A boost for the retail economy?

The long-awaited business rates reform has been largely welcomed by the retail property sector, with an average reduction in rateable values (RVs) across England and Wales of 10% when coming into effect on 1 April 2023. While there have been varying adjustments to RVs across different property sectors, retail categories and geographies, many retail assets have seen reductions.

The news has generally been met with positivity, and as a consequence, we have seen an uptick in landlord and tenant activity since the announcement, with expansionist retail occupiers gaining confidence despite ongoing economic and occupational headwinds.

Several of the UK’s top retailers have indicated that the revaluation will result in annual savings of £10–20 million, while some department stores are saving that within one unit. This couldn’t come at a more helpful moment, given the pressures of other occupational costs; some retailers are indicating their energy prices have gone up 400%.

The revaluation favours larger stores (> 1,850 m²), which will see rates reduce by more than a third, compared to small stores (< 750 m²), with reductions of 8%. This should benefit prime units for fashion and comparison goods and has been met with enthusiasm within the shopping centre market, where stores with larger footprints tend to account for a greater proportion of revenue than non-prime high street units. The challenged department store market has been granted significant respite with a 30–40% reduction; a silver lining that could support a recovery for those operators still active.

The good news, however, is nuanced, with the rate changes varying significantly by retail category, retail sector and geography. For example, supermarkets can expect average reductions of 5%, while convenience stores are set to increase by 13%; pubs and restaurants are down 17% and 5%, respectively, but takeaways are increasing 7.5%. The thriving drive-thru market is perhaps a victim of its own occupational success, with an average increase of 14%. The question is whether this will slow rental increases in this subsector, or whether demand for space will continue to drive rental growth unabated.

The key points are:

• Falling RVs for much of the sector nationally, reducing by an average of 10% for retail and 2.2% for leisure, but with far more significant changes apparent when drilling into specific assets and locations.

• No downwards phasing of liabilities – this means that a property will have its entire reduction in rates payable from day one. This was unexpected but very good news. Increases will remain phased.

• Rate reductions appear to favour larger units and prime retail and leisure locations, with some off-pitch, local and independents biased locations significantly worse off.

• However, a continuing benefit to small businesses is the 50% relief being given to retail, leisure and hospitality occupiers in 2022 as a result of coming out of Covid. This will be increased to 75% relief in 2023, but subject to a cap of £110,000 per business (not per property)
  

• A cap on the annual multiplier – it was set to increase by inflation (10.1%), but for 2023–24, it will be frozen at the current level.

• Encouragingly, we’re seeing deals that were teetering on the edge now progressing as a consequence to lower RVs and savings softening the blow of other increases to occupational costs.

• The relief felt by retailers is tempered for those exposed to large tracts of logistics space, which are seeing an average rates increase of 38%. However, most retail brands’ store portfolios significantly outweigh their storage space.

A reflection of market activity…and Covid

The 2023 revaluation looks at the market position in April 2021, and RVs should directly reflect the fortunes of retail via its rental profile. However, much has happened since then, and in some cases, the rate relief is too little too late; department store RVs have come down markedly, but a large number of these shops have already disappeared. The fortunes of fashion operators competing against online is widely reported, so for those in larger shops, the rate changes cannot come soon enough and will be welcome news. However, the needs of smaller retail outlets struggling with other market pressures are not as positive, and some increases to RVs have been seen. It is possible that significant Covid relief and grants from the government might have held up rents for smaller retail units, resulting in a smaller RV benefit.

For food & beverage (F&B), there are mixed fortunes. Restaurants struggling during the pandemic received significant government support, and while a consumer boom has helped post-lockdown, staff shortages and increased energy and food costs have left many businesses in the red. A reduction in rates provides important respite. Meanwhile, cafés and takeaways, which have been relatively resilient through Covid, are seeing little improvement or a rate increase. However, any suggestion that there is a link between the result of the revaluation and resilience through Covid is coincidental and is more indicative of the trends that were already underway (such as the boom in home delivery and the bust within casual dining).

The previous valuation in 2017 was way before anyone could imagine the fallout from a global pandemic and consumer recession, but structural issues were already impacting the retail sector. Since then, we have witnessed a marked rebasing period (2017–2022), with retail rents now 21% lower on average; shopping centre and regional high street rents have fallen by over 30%, while retail parks have fallen by 16%¹. The revaluation is reducing prime shopping centre RVs by 30–50% and retail parks by 9%, so in some areas, the revaluation has tracked the rebasing of retail since 2017. And yet the revaluation will have not gone far enough for many retailers, given further rental softening in the last 18 months and the cost-of-living crisis that has held the narrative for much of 2022. This is unlikely to even be addressed in the next revaluation in 2026 because that will be based on rental levels in 2024, thereby missing a fairly significant three years of activity given current economic conditions.

One indication that the latest revaluation comes at an awkward moment in the economic cycle is that it should reflect the market position in the years adjacent to the valuation date. But the retail demand and performance seen in the years before 2021 is likely to be very different in those that follow. We’ve tracked significant variations in pre- and post-pandemic footfall in retail across the country, and the speed of recovery has not neatly followed the past trends from previous economic downturns. Town and city centre pitches have shrunk, accelerating the ‘flight to prime’ trend, while more local shopping habits have increased the performance of community- and convenience-based high streets and retail parks. Some office-based locations (e.g. City of London) have seen an increase in RVs, but footfall levels are yet to return to pre-pandemic levels. We don’t know how long these footfall trends will persist, but any positive or negative impact of the RV changes looks polarised to favour prime fashion-led high streets and shopping centres, and adverse to secondary and independent-led pitches.

Market variations from the new RVs

When analysed at national or sector level, the data doesn’t pick up what is happening at the town, scheme or street level. There are some important and notable variations.

Large shopping centres seem to win over small high streets, with the recent performance of convenience-based retail and F&B being reflected in both rental uplift and business rate increases, compared to mainline retail and larger stores that have been more adversely impacted by changing consumer behaviour. The top 50 shopping centres (England & Wales – by sq ft) have seen RVs reduce 34–50% – a great boost for F&B-based schemes.

Set against the average change within retail parks of -9.3%, we’ve drilled into a number of large schemes across the country to see the RV impact and are seeing surprisingly large variations within single entities, with the variations seeming to (but not always) benefit those with more fashion retailers and those with larger footprints. The average within our benchmark is actually 0% change, but it is difficult to make further conclusions when ranges of -40% to +55% exist within one scheme. In Rushden Lakes, which probably sits somewhere between shopping park, leisure scheme and open-air shopping centre, it is notable that the restaurants and cafés in the West Terrace and Boardwalk have seen increases of 16% and 23%, respectively, which is a very different narrative to that seen in those subsectors at the national level.

Looking for the picture within high streets, Manchester city centre will see an average reduction of 8% in retail RVs, but with significant wins in prime retail pitches offset by significant losses in secondary and tertiary pitches. Harvey Nichols, Selfridges, House of Fraser and Marks & Spencer will see 35–46% reductions, while prime Arndale and Market Street pitches will see a fall of around 30%. Yet the independent retail and leisure scene in Manchester’s Northern Quarter, which Time Out recently ranked as the 30th coolest district in the world, is being punished for its success, with an increase of 17% (Thomas St alone is increasing 50–60%). Being ‘cool’ does not automatically mean the businesses trading there are prosperous, but the defensible position from the VOA might be that these places were considered to be undervalued at the last rating.

A similar picture is mirrored in central London, where high street stalwarts on Oxford Street will see RV falls of 30% to 40% (John Lewis has come down from £16.5m to £6.5m – a 60% decrease). However, in the City of London, where retail has struggled to recover post-Covid, the RVs are set to increase on average by 15–25%.

The RV changes in Greater London also seem to favour more affluent boroughs over less affluent ones, but conversely, the trend for affluent towns in the regions suggests these are being more negatively impacted, with some market towns seeing significant increases. In Knutsford, Cheshire, which supports a local shopper through a largely independent retailer base, 75% of shops will see an increase (an average­­­ of +22%, but a quarter seeing > 40% uplift). It’s a similar picture in Stroud, Ross-on-Wye, Clitheroe and Swanage, where some of the largest increases nationally are seen. In Cheltenham, too, large reductions for prime high street assets have been offset by RV increases for secondary assets. In all of these markets, there are a growing number of vacant units that have remained vacant for prolonged periods, and there are clearly wider structural issues that the increase in RVs do not reflect. It is hard not to conclude that local high streets that worked hard to remain viable during the pandemic are being punished for their resilience, even though it was only ‘essential’ stores that were able to trade consistently throughout the period.

Retail logistics versus shop RV liabilities

What about retail logistics space?

Larger retail brands that have benefited from large rate reductions on their retail units will see RV increases within their warehousing portfolios. An average increase of 35% for large distribution warehouses is quite a hike, but there are several reasons why we believe the rate changes favour retailers with a strong store presence.

Firstly, it is probably accepted by most retailers that for a long time they have been underpaying on their rates liabilities in sheds, while overpaying in retail. So we’re unlikely to hear a lot of grumbles from those with omnichannel, or those weighted more favourably to an in-store business. Pure play less so (more on that later).

Secondly, sheds are efficient spaces that are typically fully utilised to higher levels of efficiency. Shops, by contrast, can be clunky underutilised spaces, particularly where on multiple floors on high streets. Many retail brands have been struggling with store optimisation for years in terms of how much space is required on the shop floor and how much is devoted to stock, returns, and click & collect orders. Fifteen years ago, many of the biggest high street brands were looking for large prime high street units. No longer; many of these are being subdivided if they haven’t been already. Few shop units are fully optimised, and this is where a reduction in rates can make a real tangible difference to the profitability of a store.

Thirdly, fewer retail brands are as exposed to large amounts of shed space as it might first look, given that brands like Tesco, M&S and Next have significant amounts themselves. The most prominent omnichannel retailers have logistics space roughly 25–40% of their total retail floorspace². However, the UK has almost 1.7bn sq ft³ of shop floorspace, and the total logistics space taken by high street and food retailers is around 157m sq ft⁴; i.e. an average ratio of under 10%⁵. This means that business rate changes in logistics tend to impact the bigger brands, but will be largely offset by strong omnichannel businesses and in-store rate reductions. Meanwhile, smaller brands and independent retailers will see the in-store benefits, while the changes in logistics rates will largely go unnoticed.

The pure play e-commerce market is more challenging. Costar record Amazon’s UK warehouse portfolio at around 45m sq ft (Ocado 2.98m sq ft; ASOS 1.16m sq ft; THG 0.85m sq ft; and Boohoo 0.45m sq ft⁶). Ongoing performance challenges for these brands are well documented, and the share price of THG, Boohoo and ASOS are all down about 85% in the last 1–2 years. ASOS is expected to write off as much as £130bn in 2023 for excess inventory due primarily to supply chain bottlenecking, seeing a concurrent release of 2021 ordered stock and unexpectedly early arrival of 2023 stock at a point when sales were already below expectations. Given already low margins, increased commodity prices and turbulent stock levels, the business rate increases may be less than welcome.

What will the market do next?

Increased positivity from occupiers and landlords

A reduction in RV provides some help towards unavoidable increases in occupational and operational costs. The immediate reaction from the market is that this is providing a lifeline for some key locations. Since the announcement, competitive situations on prime high streets we’re active in has allowed operators to review the level of rent they can offer on new locations, and board approval for some deals has been more readily attained.

Rates can typically account for around 30% of total occupational costs (TOCs), roughly double those from service charges, on average⁷. Even accounting for the increased pressures from energy prices and staff shortages, a reduction (or increase) in RV will make a tangible difference to retail overheads. For instance, a saving of 10% in business rates could be equivalent to a 20% increase in service charges, offering a cushion to the upward movement of non-fixed costs. However, for those expecting an increased RV, the impact on profitability could be severe, hindering both margins and reinvestment potential.

On vacant units within shopping centres, the reductions reduce the landlord’s non-recoverable overheads, assisting the NOI (net operating income) position. This saving should leave some better-funded assets with capital to reinvest in the centres and bring repurposing projects to fruition. One landlord has cited the potential for positive sustainability gains as EPC/ESG improvements may become more viable. On existing TOC deals, there will be a financial benefit to landlords, but we would expect retailers to revise future TOC deal percentages on new leases and renewals to secure the benefit of the reductions. So in some cases, landlords, going forwards, won’t be in a better position, nor worse off.

The removal of downward transitional relief has been welcomed by both occupiers and landlords, with upwards transition being a benefit for those faced with an increase. The Welsh VOA (Valuation Office Agency) has opted for three equal steps over three years for anything where the rates bill has gone up by more than £300, which will make a big difference for retailers that have seen an upward adjustment to their RV.

Any temptation from landlords to use this as an opportunity to increase rents will see this reflected in the next revaluation which takes place in 2026, but based on 2024 rents, with business rates being moved to a three-year rating period. Caution should be taken with using rate reductions as a negotiating tool to drive up rents as this would lead to rates being revised upwards at the next review, which may undermine the positive move made now. In theory, with the main rental rebasing period occurring prior to 2021, and with little or no growth anticipated outside of prime high street pitches prior to 2024, the 2026 revaluation should not be as dramatic as the 2023 one. However, that assumes that in 2026, the VOA doesn’t make significant readjustments to balance any mistakes in the 2023 RVs.

Appealing the revaluation

The general perspective from retail pitches and sectors that see the most occupational activity is pretty positive, but in locations with less market evidence or off-pitch, the story is more unreliable and not always positive. There is likely to be plenty of scope for appeal and reassessment, but this will favour landlords of larger portfolios who have access to the resources required to understand these nuances and, where necessary, object to them.

With an average increase of 14%, drive-thru operators are likely to appeal, but given the upward trajectory of drive-thru rents in recent years, the VOA argument may be that the subsector was previously undervalued. Convenience stores can expect a similar increase, but this really is a polarised market between the strongest brands performing well in high footfall locations and smaller convenience groups operating from parade and local community-based locations, where sales densities are more muted.

Landlords and occupiers will undoubtedly still seek to challenge the new RV listing, even where there has been a dramatic drop, to seek further savings where they do not agree with the new assessment.

Negative consequences

With the benefits of the 2023 revaluation appearing to favour larger, prime and mainstream retail, there is a risk at the more local high street level. We conclude that non-prime retail may have received a bit of a raw deal. Some of the largest increases we have identified are in convenience-, retail services- and independent-biased locations; categories that we have previously championed as important differentiators and a potential antidote in ‘failing’ high streets and shopping centres.

Some businesses that typically serve communities and have proven resilient during the last few years against a backdrop of severe headwinds may now find themselves being punished for their success. Yet the backdrop to challenging market conditions and oversupply remain ever-present.

Given rising occupational costs, any increase in business rates risks market failure, which would speed up the urgency for repurposing in some markets. Part of the rationale for seemingly high increases for smaller businesses could be from the lack of adequate evidence or previously low rates being rebalanced. Even if deemed ‘fair’, the scale of the uplift in some areas could be extremely damaging. The counter-argument to this, however, is that small businesses continue to benefit from rates relief, at least in the short term.

¹MSCI, ²Savills, ³Savills/VOA, ⁴Savills/Costar, ⁵Savills/UKWA, ⁶Costar, ⁷Savills Property Management