The travails of the retail sector has been one of the most talked about features of the UK economy since the financial crash. Regular articles in the trade press and the national and local dailies and weeklies are full of the ‘high street’ woes but how deep are the problems and is conventional retailing in terminal decline, or are these issues merely temporary with better times ahead?
Commercial property has produced more than satisfactory returns since the financial crash. Looking at the market as a whole, annualised total returns from end 2009 to end 2017 have been 10.1% p.a. compared to CPI inflation of 2.2% p.a. – a more than acceptable real return of 7.7% p.a. over these eight years (source of all property performance figures: MSCI/IPD Quarterly Index).
Part of this relatively strong level of returns can be explained by commercial property’s high yield, at a time when the hunt for yield offers few other options. This also fed through to the highest yield sector in commercial property, the industrial sector, which over the same eight years delivered quite exceptional average total returns of 12.6% p.a. nominal or 10.2% p.a. real. Industrial properties have benefited from the twin features of strong investment demand for their higher yielding assets and the recent boost to manufacturing from sterling devaluation.
Given the dire warnings during the crash and post the EU referendum of the threat to employment and business activity, primarily, but not exclusively, in Central London, the office sector has also generated surprisingly favourable rates of return of 11.4% p.a. nominal and 9.0% p.a. real over the same timeframe. What the lacklustre GDP figures over these years have hidden is the surge in job creation since the crash: after all, employment numbers are crucial to office demand.
It is the retail sector, comprising in the main shops, shopping centres, retail warehouses, retail parks and supermarkets which has struggled in the post crash environment. Despite the sector’s woes, nominal returns of 8.0% p.a. and 5.7% p.a. real can hardly be described as disastrous, but they fall well short of those of the other sectors. True, data over the immediate past shows the retail sector in much poorer light, as nominal returns of 6.1% p.a. (4.5% p.a. real) over the last three years (2015-17) indicate, trailing returns from the industrial and office sectors (real returns of 13.1% pa and 7.4% pa respectively. But even these depressed retail performance numbers are hardly that of a sector in meltdown, as one would gather from the press headlines.
What has caused the decline in the fortunes of the retail sector? After all, following previous economic recessions, retailing has generally been the area to kick start recovery. Its problems can be explained by a couple of separate but related factors; the loss of confidence and spending power of the consumer and the structural changes underway in retailing. There are signs of some improvement in the former but little respite in the latter. Both factors were compounded by the vote to leave the EU two years ago which apparently dented consumer confidence quicker than that of businesses (although the prospect of a ‘no deal’ exit may now be beginning to adversely affect office occupiers).
Retailing has undergone a sharp shakeout in recent years. Already 2018 has seen a raft of retailer profit warnings and the collapse of occupiers such as Maplin, ToysЯUs and Moss Bros, several company voluntary arrangements (CVAs) and downsizings of businesses as diverse as Marks and Spencer, New Look, Carpetright, House of Fraser, Debenhams, Homebase, Jamies’ and Byron’s. Even one of Britain’s best performing retailers, Next, in its January results showed that it was not immune to financial pressures when it revealed that it had renewed 19 leases in the previous 12 months and cut its rent by 25%. It is anticipating a similar magnitude of reduction when it negotiates rent on its 29 renewals this year. Landlords must heed the warning from the Chief Executive of Next, Lord Wolfson, who stated that “if the landlord wants a reasonable rent, we’ll stay, if they don’t, we’ll go”. Next are not alone in seeking to cut costs.
Such retail shakeouts are of course not new. Retailers come, retailers go; formats change; prime pitch moves. That merely reflects changing consumer habits and requirements and is a sign of a healthy and dynamic retail environment.
What is different this time is that there are far fewer new players coming in to replace the failures and much fewer existing retailers seeking to expand their portfolios. A survey by PwC for The Local Data Company revealed that across the top 500 retailing towns in the country, a total of 5,855 outlets closed in 2017, the largest number for some years. Compounding the problem was the fact that only 4,083 outlets opened to compensate – the lowest number since 2010. This resulted in a net loss of 1,772 outlets in the year across the UK.
Businesses most at risk of closure were fashion (around 700 closed in the year), pubs and inns (200), closely followed by shoe shops and convenience stores. Ironically, the landlords’ saviour during previous economic downturns, the charity shop, itself fell foul of the economy with almost 300 shops closing. In contrast, growth areas included beauty shops, nail bars, coffee shops and ice cream parlours. One wonders just how sustainable these new ventures will be. Additionally, many of these openings will be of small units and perhaps located off prime pitch. They would hardly appear to be the type of venture that can replace a departing tenant operating out of a 30,000 sq. ft. shop.
Consumer spending has been suffering for years. While low interest rates were a boon to those with mortgages, they were particularly hurtful to those depending on their savings. Add to that stagnant wages for years offset by rising inflation post the EU referendum meant many consumers were feeling the squeeze. Hardly a surprise then that retail spending has suffered in recent years.
As well as depressed consumer spending, retailers have been struck by a perfect storm of cost pressures. Sterling depreciation has pushed up input costs for many, the rates revaluation has hit retailers disproportionately – it has been estimated that retailers will pay an additional £3bn over the coming three years compared to the last three – while energy and labour costs are again rising. The British Retail Consortium estimate that the National Living Wage costs the retail industry between £1.5bn and £3bn a year. All at a time when total consumer spending is at best flat, but when the share accounted for by physical shops continues to fall.
Without a doubt, the biggest challenge facing the retailing sector is that of changing consumer habits. No longer is a day shopping in town centres or at shopping centres or retail parks the only option available to the consumer. Online consumption now accounts for around 20% of all sales, and significantly more than that for some segments. Without the right online offering, retailers are suffering and will continue to suffer; even with one, the in shop experience has become vital.
All this has resulted in many retailers admitting that they have too many shops, that their expansion during the last decade or so has been too aggressive. As stated earlier, some retailers have failed completely while some others are seeking to downsize their portfolios. For instance New Look is looking to close 60 UK stores out of its portfolio of 600 while Marks & Spencer announced plans to close 100 branches (one in three), House of Fraser is seeking to half its portfolio, Homebase wishes to close a quarter of its 250 stores and Byron, the “proper” burger chain has been forced to close 20 units. There are many other businesses facing similar problems.
The need for such closures has often come about because of a reckless expansion spree by many companies in recent years, partly fuelled by low borrowing costs and by the misguided belief that consumer spending would quickly rebound from its collapse following the financial crash.
News that Hammerson plc was urging its shareholders not to vote in favour of acquiring Intu plc, another shopping centre REIT and independently Klépierre’s decision to pull its own bid for Hammerson once again highlight the fragility of the UK retail environment. Hammerson’s statement that its proposed merger with Intu was no longer in the interests of its shareholders was prompted by growing investor disquiet which in turn was down to the intensifying pressures within the retail industry referred to earlier in the report. It was also quite telling how negative Hammerson’s interim statement in July was about the UK retail environment, posted just a few months after its aborted bid to increase its exposure to that market.
But is there any way back for the once proud retail sector? Arguably, the retail environment remains extremely challenging, as shown by the raft of corporate failures, downsizing and CVAs and in the corporate decisions of Hammerson and Klépierre but I believe that there are glimmers of hope for the sector, if not in the short term, then over the medium term.
However, it does not seem likely that the coming few months will see a dramatic change of fortune for either the retail sector or for the occupiers, given the approaching March Brexit and the uncertainties still surrounding it. Retailers will remain under intense pressure to adapt to the ever
changing environment and these pressures will not disappear overnight. Corporate downsizing, strategic relationships and mergers will continue (witness Sainsbury discussing the possibility of a merger with Asda) while struggling businesses will seek to cut costs, whether through staff cuts, portfolio reductions or rent ‘adjustments’.
However, the position looks slightly more optimistic from the consumer’s point of view. The wage squeeze, where wage rises were failing to keep pace with inflation, now seems to be ending. News that wage growth is now outpacing consumer price inflation for the first time in a year is a welcome boost for the hard pressed consumer. With inflation seemingly on a downward trajectory as the Brexit-induced sterling devaluation passes through the system, the consumer can at long last look forward to better times ahead. Additionally, the Government’s implicit abandoning of the public sector wage cap reinforces that argument. News that the March survey of people’s perceptions of their own personal financial situation had jumped to its highest level since before the financial crash is another positive signal for consumer spending.
While there will still be high street failures and possibly less new entrants seeking to replace them, perhaps the stark challenges facing town centres will now mobilise combined action from investors, developers, local authorities and planners to reinvent the offer to consumers. Instead of banks, why not doctors’ surgeries; instead of travel agents, why not virtual reality experiences? The possibilities are endless, but only with a little imagination. The high street will look different in the future, but such bold plans may just be the catalyst for reinvigorating the town centre.
Retail assets now look more realistically priced than for many years. That alone does not justify a move to overweight the sector.
According to the IPD Quarterly Index, average retail assets have been falling in value for six months and while value falls had previously been confined to the shopping centre segment, the Q1 and Q2 2018 data shows that value declines have spread to the retail warehouse segment as well. And though shops overall are still seeing modest rates of rental growth, the average will include many whose rents are falling.
Many retail properties will underperform for some time yet as retailing adjusts to the modern world. Not all shopping centres, retail warehouses, nor shops for that matter, will offer growth potential in the future. Rather, outperformance will come from a much smaller, ‘core’ set of properties where location, configuration and tenant are paramount. Due diligence will become even more important – not just in terms of location, size and configuration of the unit – but also in choosing suitable tenants in the right type of business which will thrive in the coming years and which will be able to afford market rents. For properties that satisfy these demands, total returns could be more than acceptable as many will command a generous starting yield.
The “market” is not totally convinced of that likelihood. But that is what makes a market. Consensus forecasts for the retail sector published by the IPF have been particularly downbeat for many years. That has not changed. The most recent set of forecasts, published in May 2018, does not necessarily indicate that better times lie ahead. Not everyone agrees with that negative scenario.
Forecasts across all sectors and segments of the property market display particularly wide spreads, indicating the lack of unanimity currently present in the market. While expectations for shopping centres remain well adrift of the all property average for each of the next five years, those for retail warehouses exceed the all property average for the first time in many years, while those for standard shops are roughly in line with the average. The wide range of forecasts from the contributing houses indicates that there are some investors who are much more bullish.
A wise, albeit brave, investor could be well rewarded for seeking out retail assets.