Retail is detail
?“There has never been a better time to go shopping. There has never been a tougher time to run a shop.”
??-?from Oliver Wyman's report titled "Retail's Revolution"
The news that online retailer Amazon is closing its two ‘4-star’ shops in the UK and bookstore formats in the US, suggests that online retailing is not going to be the saviour of the high street after all. Nor perhaps is an online sales tax, which may hit the same retailers that the tax is designed to help. Alex Baldock, Chief Executive of Currys, described the very concept of an online sale as “increasingly out of date”. This sentiment is likely to be behind the decision by Macy’s to reverse the decision not to separate out its e-commerce business.
Rising freight costs rather than online taxes are the immediate concern for online retailers, with losses at Made.com more than doubling to ￡31.4 million due to a five-fold increase in freight costs. Retail is in a state of constant flux, the comeback in book sales prompting Waterstone to consider a takeover of Blackwell and John Lewis deciding to drop its ‘never knowingly undersold’ pledge.
The declines in retail rental levels and capital values prompted DWS to reclassify retail property as a value-add product, although core investors likely to remain ‘shy’ still of retail in the next year. The reward for value-add investors is expected to be “a bottoming out of prime rents by the end of the year” and a slow rental recovery over the medium-term. As Nuveen emphasizes, stores will remain the epicentre of spending in Europe over the next five years and with average prime shopping centre yields reaching close to 9% last year, there is evidence that liquidity is returning to the market. The prospect of a yield improvement and a juicy initial yield prompted AEW to make prime shopping centres the most attractive sector in its 2022 European outlook.
With many rents now rebased to sustainable levels, deals are starting to accelerate, including the sale of St Georges Shopping Centre, Harrow for a net initial yield of 8.3% and a large site in Nottingham predominantly let to Primark for ￡21 million. Outside Europe, CPP Investments is developing a regional retail centre in Alipore, Kolkata in a joint venture with The Phoenix Mills Ltd., a leading retail mall developer and operator in India.
For non-prime shopping centres alternative uses are being explored, but early indications are that the process may not be straightforward, with the owners of Eastgate shopping centre in Basildon going into administration despite obtaining planning permission for the complete redevelopment of the scheme and construction of several new residential towers consisting of homes built for rent and for sale; and its yet to be proven that “medtail” tenants who are mostly internet-proof, are the panacea either.
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Hammerson are confident of a bright future for UK shopping centres despite reporting an overall loss of ￡429 million last year, which was at least a big improvement on the loss of ￡1.73 billion in 2020. “We’re not necessarily calling the bottom but we are starting to see some stabilisation,” said Rita-Rose Gagné, the company’s chief executive. The results from Simon Property Group were certainly encouraging with occupancy improving in the fourth quarter a further 60 bps to 93.4% following consecutive periods of 100 bp gains. Occupancy may be coming at the expense of rental tone but this might be changing "we haven't quite had the level of pricing power that we'd like to see… we're starting to see that strengthen." The recovery from the pandemic drove an impressive portfolio NOI increase of 33.6% over the final quarter.
UBS estimate that, assuming a 7% required return, current REIT pricing implies 1.4% pa future rental growth. With inflation rising and indexation of rents in most European countries this would seem a low bar but ominously, the French retailers' association Procos (300+ retailers) communicated that rent indexation is ‘unsustainable’. Retail is certainly still facing further severe economic headwinds with PayPal noting "the impact of Omicron and the effect of inflationary prices, combined with lack of stimulus, is having an impact on spending."
The fall in retail values has pushed up leverage. UBS estimate that current LTVs range from 43- 47% across the retail REIT sector. Whilst they consider this to be a sustainable level, further disposals are recommended. At the beginning of the COVID-19 pandemic, the marginal cost of debt of the retail REITs increased materially, with URW and Klepierre's bonds trading in the 2-3% range. The situation has since stabilised at the pre-pandemic level and refinancing “can now be considered an opportunity, rather than a risk”. Debt is available across Europe for the right retail product. Hines secured a €50m green loan for Madrid retail project that recently underwent a €12 million refurbishment. Allianz Real Estate has lent €466 million on a long-term basis to a consortium of borrowers for the refinancing of a portfolio of 12 long-let prime retail assets across France and Belgium. ConduitRE have financed one, and are in the process of financing another traditional shopping centre (which intends to stay as such), and there are forward-thinking lenders and structurally superior ways to do so.
Oliver Wyman’s conclusions on how retailers should adapt, are that first; there are huge opportunities for new businesses and inventive incumbents to thrive in retail. The shopping experience of the future is still being designed, and every new solution will be followed by something even better. Second, making the most of these opportunities will require visionary leaders who embrace change. Some are already altering the landscape of the industry. Third, new retail business models will be very different from those of today. Reports of the death of traditional retailers are certainly exaggerated, but many will need to invent new roles in the shopping system to survive and thrive over the long term. Fourth, brand owners and manufacturers are not immune from disruption either.
As Khosla Ventures put it, most innovation in any industry comes from participants outside of it, not from incumbent players (think SpaceX, Uber, AirBnb, WeWork and many others). In terms of registered patents on retail activities, Amazon, eBay and Alibaba dwarf global patents applications granted to traditional retailers. It’s the age of the reformer and the success in retail – for Landlords, Tenants and Investors – will be in the detail.