The last iteration of this spotlight, written in June of this year, was full of optimism for the sector. The positivity was reflective of the resilience it had shown throughout the pandemic and its continued improvement across a number of performance measures, allowing the sector to stand out positively, particularly when benchmarked against shopping centres and high streets.

Investment volumes in the retail warehouse sector were high, having reached £3.76bn in 2021 (the most active the market has been since 2015 and the fourth highest turnover of the last 21 years). Footfall continued to outperform the rest of the UK retail market and, on many occasions throughout the year, reached levels in excess of those seen pre-pandemic.

Appetite for new units from retail and leisure operators across all product categories was as strong as ever, reaching a total of 1,021 for 2021 – the joint highest recorded over the last decade. Furthermore, the strong acquisition activity was subsequently driving vacancy downwards, reaching 5.4% by the summer months, down from 6.1% at the start of the year. This, of course, contributed to net effective rental growth across the sector – 2021 saw a YoY increase of 10.3% on average, on the agency deals Savills was involved in.

As a result of high demand for portfolio expansion and the falling availability of additional space, there was some real optimism surrounding the potential for continued rental growth going forward. This was supported further by the consideration that the majority of the large, arguably unsustainable, rental agreements that were signed 10 to 15 years ago had now been rebased in the sector (only 26% of tenants across retail and shopping parks have a lease expiry sometime in the next three years).

Consumer spend had also been elevated for some time, with a number of retailers' fortunes significantly improving as a result of the pandemic. Barclaycard consumer spend figures were demonstrating distinctly that those sectors pertinent to the out-of-town market – namely grocery, household goods, DIY, discount stores, and sports and outdoor retailers – were those sectors in the last few years that have seen significant positive average spend growth, versus 2019. The trading statements of some of the sector's key operators supported these findings. Kingfisher and Wickes remained confident of positive consumer spend going forward, off the back of results well ahead of pre-pandemic trade levels, for example.

So, everything in the retail warehouse market looked rosy, it seemed. Or did it? A cursory look back at our report in June and it is evident we were already well aware of the headwinds the sector was facing. The report's headline stated the following:

The rising cost of living, building materials and energy were all acknowledged as having the potential to constrict occupational performance going forward, suggesting any outlook in the short term should be handled with some trepidation. However, what wasn’t evident at the end of H1 this year was just how strong these headwinds could and would get.

The cost of living has increased at its fastest rate in 40 years in the last six months. The Consumer Prices Index, including owner occupiers’ housing costs (CPIH), rose by 9.6% in the 12 months to October 2022, up from 8.8% in September 2022.

Oil and gas prices increased due to greater demand for energy, as life got back to normal post-Covid. At the same time, the war in Ukraine has meant less is available from Russia, putting further pressure on prices.

Furthermore, the war in Ukraine has also led to food prices going up by reducing the amount of grain available in Europe. The price of food and non-alcoholic drinks rose by 16.2% in the year to October, up from 14.5% in September.

In response, the Bank of England has also increased interest rates by 0.75 percentage points to 3% in recent months, the biggest hike in more than three decades.

The question for the retail warehouse market is therefore an obvious one. Has the positive occupational performance of the sector continued, or have its fortunes changed with the tide as quickly as we have seen a squeeze on both operator costs and consumer spending? In addition, what does this mean for the sector over the next 12 months?

Early tapering of consumer spend suggests the market should tread cautiously; however, some operators remain more positive than others off the back of strong trading results.

The most recent Barclaycard data suggests some sectors pertinent to the retail warehouse market should indeed prepare themselves for a leaner period of consumer spending. However, others may fare much better.

Most of the sectors that had seen such positive growth in the last few years have seen a decline in average YoY spend between August and October, including clothing, household goods, home improvements & DIY, electronics, furniture stores, and sports and outdoor goods (see chart, below). Previous downturns suggest big-ticket items and non-essential goods are the first to go. A fall of 7.2% on spend in furniture stores and 2.2% on clothing, respectively, suggests the market should certainly keep a watchful eye on performance across those sectors in the short term.

However, it wasn’t until summer 2021 that the UK consumer was free of all restrictions on their movement, which is why a YoY comparison of spend is most appropriate between August and October. It is likely that the most recent downturn in consumer spend can be attributed, in part, to its comparison to a post-lockdown-driven period, where the UK consumer once again was able to spend much more freely. As a result, there was a lot of pent-up consumer demand in the market. In addition, this was off the back of the high lockdown-driven performance that many sectors saw prior to the end of restrictions.

The most recent findings should, therefore, perhaps be viewed as a gentle warning of a more challenging winter than we have seen in recent years rather than the beginning of Armageddon, as some more pessimistic commentators may have you believe. The performance of much of the retail warehouse sector has been sufficiently strong prior that most of the key operators should weather the storm with a relative degree of comfort.

The chart above highlights further how supermarkets have seen continued growth despite a pandemic-fuelled uptick in performance in recent years. The same is true of spend in discount stores, where we have seen additional YoY growth between August and October, despite such high comparatives with the performance over the same period the previous year (albeit only 0.6% on average).

As is always the case when consumers have swung into belt-tightening mode, there are always winners and losers. October sees YoY spend growth of 5.7% on essential items, for example; however, non-essential spend is also still seeing some growth versus last year at 2.5% last month.

As a result, it is clear the value end of the market, now a sizeable part of the retail warehouse sector, will likely continue to fare better through this period of austerity, as many consumers look to trade down in order to make savings when money is tight. According to GlobalData’s monthly survey, 79% of consumers will continue to switch to cheaper retailers over the next three months in response to rising prices and squeezed household budgets, so it is no surprise that it will be the discounters that prosper most and steal share in 2022.

The performance of the DIY, furniture, homewares and home improvement operators will, of course, need to be monitored closely and in isolation in order to fully understand how much consumers are likely to make additional savings by going without these products. However, the market shouldn’t be quick to assume the worst. The most recent performance of some of the key operators seems to reflect the wider market. Those brands that have done well, not simply by virtue of being a ‘discounter’, are those that have implemented strategies to tackle the rising cost of their operations, as well as those that have adapted their offer to continue to remain relevant to the consumer at a time when their budgets are getting tighter.

The individual trading results of key retailers in the sector suggest some operators will feel the impact of a rising cost of living more than others; however, many have implemented coping strategies or are sufficiently positioned financially to weather the storm over the next 12 months.

Kingfisher produced a resilient set of results for the three months to October 2022, with growth of 0.1% in the UK & Ireland and group sales growth of 1.7% to £3.3 billion. This has been helped, in part, by consumers looking to make improvements to their homes in order to keep them warm over the winter months as the price of energy continues to increase. However, the retailer has also begun to offer shoppers greater value through its own brand ranges, which accounted for 45% of sales and focused more on trade customers, driving TradePoint like-for-like sales through its B&Q stores to rise 1.9% on last year.

ASDA’s investment in its loyalty program, fresh produce and a value-driven range targeting price-sensitive shoppers has also resulted in positive results in Q3 of this year with like-for-like sales up 4.7% – the best performance ASDA has seen since Q1 2021. Its recovery following H1’s negative revenue growth trend is promising (Q1 -9.2% and Q2 -1.2%), suggesting the retailer laid the groundwork for any challenging months that may lie ahead.

Alongside Aldi, Lidl will make the strongest share gains in the UK food & grocery market this year – estimated to rise 0.3 percentage points to 5.0%. While Lidl has reported a modest revenue growth for its 2021/22 financial year of 1.5%, UK sales have reached £7.8bn (£41.1m profit before tax). This is an improvement even against high Covid-19 comparatives and is in line with the wider UK grocery market – ensuring its market share remains stable.

It is expected that Christmas will be a crucial period for the discount food operators as consumers face greater financial pressure and shoppers look for more affordable solutions and alternatives to enable their festive celebrations. If both Lidl and Aldi can continue to promote product quality and food provenance, they should secure customers for the long term – not just for Christmas. This is great news for landlords of retail parks. Both these operators have a strong presence in the out-of-town retail market (both operators have more than 900 out-of-town stores). They have consistently topped the charts in terms of new openings over the last five years, each acquiring c.50 new stores on an annual basis – growth strategy both operators are keen to continue with for the foreseeable future.

B&M is also on course to be one of the winners during the cost-of-living crisis as constrained shoppers migrate to the discounter as its low prices and value for money appeal. Overall group revenue increased 1.8% to £2,309m, aided by double-digit growth at its discount grocery division, Heron Foods. Sales through its core UK fascia declined marginally but improved throughout the half – rising from -6.1% in its Q1 to +5.0% in Q2, with UK like-for-like sales following a similar pattern, down -9.1% in Q1, but up 2.0% in Q2. This momentum has continued into its Q3, with B&M’s UK like-for-like sales +2.5% for the first six weeks of the period, as the ratcheting inflation encourages shoppers to trade down.

Higher levels of pet ownership following the pandemic, coupled with Pets at Home’s ability to recruit and retain shoppers, has helped the brand record a buoyant top-line performance during its H1 2022/23 trading period, with like-for-like growth going from 6.0% in Q1 to 6.8% in Q2. The brand's loyalty programmes have helped push revenue through its VIP members, which have increased 13.4% over the last 12 months.

M&S has also exceeded sales expectations with a strong trading performance in H1 FY2022/23, achieving a pre-tax profit of £208.5m, an 11.3% increase on last year. Its food division has outperformed the wider UK grocery market, with sales up 5.6%. This can be attributed to increased footfall in stores outweighing a decrease in basket value, as the retailer’s focus on value for money, product innovation and high quality. This, in turn, has attracted customers trading down from foodservice operators and restaurants and appeals to those wanting a treat in times of more considered spending. However, operating profits for M&S food are down 50% following this investment in pricing and increased running costs related to inflation.

Tesco’s H1 performance for FY2022/23 has also been pleasing amid a challenging backdrop. UK food sales like-for-likes are up 1.6%, contributing to market share gains over the period. Tesco’s share of the UK grocery market is set to rise 0.2 percentage points over the full calendar year, meaning it now stands with Aldi and Lidl as the only major UK grocers to grow share in 2022, as customers stay loyal following investment in price and value.

However, despite the top-line sales improvement, retail operating profit declined 10% to £1,248m. This has been caused by a combination of factors, including softer volumes versus elevated pandemic levels, a drop in demand for non-food categories (UK like-for-likes dropped 6.0%), and high inflation. In addition, the ongoing investment in value and price-matching schemes to protect against the competition, as well as increasing salaries for its employees to cope with the cost-of-living crisis, have also had an impact.

As is evident in the wider market, operators in some sectors have therefore found navigating a path through the recent headwinds more challenging than others. Up against a strong comparative, Dunelm has started its FY2022/23 with a decline in sales. Indeed, with tightening consumer budgets, total sales in Q1 FY2022/23 were down 8.3% on the same period last year to £356.7m. Halfords also reported underlying profit before tax fell 54% in H1 FY2022, compared to last year. This was due to significant inflationary pressures and low consumer confidence, as spend in discretionary areas, such as its cycling products, have softened.

It is clear that big-ticket, non-essential, or discretionary items will likely see the greatest contraction on spend over the coming months; however, the performance of specific retailers who operate in these sectors will vary, dependent on the respective coping strategies they implement and how much of a financial cushion they have in place. What is comforting, however, is the out-of-town retail market is perhaps less exposed to any one sector as much as it once was – the market is now less reliant on sectors where spend is more discretionary and more exposed to brands that provide consumers with their essential goods shopping.

The chart below highlights how, back in 2012, 40% of occupied floorspace in the market was attributed to bulky goods brands (including DIY, electrical, motoring, furniture and fixtures and fittings, such as kitchens, tiling, carpets and other floor coverings). In 2022, that has fallen to a quarter of all occupied space. As a result, we have seen growth in the coverage of grocery, particularly with the expansion strategies of Aldi and Lidl – grocery now occupies 31% of all occupied floorspace, up from 18% a decade ago.

We have also seen a number of discount homeware brands significantly increase their exposure in the retail warehouse sector. The growth of the likes of The Range, B&M, Home Bargains and Poundland has helped the exposure of homewares increase from 8% of the market in 2012 to 14% of the market in 2022.

The growth of value-orientated operators in the last decade will also go some way to mitigate the challenges the retail warehouse sector faces in a period of consumer recession. In 2012, just over a quarter (28%) of the brands in the market were value-based or discount-led. Today, that figure has risen to 38% and is increasing all the time (half of all new openings so far in 2022 have been value-led brands).

Additionally, and what is undoubtedly a positive result for retail warehousing from a market perspective, is the increasing prevalence of in-store spending seen in recent months. Barclaycard saw in-store spend increase by 5.6% in October versus the same month the previous year, outstripping the 1% growth in online spending over the same time period. Many of the products traditionally sold out-of-town are more defensive to online retailing, or at least require the store in some way in order to make an informed decision on a purchase or indeed fulfil an order through click-and-collect (potentially driving additional sales to the store).

Increasing overall store sales, along with a strong exposure to brands at the more price-conscious end of the market will certainly help buffer the retail warehouse sector from the impact of a rising cost of living, more so than is true of high streets and shopping centres.

The chart below highlights how retail park footfall continues to outperform the rest of the UK retail market. In the summer, footfall peaked at 2.2% above the levels we saw at the same time in 2019, pre-pandemic. In the most recent weekly figures (w.b. 19/11/22), high street footfall was down -14.8% compared to 2019 equivalent levels, while shopping centre footfall recorded a -20.5% gap. Retail parks continued to outperform, with footfall levels only -5.8% below 2019 levels (having fallen slightly from only -2.5% at the beginning of the month).

Have we seen continued rental growth in the retail warehouse market?

With the record number of new openings last year and a vacancy rate continuing to fall, as a house, we were relatively bullish about the possibility of continued net effective rental growth. That said, nobody quite predicted the severity of the headwinds we were beginning to experience. As a result, average YoY growth on all of the agency deals Savills has been involved with up to the end of Q3 remains flat (see chart, below).

On reflection, this in itself is a positive result. Despite spiralling energy costs, record levels of inflation and interest rate rises, retailers are still looking to expand their reach and are doing so on terms no worse than they would have 12 months ago. What is most important, however, is it hasn’t so far led to a lack of appetite for deals or a desire to only do a deal at a reduced cost, in order to better safeguard their return on their investment.

The reason for this simply comes down to supply and demand. The chart below shows the number of new openings in the retail warehouse market this year, up to the beginning of November. At 906, the market has already surpassed the decade average of 855 and looks set to at least match last year's record of just over a thousand, with two months of openings still to be accounted for.

As a result of this continued appetite for new space from brands of all sector types, vacancy continues to fall, now at 5.0%, down from 5.4% six months previous (having fallen from 6.1% at the turn of the year). With very little space coming to market by way of new development, supply will only continue to tighten. As a result, and despite an initial pause as the markets take a breath over the immediate impact of the cost of living crisis, we do expect net effective rents to begin to climb, albeit modestly, as we move through the final quarter of 2022 and into 2023.

Interestingly, the average net effective rent of £18.41, highlighted in the chart above (Annual average net effective rents), is for units above 2,500 sq ft and therefore excludes any drive-to or drive-thru deals Savills has been involved with. The level of competitive tension for new space at that format is so high it skews the level of growth we are seeing across the rest of the market. Average net effective rent for units under 2,500 sq ft is £41.26, a further 2.7% growth over the last 12 months, in addition to the 10.6% growth we saw the previous year.

The table below highlights just how active the food and beverage sector has been in the retail warehouse market again this year. When ranked by number of units, 7 of the top 20 most acquisitive operators for this year are F&B brands. These include Tim Hortons (28 units, ranked 4th overall), Costa Coffee (26 units, 5th), Starbucks (17 units, 10th), McDonald's (13 units, 13th), Burger King (11 units, 14th), KFC (11 units, 14th), and Five Guys (10 units, 15th).

In fact, F&B operators have accounted for 30% of all new openings so far in 2022 on a unit basis (which equates to 9% on a sq ft basis). As F&B operators generally take smaller units, it is only Tim Hortons that appears in the top 20 most acquisitive brands ranked on floorspace. The table below highlights the retailers that take larger floorplates in the market and therefore are the most acquisitive in terms of overall space.

Business rates reform will provide welcome financial relief, particularly for retail warehouse operators with larger units, strengthening further the optimism around net rental growth over the next 12 months.

The long-awaited business rates reform has been largely welcomed by the retail property sector, with an average reduction across England and Wales of -10% when coming into effect on 1 April 2023. While there have been different levels of rateable values across different property sectors, retail categories and geographies, most aspects of retail have seen reductions. Furthermore, there is no transitional relief, which means occupiers will see the full benefit from day one.

The retail park sector is due to see an average -9% reduction. As a consequence, we have seen an uptick in deal activity since the announcement, with retail occupiers gaining confidence despite ongoing economic and occupational headwinds.

The good news, however, is nuanced, with the rate changes differing significantly depending on retail category, retail sector and geography. For example, large supermarkets can expect average reductions of -15%, while small convenience stores are set to increase by +13%.

The revaluation also favours larger stores (> 1,850 m²), which will see business rates reduce by more than a third, compared to small stores (< 750 m²), with reductions of -8%. This should be met with enthusiasm within the out-of-town market where store sizes are much larger than high street units on average.

However, the celebrations will not be felt throughout the sector; the thriving drive-thru market is perhaps a victim of its own occupational success with average increases of +14%. The question is whether this will slow rental increases in this sub-sector or whether demand for space will continue to drive rental growth unabated. Either way, it is anticipated that the drive-thru market will appeal against the VOA's decision.

The relief felt by retailers is tempered somewhat for those exposed to large tracts of logistics space, with retail logistics warehouses seeing an average increase of +38%. However, most retail brands’ store portfolios significantly outweigh their warehouse space.

_{Read the articles within Spotlight: UK Retail Warehousing below.}