The investment market started the year strong, with £862m of transactions in Q1, the highest Q1 we have seen since 2010, and well in advance of the £549m that we saw in Q1 the previous year. This followed on from the momentum we saw the previous year when volumes grew as the year progressed, peaking at over £1.4bn in Q4. In fact, investment volumes reached £3.76bn in total in 2021, the most active the market has been since 2015 and the fourth highest turnover of the last 21 years.

It is, therefore, fair to say that retail warehousing saw strong recovery in investor interest in 2021, with the realisation the sector had proved to be much more durable in the face of the pandemic than was the case with the rest of retail. It is our view that, despite the current economic turmoil in the UK, and what that means for consumer spending and operators' profits, the retail warehouse sector will once again prove its resilience off the back of its strong occupational performance, which will have a positive impact on investor interest in the sector going forward.

Despite the positive start to the year, it is no secret that transactional activity slowed considerably by the end of H1, with Q2 volumes two-fifths of what they were the previous quarter, at only £347m. At this juncture, market valuations were still broadly reflecting the sector's most recent success; however, the UK’s economic headwinds were quickly increasing in severity. This led to a disparity between vendor aspirations and purchaser pricing requirements, which ultimately resulted in an immediate and significant reduction in retail warehouse transactions as we essentially hit an impasse – there was no great push from purchasers as they paused to see if assets were going to get cheaper still, as a result of the instability in the UK economy.

With UK retail perceived to be at the sharp end of the economy and directly affected by consumer budgets, it is often the case that economic uncertainty will impact the sector quite quickly. However, the good news is the occupational story has remained a strong one in the retail warehouse market. As we learnt when the sector first proved its resilience in the face of the growth of e-commerce, it is important not to tar all types of retail with the same brush. The relative naivety of some investors in doing so in previous years was based on the assumption that retail was increasingly being fulfilled online, thus eroding the relevance of the physical store.

However, the products typically sold out-of-town proved to be much more defensive to online-only transactions. Consumers prefer to sit on a new sofa and get a feel for it before they make a purchase. Furthermore, retail warehousing proved to be a convenient solution for click-and-collect, which of course, has the added advantage of driving additional sales at the point of collection. Even with the exponential growth of online grocery orders throughout the pandemic, retail warehousing proved invaluable – grocers were only able to service their consumers due to the pre-existing network of out-of-town stores throughout the UK, close to where consumers live for last-mile delivery.

It is the same story this time around. Retail parks continue to appeal to consumers for the reasons they grew in prominence in the first place. That is by virtue of their convenient, easily accessible, highly visible roadside locations with large units and adjacent free parking. As a result, the fundamentals of the market remain solid, which should give potential investors some comfort going forward. With record numbers of new openings across a diverse range of retail and leisure operators, and full occupancy across much of the market as vacancy continues to fall to its lowest point since 2019, there remains some competitive tension in the occupational market.

As a result, we have seen no significant negative rental growth on new deals, despite the speed and severity of operator cost increases. Couple that with the business rates reform due in April next year, which will lead to a significant and much-needed reduction in operating costs for many operators, there is real optimism for rental growth over the next 12 months. A position which would see the market pick up from the positive growth we saw in 2021, the first time we had seen growth in five years, before the cost of living crisis brought about a pause in the progress we were seeing.

In terms of pricing, it is the speed at which we saw yield hardening that led to a sudden pause in transactional activity. From May of this year, we essentially lost just over a year of yield compression. Prime Open A1 and Prime Restricted yields increased from 4.75% back in the spring to the levels we see currently, namely 5.75% and 6.00%, respectively – the position the market was in back in October 2021.

Many investors seemingly decided to wait. With plenty of economic uncertainty, those sitting around the decision table found it difficult to convince stakeholders that the time to buy was now because it was likely to be when prices were at their best in the short term.

However, although we expect yields may oscillate around the levels we see currently over the next 12 months, we do expect them to remain broadly stable and be somewhat similar this time next year. It is true that consumer budgets will tighten further post-Christmas. However, they are expected to improve as the year moves on (particularly as we require less energy to heat our homes as we approach the summer months). This will undoubtedly provide small fluctuations in retail warehouse yield; however, now the fireworks that were ‘Truss-economics’ have been extinguished and interest rates have settled, we have a market environment much more conducive to trade. With the occupational market still holding strong, pricing once again begins to look attractive, a position it was in last year when the investment market was particularly strong.

Of course, with the cost of debt having risen, net income returns are likely to be lower for investors. The cost of borrowing in order to buy an asset has increased – the Bank of England’s current interest rate is 3.00%, having risen from 0.25% at the start of the year. However, investors in the sector may arguably need a dose of realism on the level of returns the sector can realistically offer going forward. The perfect storm, evident over the last 12–18 months, of a strong occupational market, sensible yields, and very cheap debt may not happen again for at least five years or more. It is rare that the planets align this way in any market; however, a strong occupational market and sensible yield levels remain, and in the words of the late singer Meat Loaf, “two out of three ain’t bad” – suggesting the market can still deliver a favourable return on investment moving forward.

As a result, retail warehousing is once more seemingly well-priced versus other asset classes. Industrial yields are currently at 5.0% by comparison, suggesting investing in retail warehousing gives you an additional fifth more for your pound. Shopping Centres look well-priced at 8.0% yield, but the occupational story is nowhere near as strong, and sustained rental growth much less likely, meaning they are much more of a gamble.

The current scenario may mean we see an increased return of more institutional investors to the retail warehouse buyer pool, looking for a stable, predictable income over the next few years. MSCI is suggesting the current level of income return for retail warehousing is 1.4% at the end of Q3, greater than that seen for offices at 0.8% and industrial at 0.7%, for example.

In summary, the current investment market is looking much more stable than it did at the start of Q2. Even with the rise in debt costs we have seen this year, the sector has repriced to a sensible level. The occupational market remains strong in so much as it is broadly fully let. It has also seen the majority of its rents rebased over the last three to four years and has since seen rents on new openings improve, the appetite for which remains unabated. As such, the market has a much more stable outlook as we move into 2023 – the current entry-level pricing is increasingly peaking investor interest and fostering a favourable environment for vendors, too, that have assets they want to dispose of.

A consensus view on where pricing is breeds confidence in buyers and investors alike and, as such, results in a market that is more conducive to trade. As a result, we are seeing funds returning to the negotiation table as a greater degree of comfort returns to the sector both in terms of pricing and the continued performance of the sector occupationally moving forward.

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