The head of UK research and strategy at LaSalle Investment Management believes all is not lost for investors interested in bricks and mortar retail real estate.
Simon Marx says in an opinion piece that despite headwinds, Covid-19 will not spell the end of physical retail.
‘Physical stores are known to have a “halo effect”, which is the idea that a physical store can positively impact a retailer’s online sales by driving brand awareness,’ he says. ‘This means that few physical or multi-channel retailers will move online entirely, as otherwise they risk losing local online sales, while pureplay online retailers may choose to open physical stores in search of the halo effect.’
Marx does not shy away from the hardships for retail property owners or the tough choices they face.
He says landlords are being confronted with having to make considerable upfront capital expenditure to facilitate changing consumer demands and ongoing expectations for social distancing or it might mean repositioning physical retail altogether as a different property type.
‘Urban retail is the most likely candidate for this level of redevelopment but in a lot of cases this will simply not be financially viable. Accordingly, many institutional investors with balanced portfolios will look to reduce their exposure to retail properties. At the most extreme, investors may even opt to sell at significantly below current valuations in order to mitigate potential drag on future portfolio performance.’
He goes on to explain in other situations, landlords will choose to absorb higher tenant incentives, more asset capital expenditure, lower rents, and possibly even structural voids.
‘In European countries where turnover leases are not already commonplace, landlords and valuers will need to adapt to this lease structure, which is quickly becoming the preferred option for retailers looking to share the burden. Even several years into the post-vaccine phase, we believe that retailers may have the upper hand in lease negotiations in all but the most sought-after locations.’
However, he concludes by saying investors will be able to find value.
‘For the highest-quality assets in central locations in gateway cities, such as open-air shopping centres with strong experiential and leisure attractions, investing in leisure facilities will likely provide sufficiently attractive returns. Covid-19 might well have brought forward the beginning of the end for some retail properties, but assets with the strongest formats and locations will continue to offer value to many investors.’
Here is the full text of an opinion piece by Simon Marx of LaSalle Investment Management
Retail therapy: How investors in retail assets can find hope in a post-COVID world
One measure of how the recession instigated by the Covid-19 pandemic is different to the global financial crisis is the performance of retail assets. Back in 2008/9, retail was one of the most resilient property types. Today, structural issues that were apparent before 2020 have deepened and accelerated. But investors should not rule out the sector altogether.
Deep-rooted challenges
The growth of online commerce and rising costs have been impacting profits in the retail sector for several years, while changing consumer behaviour has been leading to a growing popularity for experiential retail with leisure offerings. The result was an increase in store closures and insolvencies, rising vacancy rates within shopping centres, negative investor sentiment, and ultimately a correction in pricing. These shoots first emerged in UK, with CVAs as a catalyst, before spreading to the Continent.
The pandemic has exacerbated these trends. With consumers first unable and then in many cases unwilling to visit physical stores, e-commerce has penetrated further, with click & collect services seeing a particularly notable growth in popularity. “In the UK, in the year to July 2020 online retail sales grew 37% year on year, increasing the e-commerce penetration rate to 28%, following a record 33% in May.”
This has resulted in retail properties with significant exposure to houseware goods and apparel, such as high-street stores and shopping centres, experiencing substantial rental loss. On the other hand, properties with a high proportion of tenancy in essential segments (such as grocery, pharmacies) or e-commerce insulated segments (like home improvement, services) have experienced the most recovery in occupancy and the least rent decline.
Looking to a post-COVID world
During the lockdowns in the UK and across Europe, mandated store closures decimated sales. The easing of lockdowns brought hopes of a slow, steady recovery in footfall and sales. However, it has also created new hurdles for retail to overcome, including additional running costs, behavioural shifts in its customer base, and accelerated e-commerce demand.
In the future retailers will not only have to compete on quality and the price of products, but factors such as shopping experience, brand ethics, and customisation options will matter even more. For instance, in certain markets with more wealthy customers, there will be increasing emphasis placed on a retailer’s ethics and whether they are taking their corporate ESG responsibilities seriously. The rise of experiential retail will also demand investment in new facilities.
The options for retail landlords
Despite these headwinds, the coronavirus pandemic will not be the end of physical retail. Physical stores are known to have a ‘halo effect’, which is the idea that a physical store can positively impact a retailer’s online sales by driving brand awareness. This means that few physical or multi-channel retailers will move online entirely, as otherwise they risk losing local online sales, while pureplay online retailers may choose to open physical stores in search of the halo effect.
For landlords, this will require considerable upfront capital expenditure to facilitate changing consumer demands and ongoing expectations for social distancing, or it might mean repositioning physical retail altogether as a different property type. Urban retail is the most likely candidate for this level of redevelopment but in a lot of cases this will simply not be financially viable. Accordingly, many institutional investors with balanced portfolios will look to reduce their exposure to retail properties. At the most extreme, investors may even opt to sell at significantly below current valuations in order to mitigate potential drag on future portfolio performance.
In other situations, landlords will choose to absorb higher tenant incentives, more asset capital expenditure, lower rents, and possibly even structural voids. In European countries where turnover leases are not already commonplace, landlords and valuers will need to adapt to this lease structure, which is quickly becoming the preferred option for retailers looking to share the burden. Even several years into the post-vaccine phase, we believe that retailers may have the upper hand in lease negotiations in all but the most sought-after locations.
But for the highest-quality assets in central locations in gateway cities, such as open-air shopping centres with strong experiential and leisure attractions, investing in leisure facilities will likely provide sufficiently attractive returns. Covid-19 might well have brought forward the beginning of the end for some retail properties, but assets with the strongest formats and locations will continue to offer value to many investors.
