It is one of the tenets of investment markets that where there is disruption there are opportunistic returns to be made – if the timing and strategy are well-judged. But to date, few managers have concluded that the time is yet ripe for retail real estate, despite the havoc wrought by covid, which has further powered the sector’s already gale-force structural headwinds.

The moment is almost at hand, predicts Josip Kardun, chief investment officer at London-based manager MARK. “For the other popular asset classes, we are relatively late-cycle. In residential and logistics, cap rates are really aggressive. Up to a point, investors will play a trend, and then they will stop and become granular. Urban repositioning in city centers with a redevelopment component is granular. Already everyone is talking about it. In two or three years, every second manager will be active in urban repositioning.”

The time has come to stop trying to defend “vertical” retail, Kardun argues. “Maintain the retail where it should be, on the ground floor and first basement level. But on the upper levels, transform it into office, residential, co-living or co-working. Very often in a city center, vertical retail locations sit close to, or on top of, public transport hubs. The repurposing of classic suburban shopping centers into residential can maybe work in individual cases. But the big wave of repositioning will happen in the city centers where you can eliminate the weaknesses and make use of the locations’ strengths.”

Repositioning enhances value by increasing competition among retailers to secure the remaining ground floor space. Meanwhile, reducing the overall proportion of shops, so that the asset is no longer perceived as primarily retail, improves exit liquidity, says Kardun. “It is not only conversion of retail. It can also be hospitality space. A lot of hotels will lose their right to exist because of covid,” he adds, citing the example of Pershing Hall in Paris, which MARK has converted from a hotel into a mixed-use scheme with retail space for high-end streetwear brand KITH, and offices on the upper floors.

Department store woes are an opportunity

Retail markets in Europe and the US have been rocked by a string of high-profile department store chain closures. But their real estate presents striking opportunities for repositioning, says Chris Gardener, head of European retail investment at CBRE.

“On Oxford Street in London alone, Debenhams, House of Fraser and John Lewis, three behemoths of the retail market, will all be transformed in the next two years. Looking at old buildings that are not going to serve that full retail function anymore, and how we can repurpose them, is probably the big value creation story for the next two to three years for our sector. Capital is pre-raised for that already, not in a department store renovation fund. But it could sit within a multi-sector opportunity fund where the risk is balanced across different segments.”

Pershing Hall, Paris: the hotel to mixed-use conversion keeps retail on the ground floor

The key requirement for unlocking such opportunities is, of course, pricing. CBRE figures show shopping centers have declined as a proportion of the retail assets traded annually, falling from more than 40 percent a decade ago to around 25 percent in 2020.

Meanwhile, the percentage of supermarkets traded has risen, a trend that has only intensified in the post-covid market. Unsurprisingly, few owners want to sell at the prices currently achievable.

Greg Maloney, president and CEO of retail for the Americas at JLL, suggests that the pandemic-induced freeze in the shopping mall market could soon end.

“Stabilization is essential over the next six months so that the bleeding is stopped. When shopping centers have a stabilized rent roll then we will know what their value is and we will see what lenders will do. Will they work with owners to extend and give them some cashflow, or sell, take the hit and move forward? We know that a lot of those decisions will be made at the end of the second and beginning of the third quarter this year.”

However, big retail owners will be reluctant to set a precedent that could negatively affect values across their wider portfolio by selling assets at steep discounts, says Kardun. “People don’t have to do deals. They always find a way to pick the moment of reckoning for themselves.”

He argues that a more productive approach for buyers is to secure off-market deals by discounting vacant space, while offering a headline yield that the seller can live with. “As a buyer, you get attractive pricing on an off-market basis, while the seller is not getting ripped off because they are selling at value-add prices and not opportunistic ones.”

Large quoted retail property platforms will seek to form partnerships with private equity managers to reposition struggling assets, he predicts. “Trading at a 50 percent discount to net asset value, they need external capital. Otherwise, they will end up selling assets one by one at a lower pricing than they could achieve by teaming up.”

Getting closer to the tenant

For managers that already own substantial retail property portfolios, value creation is an existential issue. CBRE Global Investors’ European retail portfolio was valued at around €16 billion in pre-covid prices and includes some 600 assets from supermarkets to shopping centers. The past 12 months have been dominated by dealing with the impact of the pandemic on retail tenants, says EMEA head of retail Eric Decouvelaere. But that close contact has fostered a deeper knowledge of tenants’ businesses that will help to inform the portfolio-wide transformation that must follow.

Pershing Hall, Paris: Manager MARK has created retail space for high-end streetwear brand KITH

“Retail asset managers cannot work as we have over the last 20 years, when basically our industry was supply-driven instead of being demand-driven, as it is now,” he says.

“We have used the crisis to build closer relationships with our tenants. We need to understand them better to know which assets will still be relevant in the future, those that will not, and those that will not stay relevant solely as retail, and are in need of repositioning.”

While repositioning looks like it will soon be in vogue, few managers are prepared to engage in ground-up retail development at present.

A rare exception is AneVista. The Chicago-headquartered private equity platform has been raising family office and high-net-worth capital to develop small-scale 20,000-30,000-square-foot drive-thru restaurant-anchored strip retail centers, alongside e-commerce micro-fulfilment centers, in suburban and fringe urban locations in the US.

“We think there is tremendous opportunity in playing at the intersection of retail and logistics,” says co-founder and managing partner, David Schreiber.

“There is an ability to use the community-oriented real estate that consumers engage with for their daily needs as a conduit for off-premise engagement. We can help our retailers serve consumers on site while also using the real estate as a conduit for last-mile fulfilment.”

By working with end users and building pre-let space to meet their needs, AneVista will bypass the dilemma confronting many retail landlords, he claims.

“Large format retail owners are faced with the question of how to increase the relevancy of their assets to the consumer. In many cases, that will mean bringing in other uses to create a more synergistic vibrant community. But it is incredibly capital intensive, and you are making assumptions around consumer preferences that are constantly evolving.”

Schreiber believes that most existing owners will lack sufficient conviction to commit to the necessary capital investment required, opening the door for buyers with creative strategic approaches.

“This is the most interesting time in retail in the last several decades, mostly because there is a limited appetite for the sector,” he says. “That is usually a sign that innovators and entrepreneurs can make some money.”