What impact are online sales going to have on the retail market? Fund managers are beginning to reposition themselves in anticipation, writes Maha Khan Phillips
A decade ago, retail property investment was a far simpler value proposition than it is today. Consumers with money to spend, goods to purchase, would make their way to a local high street or shopping area, lined with a variety of stores, restaurants and services providers like banks and post offices. Alternatively, they would venture to a regional mall to get what they needed. Fund managers had only to identify where people did their shopping, and make their acquisitions.
Now, of course, more and more consumers are doing their shopping in cyberspace. From the sales of DVDs, toys, and clothes, to groceries, banking, and postal services, online shopping and lifestyle management has changed the structure of the retail market. And it has significant implications for property managers.
“Fund managers are trying to assess what the likely impact of online shopping is going to be going forward, in order to rebalance their portfolios if needed,” says Douglas Crawshaw, senior investment consultant at Towers Watson.
Already, the impact has been significant. In 2011, retail websites captured €165bn of the €1.5trn of retail sales in the three largest online European markets of the UK, Germany, and France, according to research from AXA Real Estate. The firm estimates that online sales will grow 14% in the UK this year, 13% in Germany and 22% in France. Between the end of 2012 and 2016, 90% of the total growth in retail sales – approximately €91.5bn to €101.2bn total, in these three countries – will be captured by online spending. For less developed online markets, AXA Real Estate argues that growth rates will be even higher, albeit starting from lower bases.
AXA Real Estate has also calculated that physical store sales will be diluted by -1.5% in the UK by 2016. France will suffer the biggest decline in sales per unit as a result of a 4.3% projected increase in retail sales area and a cannibalisation of physical store sales by online sites, resulting in a net effect of a 6% decline in sales per unit area over the period. Spain and Germany will also see declines. “A fall in sales per unit area will reduce the ability of retailers to meet their occupancy costs,” warns AXA Real Estate.
This will result in vacancies. “Even in major markets you can get vacancy of up to 20%,” explains John Danes, director, property research at Aberdeen.
It is something that retailers have been speaking about. “Ten years ago, to have UK coverage you needed about 150 stores... now, 50 to 60 stores are all that’s required,” says Mike Shearwood, chief executive of UK retailer Aurora. In March the group announced that it would spin off its Warehouse, Coast, and Oasis brands over the preceding 12 months, arguing that the delayering process will equip the brands for the huge shift to online sales globally.
“Businesses that are flatter, leaner, more competitive, and independent, will naturally be easier to sell in an omni-channel retail world. Retailing is no longer about gearing your operating model around bricks and mortar,” said chairman Derek Lovelock.
A report by the British Council of Shopping Centres estimates that around 20% of the current retail space in the UK will become surplus to requirements, while Aviva Investors suggests that average real rental value growth will fall to between 0% and -1% throughout the 2010s and 2020s. The investment manager says income risks will increase for certain property types and occupiers, leading to higher yields and required rates of return, although demand for high volume and convenience locations are expected to continue. Aviva Investors also believes that landlord and tenant relationships will become more flexible, as demand for shorter and more flexible leases will increase.
And this is very much a global challenge. In France, supermarket chain Carrefour now boasts over €1bn in online sales and is Europe’s largest online retailer by sales volume. In the Netherlands, Royal Ahold, owner of supermarket chain Albert Heijn, bought bol.com last year. Bol.com has 2.4m active customers and had sales of €355m in 2011, according to Aberdeen Asset Management. “Even in Norway, a country where consumer spending and economic growth remained healthy in 2011, a third of shopping centres experienced falling sales, we suggest because of spending migrating online and to more dominant centres,” Aberdeen says.
In Asia, structural changes are also occurring. According to a report from Pramerica Real Estate Investors, the pipeline for prime retail space in South East Asia (with the exception of Singapore) ranges from adequate to abundant, depending on the market. Some markets, like Vietnam, will see significant supply risks looming ahead in major cities, the report warns.
“It’s a truly global trend and part of it is driven by the fact that a lot of retailers are looking at how they can service more geographies via the internet,” says Alice Breheny, director of property and global head of research at Henderson Global Investors.
Are fund managers logged on?
All this has significant implications for fund managers buying and managing retail assets. “In the past, fund managers have looked at a shopping centre and said, that’s fine, we’ll make money out of it. Now they have to be active and constantly manage their property,” says Debra Kent, property partner at Charles Russell, the law firm.
Kent says landlords and investors will need to think more carefully about what types of tenants they have in place. “If you were an owner of a strip of shops on a high street, you would not want to sign everyone up to a 10-15-year lease. You would actively be managing the high street to catch the latest entrepreneurs and businesses. That’s not traditionally a great thing for fund managers, because they want a 15-year covenant.”
Paul Richards, principal at Mercer, suggests that fund managers will go “back to basics”.
He says: “It’s about assessing your tenant and their long-term viability. Twenty years ago you might have had a bank in your unit on the corner of the high street, and then 10 years ago it may have been a mobile phone shop and now a branch of a supermarket. But the basic skill set isn’t changing.”
For fund managers, it means adopting defensive measures. Aberdeen Asset Managers suggests that supermarkets are a good defensive play, because they can fulfil a dual role both as a physical outlet and as a de facto distribution centre where ‘pickers’ can select goods for home delivery from the shop floor. “Supermarkets remain hugely popular,” Danes says. “Their property costs are much lower and they have a high level of turnover. They also distribute from their stores and they are moving into non-food goods.”
Vanessa Barnett, partner at Charles Russell, who advises clients on online business, believes supermarkets will grow in strategic importance. “If you listen to the language that the supermarkets are speaking, they aren’t talking about having just a supermarket, they are talking about mall and customer experiences,” Barnett says.
Dominant regional shopping centres and prime pitches are also defensive, according to Aberdeen. Dominant locations that offer a broad range of fashion brands in an attractive environment with restaurants to increase ‘dwell time’ are forecast to perform well, according to the firm. Aberdeen also says that retail park locations, collection centres and outlet malls, which benefit from low rents but offer food and fashion, and, in the case of outlet malls, discounted products, will continue to perform well.
Marcel Kokkeel, CEO of Citycon Oyj, talks of the “Nordic Paradox”. While online usage – or, ‘internet penetration’ – in the Nordics is significantly higher (91.9%) than the European average (73.1%), they are what he describes as “lazy online shoppers”. Online purchases represented only 8.55% of total retail sales, below the European average of 8.8% and far below the UK (13.2%).
According to Kokkeel, “multi-channel” retail will be the future. The “winners will be the retail brands who play both channels”, he says. Listed retail property specialist Citycon is moving its portfolio in favour of shopping centres that can benefit from this trend. Kokkeel says there is a very big opportunity in markets like Stockholm to bring new retail brands into the market to establish both physical and online presences in the burgeoning Swedish consumer market.
Fund managers agree that the leisure sector will be mostly immune to the threat, with more restaurants, and more multi-channel services available in stores, as well as the growth of ‘click and collect’ and collection-point services. But ultimately, location is important.
“You’ve got to look at your existing portfolio, where you own retail assets, you have to be sure they are in the best locations, the ones which have the ability to generate high footfall,” says Breheny. She estimates about 50 shopping centres or locations in the UK that are fairly “bullet proof” and will survive. “They don’t get traded very often, and they are very defensive long-term plays.”
But these assets are difficult to come by. The Hamburg Trust, which focuses only on core shopping centres, acquired a 78% stake in the Milaneo shopping centre in Stuttgart last year. “The biggest issue is that there are not enough opportunities,” CEO Dirk Hasselbring says. “We might need to look at development in order to get the right tactical growth for investors in the long term. The metropolitan areas where shopping centres could have been built are already packed with shopping centres.”
Another challenge is that investors see the decline in retail sales as cyclical, rather than structural. For many, the decline in retail is about the recession, rather than about the threat of online shopping, or the large amount of debt in the system.
“A lot of investors believe that what we are going through is purely cyclical, but the whole nature of shopping has changed,” sales Alan Patterson, head of research and strategy at
AXA Real Estate. He believes that fund managers should be focused on both high-end retailers, and the low end of the market, rather than anything in between.
Patterson says: “In this market, the upper end retailers, the ones offering high fashion and jewellery and other high cost items, will continue to do well because there is a population polarisation. The rich have got richer and they have a lot of spending power. Then you have the bottom end of the market, the discounters, and people wanting to keep costs to a minimum will go to a discounter. It’s the middle class, the middle consumer, who have less spending power because they have been squeezed by the recession. They are very conversant with the internet and it works very well for them.”
Ian Mason, head of property fund management UK at Schroders, says the firm’s balanced portfolios, which are measured against a benchmark, have been underweight retail for two or three years now. “Whilst we have taken a defensive stance, it is important to say that the high street is not dead,” he says.
“We, as a nation of consumers, are still very much intent on spending every spare bit of disposable income that we have. What we do within our investment process is analyse where the money is now being spent and how it is being spent. This is how we identify opportunities.”
It is an interesting fact that the people who actually made money during the California Gold Rush of 1848 were those who sold picks and shovels to the miners. Similarly, many fund managers believe it is time to embrace online sales, and overweight distribution and warehouse centres instead of traditional retail property.
“These are quasi retail assets in logistics and distribution,” says Kiran Patel, CIO of Cordea Savills. “Think about the internet and delivery to the home: rather than people coming to you, you are going out to everyone. Distribution becomes very important. Is it more expensive to put goods on rail than it is on the road? Or is it cheaper to build one big regional distribution centre? When Amazon first came to the UK, I think they started with a 100,000sqft unit. Now, within a few years, they have a million square feet.”
Patel is reducing Cordea Savill’s retail weighting. “But we are starting to increase our industrial distribution in all our portfolios, buying more sheds and packaging.”
Fund managers all agree that consumers will still spend money in shopping centres and high streets. But it will be more targeted shopping, and more is expected from retailers in terms of offering multi-channel services.
“It’s a knee jerk reaction to say that online shopping ended the high street. It is more sophisticated than that. Even within the online world, the businesses with good e-commerce operations are doing well, but others are suffering,” says Barnett.
But for investors and managers who think things will pick up after the markets improve, Richards makes one thing clear: “We are in regular communication with fund managers, and if they haven’t taken into account that the retail market is changing because of online [shopping] then we have a concern.”