Calmer waters economically, but mounting headwinds elsewhere – it will not be plain sailing for the UK retail market in 2016.
On the one hand, the picture is positive. The macro economy is in a healthy state going into the New Year and the UK consumer is in a good place, with real earnings growth now a welcome reality for most. The prospect of interest rate rises has also receded and increases are not now expected until Q1 2017 at the earliest. On the surface, this is filtering through to positive retail sales growth – retail sales have now increased consecutively for over 30 months.
However, this does not necessarily tell the full story. The rate of retail sales growth is definitely decelerating and the gap between sales volumes and sales values is increasing, implying a rate of a deflation that is very damaging for the retail operators, who are essentially having to sell more and more goods just to make the same money.
2016 will also see additional cost headwinds for retailers in the shape of the National Living Wage, which comes into force in April. This, coupled with the ticking time-bomb of business rates reviews, will continue to cast something of a shadow over most retail occupier markets.
- Already the most polarised of the retail sub-sectors, the performance gaps in high street shops will widen, rather than narrow. There is little prospect of the hierarchy changing within the established ‘five tier’ market (1 = Central London, 2 = Outer London, 3 = South East, 4 = Major Regional Conurbations, 5 = Rest of UK).
- With limited new supply and on-going demand from (principally overseas) retailers, retail rents in Central London are forecast to increase by 6.6% in 2016. Finite supply on the main thoroughfares (Oxford Street/Regent Street/Bond St) is seeing demand spill over onto tributary locations and driving up rents accordingly (often showing double digit growth).
- Retail rents are forecast to grow by 1.6% in the South East and by 0.8% in the Rest of the Country. However, these underlying figures mask significant disparities between individual centres and locations. As a very general rule, rents in the larger cities and affluent ‘market towns’ will continue to hold up better that in under-invested towns, where vacancy rates remain stubbornly high (>20%).
- A3/Leisure remains one of the retail sector’s key brightspots and restaurant operators in particular remain firmly on the expansion trail. Strong occupier demand from A3 operators will continue to be a catalyst for rental growth in many locations.
- The notion that online retailing is killing the high street is increasingly being challenged. Online accounts for around 13% of UK retail sales, but on a small proportion (ca. 4%) of this is ‘pure play’ i.e. totally bypassing a bricks & mortar store. The online market is increasingly moving away from home delivery and more towards click & collect.
- Investor appetite for shopping centres remains healthy, albeit concentrated at the prime end of the market. There is less depth of demand for secondary and tertiary stock, although these centres remain attractive to a different type of buyer, particularly where there are asset management opportunities. Secondary and tertiary stock with limited asset management options needs to be priced at sufficiently attractive income yields to sell.
- Having compressed steadily for some time, shopping centre yields have broadly stabilised. Rather than further yield movement, the market is starting to move towards income growth largely through asset management at present, albeit rental growth is anticipated in the better centres in 2016. Shopping centre rents are forecast to grow by 1.6% in 2016.
- The development pipeline remains steady. New openings in the second half of the year included high profile schemes such as Grand Central in Birmingham and Westfield Bradford and saw around 1.7 million sq ft of new shopping centre space come to the market in 2015. A similar level of new floorspace is expected in 2016, with key schemes including Victoria Gate in Leeds and Bond Street in Chelmsford.
- From an investment perspective, the 2015 out-turn figures for retail warehousing make for very positive reading. It was the only retail sub-sector to achieve a significant increase in investment volumes in 2015 and the number of transactions also showed healthy growth. But this masks a discernible slowdown in Q4, in turn striking a note of caution for 2016.
- There are structural issues in the retail warehousing sector, namely its reliance on UK funds, REITS and propcos (which account for ca. 90% of investment volumes). OOT retail remains almost exclusively a UK owner’s domain. Many of these owners are now over-weight in the sector, and there is no back-fill of new entrants.
- There is also significant pricing pressure and yields will soften in 2016 across virtually all retail warehousing classes. Exceptions to this will be Prime Solus Bulky units (likely to be stable at 5.75%) and Prime Solus Open A1 units, which will compress to 4.50%.
- The ‘changing of the guard’ amongst occupiers will gather pace. The rate of expansion of ‘the new breed’ (e.g. B&M, Dunelm, Home Bargains, The Range, Wren) will more than counterbalance the space relinquished by the right-sizing of ‘the old guard’ (e.g. B&Q, Homebase Currys). Vacancy rates will continue to decline, but we do not anticipate significant rental growth other than in exceptional locations.
- UK grocery will remain the most ‘challenged’ retail sector. The ‘Big Four’ operators (Tesco, Sainsbury’s, Asda and Morrisons) are still coming to terms with the scale of the structural change that is taking place in the sector and it is premature to talk of recovery.
- Re-appraisal of the development pipeline continues apace. Committed new sites will still come through, but the sweetspot for new supermarkets is much smaller now than over the last 10 years (20,000 – 40,000 sq ft versus 60,000+ sq ft previously).
- Affordability will increasingly become an issue. Rightsizing on better lease terms will be the strategy in most leasehold situations and nil increase at review is the likelihood in most OMV reviews. There is very limited impetus for rental growth outside the realm of RPI.
- The march of the discounters (Aldi and Lidl) will continue – both will expand aggressively and gain market share. However, 2016 will present challenges for them too, as they incorporate higher cost factors into their business models (larger units, new stores in London and the South East, range extensions, online trials).