Consumer confidence is clearly feeling the effects of Brexit uncertainty having reached its lowest level in five years in December, albeit February did see a one point improvement. However, the read through to retail sales has been minimal. Retail sales volumes increased 6.6% in March year-on-year, its highest increase in 28 months, reflecting an upward trend that first materialised in November which places current growth well ahead of that seen in the 12 months immediately after the EU Referendum.

An acceleration in real wage growth, supported by slowing inflation, has been key to this as well as a certain degree of consumer ambivalence to Brexit mirrored in the consumer confidence measure holding at the same level for the last three months. How long real wage growth, and in turn retail sales growth, can be sustained will be dependent on wider economic conditions in a post-Brexit scenario, which at this point is hard to call.

It’s cost, not growth, of online that is shaping occupational demand

While the overall retail sales data paints a positive picture, much of this growth can be attributed to online and has been reflected in retailer trading statements. E-commerce retail sales, on a value basis, reported a 12.4% growth in March year-on-year whereas store sales growth was estimated to have grown 2.7%. The positive is that this is growth off a much higher base and does point to an upward trend on a rolling three-month basis.

There is no doubt that migrating spend online, plus structural shifts in spending habits towards more leisure and experiences, will reduce store requirements with the fashion sector more exposed than others. But, the biggest immediate challenge is its impact on costs and margins. In their latest annual statement, Next noted that for every £1 that migrates to their online platform, there is an additional cost of six pence. Yet, at the same time, they noted the important role their store network plays in servicing their online business and mitigating these additional costs. These increasing costs were reflected in a small softening in Next’s operating profit with a similar trend seen across a number of other fashion retailers that have expanded their online platforms. In contrast, Primark, who have no online presence, reported a 25% growth in Group operating profit.

Weaker shopping centre rents under the most significant downward pressure

These rising costs and weaker margins are reflected in recent leasing activity. Utilising Savills retail deal activity across the UK, including new lettings, extensions and assignments, we have examined leasing and rental trends. What this analysis highlighted is that it is shopping centres, in particular, secondary weaker centres, that are currently more exposed with landlords pursuing more flexible terms with larger incentives in order to minimise vacancy.

While UK shopping centres reported a small increase in average lease lengths to 6.3 years in Q1 2019 on its 2018 average, rent-free periods increased by two months to 7.5 months. This is in line with the average rent free’s secured on high street lettings, but has resulted in a more significant impact on net effective rents. Average shopping centre net effective rents agreed in Q1 2019 declined by 33.2% compared with the 2018 average. In contrast, high street net effective rents largely held with only a 0.1% decline on its 2018 average, albeit we expect rental declines were largely factored in prior to 2018.

However, this decline in shopping centre net effective rents masks the disparity that exists between the weaker and stronger centres. At the weaker end, on a like-for-like basis, some centres have seen declines of between 40-60% in Q1 2019 versus the 2018 average. In contrast, stronger centres have seen net effective rents increase by an average of 3.9%.

Who’s been acquisitive in 2019?

In terms of deal count over Q1 2019 the top five retailer subcategories, as outlined below, remain largely unchanged to 2018. Fashion (including specialist menswear and womenswear stores) has overtaken F&B to account for the majority of new lettings in the first quarter of 2019. Where we have seen a shift is the entrance of charity stores into the top five, on very short terms, no doubt reflecting the challenges facing occupational demand and landlords preference to reduce vacancy.

Unsurprisingly there are no stand out retailers who are being particularly acquisitive nationally. That being said Lidl, B&M and Oliver Bonas are rumoured to be looking to add to their UK portfolios in 2019.

LOOKING AHEAD

The biggest challenge occupationally going forward is not the consumer environment but rather the expected increase in CVA activity.

For some retailers struggling with declining margins as a result of a poor offer and/or rising costs linked to online platforms, entering into a CVA can be key to survival. For the more cynical in the industry, CVA’s are a quick way to reduce costs.

Whatever your viewpoint, with more CVA’s expected to come to the market in 2019 there will be further downward pressure on rents. This year is forecast to be the nadir for rental value declines with the All UK retail forecast from RealFor suggesting that positive rental growth will not return to the market until 2022.

As seen with recent leasing activity it will be weaker retail locations that will be more exposed with strong retail markets/centres likely to outperform the All UK average supported by stronger occupational demand. However, this demand will become more mixed with the dominance by fashion retailers to wane as the growth in online penetration is forecast to be the strongest in this part of the market (35% of fashion spend to be online by 2023). Considering that returns are more of an issue for fashion retailers there will still be a strong case for brands to maintain a physical presence, what this will look like may be where we see the most significant change.

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