European retail: Keep the receipt

Retail real estate was once the darling of institutional investment, producing high returns from blue chip-anchored shopping centres, retail parks and prime high-street shops. But the boom in online sales, which surged during the pandemic, has turned this once cherished asset into a more precarious game of pick and mix.

Eric Decouvelaere, head of EMEA retail operator division at CBRE Investment Management, believes the problems affecting modern retail assets started in 2007 with the advent of the first smartphone.

He says: “Very quickly we see adoption of this product and by 2017 we have multiple distribution channels with brands reorganising themselves so that they have an online department and a retail department. And in 2020 we have the pandemic and retail is facing real challenges. What has happened is that our industry has neglected strong structural changes.”

This does not mean that retail real estate is no longer an attractive asset class, however. According to Decouvelaere: “If you look at retail at the moment, it is at a significant yield premium, offering relatively predictable cash flow. My advice to investors would be to resist buying cheap. We are starting to see well-priced opportunities, where we have solid underwriting and we know these assets will be performing well for investors.”

Perhaps the catchword during these uncertain times is caution. Hans Vrensen, managing director and head of European research and strategy at AEW, believes investors may be reluctant to embrace retail assets due to uncertainty around the returns they can expect on their investment.

Vrensen says: “The consensus that is hard to turn around is that rental growth has been very limited because of e-commerce penetration, even though it’s now stabilised a little bit.”

Despite this, a number of prominent deals have been completed in the past year or so, suggesting that for some investors the investment case for retail real estate remains strong.

Examples include Eurofund’s acquisition of Silverburn shopping centre in Glasgow, in a joint venture with Henderson Park, at a 4% discount to book value.

While this looks like a bargain, Alberto Esguevillas, CEO of UK retail at Eurofund, warns would-be investors that buying at a discounted price will no longer guarantee a good investment.

Esguevillas says: “You need to pick the right asset, one that will continue to be a destination. You need to invest in them. You cannot approach them passively as you used to. You need to have a plan; you need to have the resources and the capital and you need to actively manage the assets.”

He adds that within the first 12 months of acquiring Silverburn, Eurofund signed up 35 occupier deals, proving tenant demand remains strong for the right assets in the right destinations.

Decouvelaere agrees that investors need to adopt a very different approach to retail real estate post-pandemic. 

He says: “What we are trying to do in our own house is to have a bottom-up approach by assessing the current relevance of the tenant mix, or tomorrow’s relevance of the mix, whether we have intensive asset management to do and look at it in terms of our operational capability. 

“I really think we have been spoiled in this industry, by the yield contraction that we have observed at the end of the last century and in the first 15 years of this century when retail was returning mostly annual contraction.”

As well as understanding the relevance of a retail asset to the local area and occupiers, it is important to be able to operate the asset and to understand the “competitive lansdscape” and “customer base”. 

“It’s very nice to say, if we have the right locations or relevance, we have a winning asset. It’s not sufficient. You need to have the operating skills as well.”

Apart from the acute need to identify retail investments that are priced correctly for the current market, and the importance of having deep knowledge of the retail landscape, occupier demand and customer spending trends, investors are also grappling with cumulative capital decline.

As Vrensen says: “If you had invested in retail at the peak of the cycle, and now we’re coming out of that cycle, you would have lost 50% of your capital. And that’s a very painful experience.”

He adds that many of these assets are also financed with debt. “When that becomes due, if you have a 50% capital value decline, the lender will probably say this is going to be a big problem. And we know from our own experience as a manager that sometimes you might have to walk away as an equity investor because if the loan-to-value from the original loan was 60%, and you’ve lost 50% of your capital value, the lender is probably going to say, if we sell the asset, I will be able to recover my loan amount. 

“But as an equity investor, you might not be able to recover your equity. And so the use of leverage exaggerates the potential capital value losses. And for retail this has been quite a big problem.”

It is likely, according to Vrensen, that transaction volumes are down because many legacy owners of shopping assets are “probably in discussions with their lenders about this”. He adds: “The lenders are probably also going to be more conservative and instead of giving you 60% loan to value, they’ll give you 50% loan to value on the new lower value. And so you have two effects, both of which are not good.

“And this is a very big problem. So we probably will see a combination of debts being written off and some equity investor cash injections. This is why we are working on a lot of restructurings behind the scenes. And this is also why volumes have come down.”

Sandra Ludwig, head of retail investment EMEA at JLL, believes retail will be the best-performing real estate sector over the coming five years. But investors will need to be picky.

Ludwig says: “The retail warehouse sector is predicted to grow ahead of all the sectors, including logistics [and] the living residential sectors, because it’s a channel that works.” 

She adds that, during the first quarter of this year, there have been £1.8bn (€2.1bn) worth of transactions in retail warehousing and that around another half a billion are in solicitors’ hands.

One major caveat, though, is the need for investors to properly assess the amount of capex they will need to bring retail real estate assets in line with net-zero targets.

She says: “They need to put a lot of effort into this because in retail you are likely to have very high energy costs… in the big shopping malls and in the supermarkets there’s the need for a lot of cooling.”

Ludwig believes that many retail property owners have already embarked on intensive analysis of their assets, to work out the capex they will need to get to net zero.  

She says: “They are doing a lot of due diligence, trying to take the costs into account and set capex budgets for the next five to 10 years. But I’m convinced it won’t happen that quickly, and that we’ll need until 2050, just because of the incredible energy consumption in retail.”

Luwig’s conclusion is that investor sentiment towards retail real estate allocations remains strong, but due to inflation in cost structures, the biggest hurdle to jump is one of confidence.

It is also clear that any investor considering upping their retail real estate allocations must be an expert in the operational side of managing the asset.