Retail landlords across Europe are struggling as e-commerce eats into physical store sales and underperforming mature retail assets pressure profits. After the UK, where the market has weakened considerably, the Netherlands and Germany could be next, writes Isobel Lee.
The spiral of distress in the UK retail real estate landscape has pushed landlords and retailers there to breaking point, and the Netherlands could be next, Vivienne Bolla, European research analyst at Aviva Investors, has warned. ‘The European retail real estate market we see displaying the most similar characteristics to the UK is the Dutch market,’ she told PropertyEU.
‘In the UK, store-based retail sales growth has been eclipsed by online, as e-commerce penetration has heightened,’ said Bolla. While national government figures suggest that e-commerce sales in the UK have reached 17% [of the total], this figure stands at 11% in the Benelux region, just 6% behind the UK where there is a ‘relatively large provision of mature retailing infrastructure and a digitally savvy consumer base’. Furthermore, Bolla said, ‘the Netherlands is at risk as 97% of the population has access to the internet and the size of the country allows for relatively straightforward online fulfilment’.
As a result of the changing consumer and retailer trends, there is now ‘a significant spread between prime and secondary yields in the UK investment market’, Bolla explained. Similarly, she continued, ‘the average yield spread in the Netherlands is now well above the previous peak. We are seeing higher yield levels for retail parks and secondary shopping centres there, as investor interest in these types of assets is becoming weaker, foreshadowing what may happen in the future’.
UK retail woes
For much of the UK retail market, the outlook isn’t that positive, approaching the end of a difficult year which has seen legacy retailers such as M&S and House of Fraser rattled by long leases on increasingly unwieldy portfolios. In mid-October, a mall in Maidenhead went bust, dubbed the first shopping centre to go into receivership this cycle. ‘Business rates for physical stores in the UK are so high relative to logistics facilities for online firms, the occupancy cost ratio is becoming increasingly unsustainable,’ Bolla added.
Retailers including New Look, Carpetright, Mothercare and House of Fraser have all used the Company Voluntary Arrangement (CVA) mechanism this year, a tenancy loophole which allows retailers to impose rent reductions on landlords and to break leases to close stores where they risk insolvency.
A weakness to the law allows some retailers to take advantage of the get-out clause, Hans Vrensen, head of research & strategy at AEW said. ‘As more aggressive private equity firms have been taking bigger stakes in UK retailers in recent times, they might also be more highly leveraged. This might amplify the financial issues, even if their operational troubles are not as bad,’ he said. ‘From a landlord perspective, this is problematic.’
UK department store operator Debenhams, which issued three profit warnings this year, announced plans to close 50 stores at the end of October, although it said it hoped to side-step the formal CVA path. ‘CVAs seem to be a uniquely British legal problem,’ added Vrensen.
Distress in store
Yet while the department store landscape in the UK is not as troubled as the US market – where a much higher proportion of malls have traditionally been anchored by department stores – it remains an asset type which has been generating distress across Europe. In early 2017 – after the first wave of bankruptcies in the Netherlands wiped out department store retailer V&D and also sports chain Perry Sport – landlord Unibail-Rodamco was complaining that retailer failures were dragging down its Dutch net rental income by as much as 8.1%. And although Unibail and other landlords managed to replace V&D in some centres with then-expanding Canadian department store chain Hudson Bay Company (HBC), this has proved a temporary salve as HBC has more recently run into trouble.
In September, HBC struck a deal with its main European competitor Signa to merge its department store businesses across the continent. As part of the agreement, Signa’s Karstadt chain will join with HBC’s Kaufhof business to operate 243 city-centre locations across Europe. Disposals are likely once antitrust authorities approve the deal.
‘Stores like Sears and their European counterparts like House of Fraser in the UK and V&D in the Netherlands have failed to grasp the notion that their role is not to provide a wide range of products but to be a meeting place, said Josip Kardun, CEO of Blackstone’s retail division Multi. ‘That’s why the gastronomy temples are doing so well. The retail of the future will look very different,’ he added. Even relative success stories, such as the John Lewis Partnership in the UK, are feeling the brunt of the market’s headwinds. The heritage retailer, which saw profits plunge 99% in the first half of the year, has announced closures of its upmarket grocery subsidiary, Waitrose. And John Lewis is one of the lucky ones. Plans to revamp 15 of its stores into ‘pilot schemes’ commenced this summer with the addition of a rooftop bar and pop-up cinema to the Oxford Street branch.
‘It’s a way to extend opening hours, drive in-store footfall and experience and become landlords themselves,’ noted Melanie Brown, director of real estate research at UBS.
Similarly, Italy’s La Rinascente department store chain has been attempting a renaissance of its own. Last year, the brand closed two drab mid-scale stores in Rome and unveiled a new temple to luxury shopping with open-plan boutiques from Gucci, Prada, Valentino, Chloe and more, plus a walk-in hall dedicated to Louis Vuitton. Topped by six roof terraces including gourmet restaurants and a champagne bar, the full-building restoration took 11 years.
Driving the problem out of town
Significant structural weakness has also become evident in out-of-town retail and secondary shopping centres in Europe’s most troubled markets. The most famous example of falling values was evidenced in a small Scottish mall, Callendar Square in Falkirk. Owner Colony NorthStar made £1 mln at auction on the asset in December 2017, after buying it for £26 mln a decade earlier. The sale represented a 61% yield, the highest seen to date in the UK market. While it is an extreme case, asset manager APAM calculated earlier this year that there could be at least 200 shopping centres at risk of administration in the UK, worth some £7 bn in total.
UK REIT Hammerson reversed plans to merge with peer Intu earlier this year over shareholder fears that it would inject the firm’s portfolio with lower quality shopping centre assets. Despite the U-turn, Hammerson’s woes aren’t over, and it commenced a drive this summer to exit the retail park sector and further reduce exposure to secondary shopping centres.
While at the time of writing Hammerson had managed to offload over £530 mln of assets so far in 2018, according to Hemant Kotak of Green Street Advisors, disposing of its nearly £1 bn of retail parks by the end of 2019 might not prove so easy. ‘You would need to find investors who really have a contrarian view of the structural issues facing the retail park segment at the moment. There are very few of those around, so that limits the buyer pool,’ Kotak said.
Tim Vallance, lead director in JLL UK’s retail and leisure team, is less pessimistic about the segment. ‘Affordability, flexibility, convenience, low site densities, rare planning consents, free parking and low vacancy rates continue to attract attention from investors and retailers from home and abroad,’ he said.
Germany next?
With the writing on the wall for weaker retail assets in the UK and the Netherlands, Germany could follow close behind, Bolla suggested. ‘The conditions for German retailers are challenging. Profitability has been falling and retailers are cautious about store expansion, choosing to invest in online distribution channels instead,’ she said. ‘We’re expecting larger cities and southern Germany to have the best growth prospects supported by higher population growth and more favourable demographics. But rental growth is a challenge and we’re seeing a lot of independent stores struggling, even on the high street. Polarisation is creating a widening gulf between winning and losing retail locations.’
Defensive routes
So what are the safest routes for investors still focusing on retail real estate in Europe’s core markets? A surprise sunny spot may be found in southern Europe, where e-commerce penetration is significantly lagging behind European averages at 4% of total sales. ‘It’s not just about internet penetration - Italian customers are different when they shop. They’re social, focused on experience; more tactile and physical in their approach,’ said Massimo Moretti, president of Italy’s shopping centre association CNCC. CBRE’s Gonzalo Senra sees a similar approach in Spain, where good weather, well developed F&B concepts and an appreciation of experiential and thus physical shopping bodes well for modern assets in the sector. However, how quickly the digital gap may close is still an issue. According to e-commerce experts PostNord, Spain’s online user population grew by 28% in the past four years to 78%, and the figure is set to keep soaring.
‘Overall we’re advocating a back to basics approach,’ said Brown. ‘It’s important for investors to really check the fundamentals – starting with location.’
‘Prime, high street retail is typically very supply constrained – it’s hard to replace the unique experience of some of the dominant shopping streets in Europe’s historical centres,’ suggested Vrensen.
‘It’s about being confident in the catchment of an asset, the dominance of that catchment, and also being mindful of additional boosts in trade,’ Brown added. ‘We like tourism and student populations, as well as a significant working day population. We’d also look for flexibility in an asset, its ability to change to consumer needs and even undergo a change of use.’
Indeed, with the Centre for Retail Research predicting that the UK retail sector will lose at least 60,000 stores by 2021, landlords everywhere will be hoping for flexibility and comprehension from local authorities about potentially exiting the retail sector.
Intu announced plans at the end of October to explore building residential assets on some of its sites to increase their values, and adding senior housing – coupled with the current UK demographics – could be the next mixed-use trend in retail development, according to Vrensen. ‘Retired people are probably going to want to be near shopping,’ he noted. ‘These changes aren’t always about maximising the rent, they’re about creating a destination that people want to visit, to really shape the city centres of tomorrow.’
