A succession of big-name retailer insolvencies and the profusion of empty units and temporary occupiers in Europe’s high streets and shopping centers testifies to the seismic changes taking place in the continent’s retail markets. That upheaval has deterred some investors from playing in the space, but Kiran Patel, global chief investment officer at Savills Investment Management, contends there are opportunities for those that understand how to navigate the turbulent waters and turn the evolving situation to their advantage.
PERE: We have become used to stories about the decline of bricks-and-mortar retail and headlines about retailers going bust. What is the future for physical retail?
Kiran Patel: There are some huge headwinds for retail real estate. E-commerce is changing how people shop, the leisure activities they undertake and how they consume food and beverages. That does not sound the death knell for bricks-and-mortar retail, however. Around 85 percent of retail sales take place through physical channels and this is still growing, albeit relatively modestly. Online sales are growing faster but represent only about 15 percent of the retail market.
Retailers are adapting to that new landscape. They have come to realize their stores are being impacted by reducing profitability as online shopping draws expenditure away. Retailers are therefore seeking greater critical mass in terms of the floor space or units they occupy; stores that can be resilient to e-commerce trends. So where they might previously have targeted 300-400 stores in a country, they are now consolidating pitches into 100-150 or so bigger units. High streets and shopping centers in smaller to medium-size towns will suffer, but occupiers are willing to pay more to get their hands on large format stores in the bigger urban areas. It’s a consolidation/concentration approach. All retailers are affected by the same trends, so those units in demand have become a scarce commodity on high streets, retail parks and in shopping malls. Tight planning restrictions and the lack of new development in the UK and Europe is only making the desired space an even rarer commodity for the retailer.
That is one of the big differences between investing in European and US retail property. In the US, there is 24 square feet of retail space per head. In the UK, it is 11 square feet and in France 13 square feet. In the US, retail yields are generally higher than office yields because the greater availability of land means you can build another mall comparatively easily. In the UK and Europe, retail yields have always been lower than office yields, reflecting the tightness of supply. Meanwhile, occupiers are getting cleverer at attracting shoppers with innovations, like fitting rooms equipped with imaging technology, which you can’t get at home by ordering a parcel. A lot of occupiers are combining bricks and mortar and click-and-collect. Multichannel reduces their vulnerability. Amazon is even starting to open physical bookstores in the US.
PERE: Which types of retail asset offer the best and worst investment opportunities at present?
“We have focused our attention more on southern Europe because e-commerce is less influential there than in the cashless societies of the north”
KP: Certain sectors are resilient to e-commerce. At the value end of the spectrum it is difficult to make money through e-commerce in England and the same is true for similar destinations across Europe because the margins aren’t great enough to justify the distribution and returns costs. Convenience food shopping is resilient too. So are luxury goods. You don’t find Gucci or Prada items sold at a discount on the internet; those brands sell them through outlet centers. The footfall at the outlet centers in Bicester or Chester is astonishing and the same is true for similar destinations across Europe. Other shopping centers will be resilient because they successfully combine retailing with leisure and food and beverage to cater for people looking for an experience. Mid-tier shopping centers are a red warning flag. It is a given that smaller shopping centers are dying already. Mid-tier centers face competition not only from their peers, but also from larger destinations and there is not enough spending to go around to maintain profit margins.
PERE: How can managers pick the best locations in which to buy European retail property?
KP:You need local teams based in each country for transactions and asset management. Then, in addition to the usual factors you consider when deciding which geographies to invest in – supply, demand, pricing, the cycle, planning regimes and lease structures – you need to look at how advanced e-commerce is in that location. The evolution of e-commerce is at different stages in different countries. It varies with factors like the take-up of cashless payment systems and broadband bandwidth. Those trends are much more advanced in the UK and northern Europe than in southern Europe.
For our Europe V retail fund, which had its first close in March, we’ve found more value in the Netherlands, both in the unit shop and retail warehouse sectors, compared with Germany and France. We’re looking at outlet centers in Italy, Spain and France; it is harder to buy those in the UK, Germany, Netherlands and the Nordics because of higher pricing. In general, we have focused more on southern Europe because e-commerce is less influential there than in the cashless societies of the north. The south is more leisure and family-oriented and people eat together more. Those cultural tendencies are strong and will not disappear overnight.
PERE: Is it possible to build scale quickly when investing in European retail?
KP:If you were buying multifamily private rented sector housing in the UK you’d struggle to get scale because the stock doesn’t exist but one of the advantages of the retail sector is there’s scale at all ends of the spectrum. Buying high street retail unit-by-unit is pretty challenging because the lot sizes are small, but by buying a retail park you can deploy €50 million-€100 million in one go. There are 3,000 shopping centers in Europe. It’s difficult to purchase the top 100 because they’re held very tightly and priced keenly but you could look at the 100-400 on that list. There are some opportunities there that require repositioning and capital expenditure improvements where net operating income has the potential to grow, if that’s your strategy.
PERE: What are the implications of the changing retail environment for fund managers?
KP:The headwinds in the retail market mean a more dynamic environment so asset managers need more specialist knowledge and expertise. You can still make money in retail property if you know how to buy well, how to position it and how to asset manage it. Because occupier needs are evolving so rapidly, working with them is a vital part of retail asset management. You can look at reconfiguring units and sometimes changing the use of space to capture greater footfall.
Virtually every real estate fund manager at the moment is raising a logistics fund because it is, justifiably, flavor of the month. Retail is a harder sell at a macro level but that has its advantages because there’s less competition to buy it, all other things being equal. The other side of that coin is, as an investor, if you want to convince your investment board to make retail acquisitions, you have to deal with the issues presented by those macro trends, accept they exist and find a way to work within them as not every unit of expenditure is going online. There is a place in the portfolio for the retail sector as consumers will continue to do their bulk of shopping, eating and leisure activity in a ‘bricks-and-mortar’ outlet, albeit one that is changing in format.
This article was sponsored by Savills Investment Management. It appeared in the Investing in Retail supplement to the July 2018 edition of PERE magazine.