between PE-owned assets and the rest. Investment volumes have normalised following the exceptional 2023 and are in line with long-term average levels (c.£600m in H1) – again, an uplift in stock on the market should boost volumes into Q4.

REITs and institutions drive shopping centre market. For shopping Centres, there is improving liquidity and a much deeper pool of investors compared to 12 months ago, with REITs and institutions returning to the prime market. A look at assets currently under offer or on the market is instructive, with the 50%, £150m share of centre:mk under offer to an institutional investment manager and The Beacon, Eastbourne under offer to L&G (c.11.00% NIY). All eyes now turn to Nuveen’s 25% stake sale of St James Quarter, Edinburgh, which will be a significant comparable for prime shopping centre assets. Competitive bids were received from a range of institutional buyers, a further signal of their renewed interest in the market.

Looking forward, as finance becomes more readily available (albeit selectively), and sentiment improves further (evidenced by the quantum of bids being received at competitive levels), there should be a notable uptick in shopping centre activity and volumes in Q4 and beyond.

The UK retail sector faces a complex mix of challenges but remains resilient with a cautiously optimistic outlook for gradual recovery, driven by improving consumer dynamics and ongoing occupier market strength. Constrained supply over recent years means that retail is ‘right-sizing’ to meet a new demand reality, and opportunities are emerging as improving vacancy rates combine with positive economic trends.

The investment market should also benefit from gradually increasing activity, as more investors seek to take advantage of the rebasing of real estate prices, and greater levels of stock on the market. Retail fundamentals appear strong in many markets, creating a powerful case for real estate investors to target the sector. The tide has finally turned, and a new era for the right type of retail has arrived.