Luxury existentialism takes hold in European capitals

Growth in Asian tourism is driving up rental values in luxury retail locations across Europe and pushing down initial yields

By Béatrice Guedj
Head of Research and Strategy
Grosvenor Fund Management Europe
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In an economic environment dominated by fiscal austerity and consumer spending cutbacks, it hardly comes as a surprise that rental value prospects for retail assets in Europe are not looking up in the best of cases and are actually looking down in the worst. But one segment remains an exception: luxury shopping streets. Indeed, New Bond Street in London and Champs-Elysées in Paris are not only bucking the trend, they continue to enjoy rude health.

In New Bond Street, where the density of high-end jewellers is probably one of the highest per square foot in the world, rental values have grown by 6.6% per annum since the outbreak of the financial crisis in 2008. Zone A rental values have now reached a staggering €8,000 per m2. Other locations like Mount Street, known as the new ‘temple’ of luxury retail, have experienced healthy rental growth over the past six years as well, since Marc Jacobs opened its first store.

In Paris, rental values have also experienced similar steady growth, and not only in the Golden Triangle. In Avenue Montaigne and Rue du Faubourg Saint-Honoré, rents have grown at an annual rate of 8.5% on average since 2008. This pace of growth has pushed values upwards over the symbolic €10,000 per m2 threshold this year. On the world-famous Champs-Elysées, rental values have increased by an even faster pace of 11% per annum, or a total of 70% since the 2008: Zone A rents are now at an all-time high of €18,000 per m2. In Saint Germain, once the home of the world’s greatest intellectuals, rental growth of over 12% per annum has been registered since the opening of the Ralph Lauren flagship store.

ANEMIC ECONOMICS
These spectacular increases in rental values in high-end locations are not correlated to the anemic economic environment. Admittedly, prospects for household consumption growth in London and Paris - the largest cities in Europe and the biggest contributors to their respective national Gross Domestic Products (22% and 29%) - are better than the national average due to a higher average income per capita. But local factors are not the main drivers of rental growth in high-end locations.

In fact, the primary drivers of rental growth on luxury streets in London and Paris are foreign and include 1) the presence of overseas High Net Worth Individuals in London and 2) the number of Chinese tourists in Paris. In 2010, approximately 900,000 Chinese tourists visited Paris. This number is expected to reach 1.8 million in 2013, an increase of +26% per annum since 2010, compared to +10% per annum since 2004. In 2012, the tourism effect accounted for between 50% and 80% of the increase in sales of luxury items. Indeed, official statistics indicate that 25% of tax-free sales were purchased by Chinese tourists.

According to our estimates, Chinese tourists spent almost €1,600 per day in 2012, an increase of 220% since 2004. Last but not least, around 48% of this spending per stay is reserved for shopping. In general, there are three main reasons why shopping in Europe is so popular: (i) the authenticity and trust in the origin of the luxury items being sold, (ii) the luxury retail experience in a historic location such as Paris and (iii) the lower prices, since import duties in their home countries inflate prices comparatively by 30% to 50%.

Recent surveys suggest that the luxury retail experience remains the most preferred pastime of Chinese tourists in Paris, well ahead of a visit to the Eiffel Tower or the Louvre. This luxury existentialism would have been grist to the mill for Jean Paul Sartre, and it has also clearly been a boon for the French luxury industry. Indeed, the Comité Colbert, which is comprised of 75 luxury brands and 13 cultural institutions and whose mission is to promote the French luxury industry and ‘art de vivre’ abroad, is now demanding more security for Chinese tourists in the French capital.

The success of the luxury industry has also been grist to its own mill: more luxury brands are now opening additional shops in Paris. A case in point is Chanel which has now launched its third shop on Avenue Montaigne. The trend to open more high-end stores is not restricted to the Golden Triangle. A number of new destinations are emerging. For example, ‘Bucherer’ - the largest shop in the world dedicated to fine watches - opened in April near Opera, in a street not traditionally known as a high-end location. This flagship store, accommodated over three floors totalling 2,200 m2, mainly targets Asian and Chinese tourists. An econometric modelling exercise indicates that over the past 12 years, a 1% increase in tourism from Asia has generated a 5.8% increase in spending per annum on Avenue Montaigne and 6.2% on the Champs Elysées. Similarly, in London, overseas consumers have driven 50% of the rental increases on New Bond Street.

ITALIAN AUSTERITY
In Italy, despite the fiscal austerity and a general decrease in rental values across its main cities, most high-end locations have shown a strong degree of resilience. For example, in Via Monte Napoleone in the Golden Quad, Zone A rents stand at €7,500 per m2, 7% higher than their values in 2012. While household spending has contracted by 6% in real terms since Q2 2009; tourist spending increased by almost 10% over the same period. Italy’s share of High Net Worth tourist from the BRICS (Brazil, Russia, India and China) has continued to grow over the past few years with visitor numbers from India rising 41%, the Chinese up 25% and the Russians up 29% between 2011 and 2012.

The trend is giving the local economy - and core retail assets - a major boost. It is no coincidence that the Hennes and Mauritz family office bought the Palazzo dell’Unione Militare in Rome’s Via del Corso for €180 mln earlier this year.
In Spain, the famous Passeig de Gracia in Barcelona, the architectural reference for Catalan Modernism, is home to both luxury and mass-market brands. This avenue remains one of the few locations in Spain where rental values have increased, again despite a strong contraction in household spending (-6.5% since 2008): In fact Apple recently opened its latest flagship store on this street.

Not surprisingly, rental value growth in Barcelona has been the lowest in comparison to other high-end locations in Europe. Nonetheless, high-end locations in Barcelona have real growth potential in the medium term. Some 14 million tourists visited Catalonia in 2012 - primarily Barcelona and its surroundings - which marks a year-on-year increase of 10% and compares to a rise of just 2.7% for all of Spain. As in Italy, the share of High Net Worth Individuals continues to increase in Barcelona, due to its location on the Mediterranean sea. Amancio Ortega, founder of the Inditex group, provices one example of the tangible confidence in the city’s growth potential: in 2012 his Puntegadea property company invested €135 mln in two assets on Passeig de Gracia. The net initial yields were around 4% and 4.8% respectively, far tighter even than what opportunistic investors have been targeting in Spain since the crisis.

The strong increase in rental values for assets in luxury high streets has coincided with an inward yield shift as a result of investors - private or public - hunting for core assets in an increasingly polarised market. On many of these high-end locations, yields have reached a historic low: 2.75% in New Bond Street, 3.75% in Avenue des Champs-Elysées, 4.25% in Avenue Montaigne or 4.5% in Saint-Germain des Prés.

TROPHY ASSETS
The Qatar Investment Authority (QIA), the sovereign wealth fund that bought London’s Harrods department store in 2010, has contributed to the inward yield shift observed on the Champs-Elysées. The QIA’s acquisition in 2012 of a trophy asset and flagship retail complex, for an estimated €515 min remains a vivid memory in the minds of investors. It was followed by another purchase on this prime hunting ground: an Art Deco building built in 1931 which includes the famous Lido cabaret with a price tag of €160 mln. As the top high-end retail location in Europe and home to luxury brands, the iconic Parisian avenue has become a target for investors with deep pockets, from sovereign wealth funds to family offices. The high prices paid mean returns are low, but so are the risks and more importantly, the required rates of returns do not share the same paradigm.

More traditional investors are also targeting high-end locations elsewhere in Paris, in other pockets of wealth such as Rue de Passy in the 16th district where yields are below 5%. In London, this could also be the case for the forthcoming sale of the retail and catering area at Old Spitalfields Market in East London. The site has become a trendy tourist destination, rather like the famous Marais in Paris. Some investors regard this as something of a ‘bandwagon effect’ and wonder whether rental values in Paris are inflated by over-optimism or ‘madness’. However, with Paris remaining the preferred shopping destination for Chinese tourists, rental values for luxury retail are not set to tumble any time soon.