UK shopping centre and high street

The consumer economy

The last three months have seen some glimmers of positivity emerging, which we believe herald a more positive outlook both for Christmas and next year.

While real earnings growth remains negative, the impacts of last years collapse in the pound are beginning to diminish. Importantly for retailers's margins they have managed to increase prices by just over 3% over the last 12 months, without decreasing sales volumes.

The last quarter has also seen some positive revisions to the official statistics on household wealth, which show that generally British households are operating with a surplus rather than a deficit, and also that they are saving a little more than was previously being suggested. While a higher savings ratio (Graph 1) might not immediately seem to be a good thing for the consumer economy, it does mean that future spending levels are less likely to be affected by rising base rates than the data was suggesting at the start of 2017.

^{Source: Thomson Reuters}

We expect that real earnings growth will return to positive territory early next year, and this combined with low unemployment levels and a reasonably benign outlook for the UK economy will drive stronger household spending in 2018 than 2017.

The retail occupational market

The retailer caution that was prevalent in the first half of 2017 has definitely continued through the third quarter. While most retail segments are seeing selective openings by both new entrants and existing players, the key word remains 'selective'.

However, improving sentiment around the consumer economy is starting to feed through into positive noises about openings in 2018, and the fact that both fashion and lifestyle like-for-like sales are up on this time last year is also a positive trend.

Springboard's latest footfall data however shows a year on year fall in footfall in all locations, and this volatility in operating metrics is characteristic of how mixed the retail story has been in 2017.

While retail sales have continued their gentle upward growth rate over the last quarter, so have retailer's costs. Some of the cost pressures are likely to soften next year as the one-off shock of the weakening of the pound begins to lessen, but other factors such as staff costs and business rates are here to stay. Given the tight relationship between retailer's margins and rental growth (Graph 2), this will make it challenging for landlords to raise rents in all but the strongest trading locations in 2018.

^{Source: Savills Research}

Generally we expect that next year will see a little more positivity amongst retailers, and this will translate into gentle increases in store portfolios from retailers who are in a growth phase. In particular we expect the next few years to be a good period for value retailers across both food, general merchandise and fashion as consumers remain value-conscious in the face of rising uncertainty around Brexit.

Refits and refurbishments will continue to be a popular option in 2018, with most of the retailers who have tried this in 2017 reporting that their new look stores have traded substantially better than before, without the cost or hassle associated with a new location.

By the middle of next year the 'perfect storm' will definitely have passed, and we expect that retailer performance will be more in line with 2016 than 2017. Expansion plans are likely to remain cautious, and landlords would be well advised to be conservative on rental expectations in all bar the most competitive pitches.

Real rental growth is unlikely to return to many markets other than the primest of London streets, and a handful of key regional prime pitches. However, we expect that void rates will continue to fall in the strongest locations, and this will deliver some net-effective rental growth for landlords as incentives shorten.

Shopping centre investment

Q3 has followed a similar path to Q2, with the ongoing uncertainty of Brexit negotiations, and poor retail sentiment within the UK, compounded by the lack of confidence from across the pond as uncertainty has loomed over consumers in the US. Investment volumes have remained subdued in Q3 with £205.3m of transactions being completed in five deals, which is an improvement on the same period in 2016, in which £111.3m was transacted in six deals. Q3 volumes for 2017 were however bolstered by one significant transaction, the 7.5% stake in Bluewater Shopping Centre which sold for £155m to Royal London.

Q3 2017 has been more lively than Q2 in terms of the number of schemes being brought to market. There were only five schemes brought to market Q3 2016, in contrast to the 10 that were brought forward in Q3 2017. Owing to this new supply in the market there is approximately £540m presently under offer. As well as a number of smaller schemes exchanging hands in 2017, investment volumes have been bolstered by the sale of a small number of large lots. The most significant in value terms include the 7.5% stake in Bluewater (£155m), The Stratford Centre, Stratford (£141.5m), Southside, Wandsworth (£150m) and Friars Walk, Newport (£83.5m). If these large (£50m plus) deals are disregarded, then just £328.8m of deals have exchanged so far in 2017 across 16 transactions.

^{Source: Savills Research. Arrow indicates forward trend}

There have been a variety of different buyer types within the market with the institutions, such as Royal London and LaSalle, continuing to make selective purchases and continuing to look for core buys.

Councils, who were the most increased buyer type in the sub £100m market throughout 2016, had invested just £35m in one transaction during H1 2017. Councils have marginally increased their market share in Q3 2017 across two transactions, including the acquisition of The Forum, Horsham by Horsham District Council and The Saddlers Shopping Centre, Walsall, which was acquired by Walsall Metropolitan District Council. This brings the total transaction volume for councils to £60m, significantly down on the £277.5m invested in by councils in the first three quarters of 2016. This decrease in activity may relate to a lack of supply rather than a reduction in the availability of Council funding.

The activity of councils acquiring commercial property has continued to dominate the press, not all of which has been positive. Recent articles have highlighted the increasing pressure from the Treasury to clamp down on councils investing in commercial real estate outside their own jurisdictions. However, in the shopping centre market, there has not yet been any investment by councils outside of their own jurisdictions, and so the impact on the shopping centre is unlikely to be significant.

^{Source: Savills Research, MSCI}

Smaller lot sizes (sub £20m) are continuing to be well received within the market and are attracting interest from smaller property companies, private companies and councils. This interest is generally on assets which require little capital expenditure produce geared returns in the mid to late teens. Schemes which are anchored by supermarkets are also being very well received within the market, this is generally an ‘income play’ with assets anchored by Waitrose, Tesco or Sainsbury’s for example, producing strong returns and long unexpired terms. Examples of these convenience anchored sales include Goldsworth Park Shopping centre, with 9.5 years unexpired to Waitrose acquired by TPF Retail for £16.6m and Cannon Park, Coventry anchored by Tesco purchased by Longmead.

We are seeing a continued shift towards the community and convenience centre which is drawing consumers not only for their desire to shop but for the necessity to spend money on household goods. By channelling the community offer towards supermarkets, doctors centres and convenience stores consumers have a need to visit the centre which serves the community rather than simply fuelling their enjoyment of shopping for pleasure. These convenience schemes, as well as London core shopping centres, are proving popular with investors within the market. The other key requirement is from investors looking for core buys, however there is a real lack of supply in this section of the market which is contributing to some of the stagnation in volumes we are witnessing.

We anticipate that the total investment volumes for 2017 will reach circa £2.5bn, well below the long term average of c.£4m. With these volumes, the question is will the final picture be as bad as 2009, when total transaction volumes were as low as £1.82bn, or could we beat 2012 levels at £2.70bn. As was seen in 2016, we expect that approximately two thirds of these deals will comprise a handful of large scale transactions.

To conclude, demand is strong for convenience and community centres that trade well. Whilst property companies and councils continue to look at sub-£20m value-add schemes, the traditional and more entrepreneurial institutions with core / core plus mandates should be the key players in a market where there is a lack of liquidity. The US based investors or buyers with US equity are still struggling to appreciate and acknowledge that the UK and European retail occupational markets have adapted, re- invented, re-positioned and are less over supplied than the US.

^{▲ CastleCourt, Belfast}

High street investment

Investor appetite for high street shop investments has remained strong, with nearly £1.8bn of transactions so far this year. Indeed, investment turnover in the shop market has exceeded that of the shopping centre market for the whole of 2016 and 2017.

The biggest buyers of high street shops this year have been non-domestic, though property companies and private investors have also been active. Institutional investors have marginally increased their activity year-on-year, but as we have examined in previous Spotlights, institutional investors continue to find it hard to find good quality medium to large retail investments.

The binary nature of buyer requirements in the high street shop sector has intensified even more over the last quarter, with the majority of buyers looking for assets that are prime in terms of location, configuration, covenant and lease term. Assets that do not tick all of these boxes are failing to excite risk-averse investors, with a typical example of this being the sale of House of Fraser store in Hull. This 22.5 year income deal was originally marketed at 6.75%, and finally traded at 9.92%. We suspect that if that kind of lease length had come to the market inside the M25 the yields would have been at or around 5%.

There are more opportunistic investors in the market for high street shops than there were 12 months ago, but generally they are being motivated more by change of use than retail fundamentals. However, for the majority of private investors in this sector the fundamentals are becoming even more important.

For many investors, the best tenant may not be the most exciting or expansionist brand, but it is the brand that is seen as more defensive in the face of a possible consumer slowdown in the face of Brexit uncertainty. Providers of staples such as Boots are becoming increasingly popular amongst investors for this very reason, though the same is true for strong trading pubs at the opposite end of the health spectrum!

Looking ahead to 2018 we expect that the shortage of prime and defensive shops on the market will keep prices high and yields low for the few that come to the market. There have been and will continue to be a steady stream of lots coming to the auction houses, reflecting the strong private investor demand for the asset class.

We believe that the definition of ‘prime’ has become a little too narrow, and as investors become a little more relaxed about the outlook for the consumer economy then this will relax. However, in the interim period there will probably be some bargains for investors who are prepared to look at investments that only tick three out of four boxes.

Institutions will remain comparatively inactive in the shops market, unless high quality medium to large sized investments come to the market more regularly. However, we do expect to see more institutional interest in shops in 2018, albeit on a very selective basis.