RETAIL REVIVES
Although the provisional figure for second quarter economic growth - the same rate as in the previous two quarters - proved to be somewhat disappointing for many analysts, it is the manufacturing sector and not the consumers who are clearly having difficulties. The former are still suffering from the levels of stocks built up during 1995 and, therefore, having to scale back production.
In contrast, consumer expenditure is strong and rising; surveys show that consumer confidence is continuing to improve. Retail sales - the subset of consumer expenditure so important to the property market - having languished for most of 1995, is now showing growth matching that of consumption generally. Although most retailers are reporting that the last 12 months was a tough trading period, they are also identifying a significant improvement in the last three or six months and expressing confidence for performance in the near future. Indeed, this is reinforced by the latest retail sales figures which, surprising city analysts, showed growth of 1% in August.
Additionally, the housing market is showing signs of life. The show indicate that prices are rising - particularly for new buildings - and agents are cautiously reporting improved levels of activity. Although the evidence is still fairly scant, the activity appears to be lead by London and the mid-to-upper end of the market. Indeed, this would be consistent with the other evidence which suggests that economic activity in London has been particularly strong and that this has benefitted the higher socio-economic groups.
Retailers' confidence has, in many cases, been translated into modest investment programmes. For some, this means new shop-fitting of their existing units but, for others, it means expanding their existing units or increasing their representation. Anecdotal evidence from the market indicates that competitive demand is strong for the better-located units and that, consequently, some rents are rising.
The Hillier Parker Rent Index reinforces this message, with growth in rental values of 1.7% over the six months to May. Of the 716 retail locations monitored for the quarterly index, the vast majority (565) are, however, showing no change over the last quarter. An handful (12) are showing falls, with only 14% (93 locations) recording rises. On a regional basis, there is a certain similarity to the residential market, with London showing the strongest growth. (Interestingly, though, the growth centred on Yorkshire and Humberside is not reflected in the housing indices).
Even these regional statistics, however, can be misleading. The reality is, in this property cycle more than any previously, demand is very localised. Typically, but not always, it is in the major centres which dominate their sub-regional catchment areas. In such locations, demand is particularly strong for large units (i.e multiples of size of standard units). This is telling us something very important about retailers' requirements and has implications for the town centre the out-of-town debate. The benefit of being out-of-town is not primarily derived from the ability of customers to have easy access - after all, most decent high streets have passing trade greater than the car-borne trade in retail warehouse parks. Rather, it is the advantage of larger units which provides efficiency of operation and enables a greater range of higher-margin goods to be stocked in the outlet.
On this basis, the sequential test could have important positive consequences for some town centres. Provided that the planning authority is able to identify and designate viable sites in or on the fringe of town centres, these could be sufficiently attractive for retailers to "move back" into the town centre. This would have parallels with the US market, where the out-of-town developments incorporating discount stores were criticised for detracting from the town centres; subsequently, when some of the discounters relocated to the town centre, they were criticised for taking trade from the existing retailers.
RETAIL BOOM?
Even though the figures for retail value growth have encouraged a modest increase in investor interest, retail yields have continued to rise - with the exception of Central London, where they have been static for the past 12 months. Investors are still wary of paying for rental value growth before it is clearly evident - although an almost complete lack of prime retail investments in the marketplace suggests that investors holding such property are very reluctant to sell at current pricing levels. The question exercising many investors' minds is whether the rental value growth occurring in the limited number of locations will spread more widely.
Part of the answer to the question will come from the economy. At the current rate of consumer expenditure growth, it is unlikely that the Government will be able to justify a further reduction in interest rates this year - or indeed, before a general election (which is likely to occur in March/April of next year). Already, the Governor of the Bank of England is warning about the risks to the Government's inflation targets of interest rates being too low, and it is likely that the next move will be one to raise them. At the very least, however, politics dictate that such a move will not be until after the election, which cannot now be much more than eight months away.
Nevertheless, between now and then, we will see improved consumer expenditure translating into retail sales. It will be given stimulus by the low mortgage rates, improving housing market, subdued prices, and (just possibly) tax cuts in November.
In the past, retailers have shown themselves to be very responsive to any improvements in their market. This is essentially a reflection of the immediate benefits that are secured from opening or expanding a shop unit - there is little lagging effect of achieving sales (at least for a reputable multiple) - unlike a service-based enterprise. The best example of this was in the late 1980s - when every new unit became an instant profit generator.
Although we are not expecting a re-run of this scenario, it is clear that competitive pressures will ensure that even short-term opportunities cannot be ignored by the retailers. They will, and are, taking advantage of demand where it is strongest. But evidence suggests that the general public is particularly sensitive to interest rate movements - more so than it has been in the past. This because a much higher proportion of the wealth is held in illiquid assets - such as TESSAs, pension funds, life policies, and owner-occupied housing. A rise in interest rates in the post-election period (in, say, 12 month's time) will be a clear signal that, with high levels of indebtedness, consumers' cash-flow is coming under pressure again. We would then expect a fairly significant drop in the rate of sales growth, leading to retailers curtailing their expansion plans.
In our opinion, this growth period will prove to be of insufficient duration for improvements in the sector's fortunes to filter down very far from the prime locations.
Even if the (expected) interest rate rise is adequate, on its own, to quell any inflationary tendencies - and our scenario implies that it could well be - the medium term does not bode well for the fortunes of the sector.
Across industry, but more particularly in the media and technology companies, substantial capital and resource commitments are being made to the new information technology. Nobody can yet be certain as to who will be the beneficiaries and who will be the losers, but competition between the players will ensure that all profit-making opportunities will be exploited to the full.
Such development will undoubtedly include the retail sector. Already systems are being put in place to provide for the secure transfer of credit card information over the Internet. Further, a concept of a "virtual" currency on the system is being taken so seriously that the Bundesbank has warned against the risks to the current monetary systems.
Retailers will, individually and generally, have to decide whether to join this market place, or leave it new players to compete with them. Already, Internet service-providers are seeking to tie-in their services with other organisations, including retailers, to differentiate themselves from their competitors. One thing is clear - these new retailers will have significantly less capital requirements and will not be burdened by the need to maintain a large asset base of high street (or out-of-town) outlets.
For further information, contact: Alan Patterson, Head of Investment Research, Tel: +44 (0) 171 629 7666, Fax: +44 (0) 171 409 3016
See More Popular Content From