Retail turnover: The uneven economic recovery has altered the landscape for retail

We all need to eat, and we all need to stay clothed. To the uninitiated, retail real estate seems like an easy defensive play, relatively resistant in any downturn. It is anything but, however, and the Great Recession has laid bare the shortcomings of any managers who thought that they could simply buy and hold.

Opportunity is always present in retail, but with it comes risk. For investors, “retail has the widest breadth of investor opportunities,” says Peter Hayes, managing director and global head of research at Pramerica Real Estate Investors, the property arm of US-based Prudential Financial. An evolutionary asset class, “it is constantly looking to reinvent itself. It is very aggressive.”

Retail can be a challenge to manage because it presents so many different options. The key ingredients are local demographics, the size of a centre’s catchment area, and local incomes. Class A office may be easy to sit on, but a mall needs constant reinvention.

“The key difference for many investors is that retail requires active investor involvement,” explains Cuong Nguyen, head of research Asia Pacific at M&G Real Estate. Cross-border investors may see that as a negative. Longer-term investors willing to invest a little bit of capital to reshape a mall and give it a competitive edge should see it as a plus. The benefit, says Nguyen, is that investing in an existing asset avoids acquisition costs and has lower associated investment risk than acquiring additional assets. The advantage of an owner’s deep understanding of the asset and its local market dynamics is critical for maximising asset performance.

The economic recovery has been uneven since the financial crisis. Asia barely suffered but now has to contend with inflated prices, in part because of “imported” inflation due to pegging to the US dollar. The United States is showing sure signs of solid growth, and Europe, to put it politely, is patchy.

Europe’s changing face

Technology, an ageing population and an explosion in the number of single-family households are all reshaping the European retail market, leading to a new set of concerns for investors who target shopping malls. This is all on the back of the very slow and uneven economic rebound in different European countries since the global financial crisis.

“There’s an economic element in this, but there’s very much a structural change going on in the retail landscape,” says Marrit Laning, head of research and strategy at Redevco. Technological innovations are changing the way we shop.

Redevco recently analysed about 800 cities across Europe to generate the most attractive options for retail real estate investment. Generally speaking, European consumers are shopping less and focusing on the most-attractive city-centre destinations for their High Street shopping. Shopping centres need to stand out in terms of experience and convenience.

Redevco is being more discriminating in its choice of investment destination as a result, using its metrics to target only the best performers. Its top two choices for investment — London and Paris — are no surprise, but in parsing the data Munich, Hamburg, Vienna, Berlin, Cologne, Madrid, Amsterdam and Milan all score high.

“We have become more risk-averse because of the structural change,” says Laning. Previously, economic cycles came and went, but investors could be fairly certain that a poorly-performing location would recover eventually based on macroeconomic factors. “That’s no longer the case. Mistakes in terms of location are no longer being corrected because of the market trend,” adds Laning.

The choices of Madrid and Milan may surprise investors who assume that Spain and Italy are all doom and gloom. But there has been divergent behaviour among the retail locations in hard-hit markets.

In Madrid, “we have found shopping centres that have closed, ones with 20 percent to 45 percent vacancy, and shopping centres with 2 percent vacancy that are doing very well,” illustrates José Pellicer, associate partner and head of research at Rockspring Property Investment Managers. He believes that Spain has “turned the corner”, after massive declines in wages and huge unemployment rates. “The punch has already been taken by retailers, and they are beginning to expand selectively,” says Pellicer.

Clothing retailer Primark, for instance, is on an aggressive expansion plan in Spain, but tenants there have plenty of options. In other European nations, it is often difficult to develop new retail, meaning that existing centres have strong holding power.

Points of interest

Rockspring has a portfolio of more than €2 billion in German retail real estate, with a vacancy rate of 2 percent. “It’s not flashy retail,” notes Pellicer. “It’s convenience retail, yet our tenants have very few options to go elsewhere.”

Redevco’s analysis shows that cities such as Amsterdam and Barcelona benefit not only from being the behemoths in their catchment area, but also from tourism travel, an added bonus.

“It’s not only the size of the city but the points of interest,” explains Laning. While that is hard to quantify, Redevco used 19 indicators to break down attractiveness and found that creative cities have better economies and better retail prospects, not only because of the industries present, but also because of the environment that people in those cities opt to live in.

People in creative industries “choose very interesting locations but also generate a lot of services that make an area very attractive,” points out Laning. “That’s true for shopping, but it also attracts companies and makes the economy better.”

The Internet is, of course, disrupting retail around the world. In Europe, where labour and transport costs are high, a number of retailers have deployed a “click and collect” strategy that holds some promise for suburban centres. Customers order online but visit a store to collect their goods; such retailers require attractive but smaller stores in a bid to muster “add-on” sales.

This calls for innovative strategies. About 25 percent of French supermarket sales are currently drive-through. Volvo Car Corp has even unveiled “roam delivery”, a concept allowing shopping assistants to unlock customers’ cars and deliver online orders to the boot.

Birmingham in the United Kingdom is an example of a city struggling to contend with the changes in the retail landscape. Despite being Britain’s “second city”, with the second-largest population, according to Cushman & Wakefield, the metro saw rents plummet 30 percent between year-end 2008 and year-end 2014 because of the financial crisis, with values also dropping precipitously. The Bullring Shopping Centre dominates the market, but plenty of new supply exists nearby, town-centre space that is struggling to find tenants.

Two Belgian cities, Mons and Charleroi, are also instructive in what to avoid. Mons has bad fundamentals all around: high unemployment, low spending power and unbridled retail expansion out of town. The local government has not restrained retail development and, as a result, virtually no international retailers are on the High Street anymore.

Charleroi was in a similar situation, according to reports, but the local government finally stepped in after a period of lax regulation. The town is now restraining out-of-town construction and is attempting to revive downtown by allowing development of an inner-city shopping centre. The jury is still out, and Charleroi is still a risky city, but the situation in Charleroi remains brighter than in Mons.

Rockspring’s Pellicer says that the “victors” in the real estate battle will be superregional shopping centres with enormous catchments, such as Westfield London in White City, Vélizy 2 in Paris and CentrO in Oberhausen, Germany. Prime High Street locations in medium to large cities of more than 200,000 people also should fare well, he says.

There is a price to remaining relevant, however. “Operating costs and the capital expenditure we have to incur in the retail we own are higher than they used to be,” says Pellicer. “We have got to be competitive in providing shopper experience.”

Uneven recovery in the United States

In the United States, sales of retail properties hit $84 billion (€74 billion) in 2014, above their prior peak of $81 billion (€72 billion) in 2007, according to Real Capital Analytics. “This is the only property type, besides apartments, that has seen transaction volumes exceed peak levels,” says Richard McLemore, the company’s director of research and valuations.

Q1 2015 retail asset total returns, at 4.93 percent, bested the other main property types, according to NCREIF, the National Council of Real Estate Investment Fiduciaries. One-year retail returns were 13.8 percent through the first quarter of 2015, with only industrial asset total returns topping them at 14.2 percent.

The retail sector, however, has not shown the same rate of recovery in terms of prices and rents as other property sectors, with prices for retail assets 9 percent below their peak, according to RCA’s Q1 2015 US Capital Trends report for the retail sector. But that average figure masks sharply-differentiated performance among markets.

As in Europe, an ever-sharper distinction is being made between the winners and losers in retail. High-quality properties with strong anchors in major markets are doing well, with prices for retail assets in the six major US metropolitan areas up 5 percent over their pre–global financial crisis peak, reports RCA.

“Unanchored retail centres and retail centres in non-major markets are driving the lacklustre price recovery,” says McLemore. “In our view, poor-quality retail is likely to be repurposed into a different use.”

Young, high-income workers continue to move to the country’s largest cities in droves. As a result, urban High Street retail space is in strong demand among investors and tenants. Target Corp is attempting to capture that demand with Target-Express and City-Target outlets, smaller stores in city centres that offer custom assortments to attract urban consumers in those locations.

Though down year-over-year, urban storefront property commanded by far the highest prices in Q1 2015, at an average of $9,892 (€8,729) per square metre, according to RCA, more than triple any other retail category. That results in the lowest cap rates, of 5.0 percent. PREI seeks to ride that wave by investing in urban-regeneration stories, says Hayes, such as in San Francisco.

He even sees potential for that kind of play, albeit with decidedly more risk, in South America, where rising incomes and improving demographics are reducing crime, and where consumers have increasing access to credit.

In North America, e-tailing is reshaping the landscape, even in strip mall locations. Electronics stores, office-supply stores and bookstores are largely being replaced, and the financial crisis has encouraged that transition. Consumers buy “commodity goods” online and favour price over brand, resulting in thinning margins for physical stores.

“The modest economic recovery and growth in wages have contributed to the consumer’s focus on price and value,” explains McLemore. Lines such as Nordstrom Rack, with its sales point “where style meets savings”, are gaining business. Taking a different tack, Urban Outfitters is opening concept stores in Brooklyn and Los Angeles that showcase local designers and contain restaurants, changing the idea of what being a speciality store means. Mall operators must cater to the growing need for healthy restaurants, fitness centres and organic food stores.

Corruption crackdown causes luxury slowdown

In Asia, the financial crisis hit property prices for a quarter, at best, in a market such as Hong Kong. China bailed out its economy with an unprecedented 4 trillion yuan ($654 billion at the time) stimulus in 2009, which had the unintended effect of causing a bubble in mainland real estate and fuelling rampant overcapacity in many inefficient companies and industries.

It did, however, mean that the global financial crisis was little-felt in Asia. Now the region is contending with slowing growth in China, likely to come in at 6.8 percent for 2015, with the government targeting growth of “around 7 percent.”

China, as the world’s second-biggest economy, is now “a developed economy, not a developing one,” according to Mark Tinker, the head of insurer AXA’s investment arm, Framlington Asia, with drivers closer to those of Europe or the United States than its old resource-driven model. “If you’re a $10 trillion economy, you can’t expect to grow at 10 percent anymore.”

That may be true of China’s east coast, a world away from the largely rural hinterland. What appears to be having a much stronger effect on retail sales, particularly at the luxury end, is self-styled hardman President Xi Jinping’s crackdown on corruption. Probably part internal purge of enemies in the Communist Party, part well-intended necessary change, there is no doubt that conspicuous consumption has ceased. That is having a profound effect in the high-end boutiques of Hong Kong. Jewellery and watch sales, for instance, fell 16 percent in the first two months of 2015, compared with the previous year.

So the Breitling, Cartier and Patek Philippe & Co stores in Hong Kong whistle like empty Wild West streets in the middle of the day. Macau’s gaming tables have plenty of spare seats, with its economy shrinking 17 percent year-on-year at last count. Hong Kong mall landlords are shifting toward charging heftier base rents to fend off the effects of weak mainland-tourist trade. Luxury goods stores have been paying turnover-based rents for much of the past decade.

The boom in online shopping in China is driving mall designers to create “shopping experiences” using innovative layouts in a break from the megamall format, incorporating low-rise buildings with, in the case of the new Swire Properties Daci Temple Project in Chengdu, the steeply-pitched Sichuan-style roofs typical of the region. The Tang dynasty temple — controversially, it has to be admitted — borders a more than 100,000-square-metre retail “village” (officially known as Sino-Ocean Taikoo Li Chengdu) of lanes and alleyways, leading to a century-old courtyard house that becomes the entrance to The Temple House, an entirely-modern, boutique, 100-room hotel.

At the other extreme of Chinese history, Swire’s Taikoo Li Sanlitun in the Chaoyang District of Beijing features avant-garde brown-pixelated panels on a multi-storey Uniqlo building, a spacious and gleaming Apple store, and outlets from edgier brands such as Britain’s menswear lifestyle company Ben Sherman.

M-commerce the next line of attack

China is used to getting all the headlines in terms of economic growth, but some would argue that Japan is now a much more compelling story. The unexpectedly-large quantitative easing from the Bank of Japan is feeding through to very strong rental growth. Prime minister Shinzo Abe’s economic plans involve the creation of special economic zones that, in conjunction with the planning for the Tokyo Olympic Games in 2020, should lead to a substantial number of urban renovation projects. As with London, there is likely to be something of a “rebranding” of the Japanese capital.

But retailers have to be smart. In Asia, Japan is the leader in terms of shopping via mobile phone, known as “m-commerce”, with 89 percent of consumers saying that they had engaged in m-commerce in the previous month, according to The Nielsen Co. Two-thirds of South Koreans have done the same. But while e-commerce in any form presents a challenge for traditional landlords, it actually may be a blessing for retailers.

“International brands can test the market by offering an online presence with a web-only store,” says PREI’s Hayes. This way, a company could determine local tastes and improve its brand image before making any costly investment in stores.

In Europe and the United States, Hayes likes grocery-based shopping malls — as long as local supply is restricted. In hard-hit markets such as Phoenix, Miami and Madrid, “we still like needs-based retail,” he says. “You’ve got the room for growth in terms of value.”

Somewhat similar to Redevco’s examination of creative cities, PREI is conducting investigative research on how to invest in tech-driven cities, where there are more-relaxed working environments and the potential for spillover into retail. In Asia, suburban development is rampant and presents a challenge for any investor. Hayes prefers central locations with “fast fashion” and plenty of food and beverage options to boost customer footfall.

Other issues to mull include supply pipelines, city-centre rejuvenation and reduced crime rates. “The interesting thing about retail is that it’s always needed, wherever you are in the economic cycle,” says Hayes. “The question is, how much retail, and what type?”


Source: IREI