"Retail is Digital" - Real Estate
The undreamed-of diversity in global retail seems to materialise in virtual high streets. But not exclusively... It is dangerous to generalise about retail real estate in continental Europe. Its demise has long been predicted, yet this dynamic sector continues to evolve even in the face of a complex mix of cyclical and structural forces. The only constant is that investors need to be careful to pick assets which will either benefit from, or are relatively resistant to these changes.
The main cyclical forces of consumer spending and new building should have a positive impact on European retail rents. Eurozone retail sales grew by 2 % between the first half of 2016 and the first half of 2015 in volume terms (source: Eurostat) and while eurozone consumer confidence dipped a little after the Brexit vote in June, it remains fairly strong. Consumers are benefiting from low interest rates, particularly in Denmark and the Netherlands where many homeowners have big mortgages and in Germany and Sweden unemployment is low and wage awards are running well ahead of inflation, boosting real incomes. The main laggards are France and Italy, although even here both countries are expected to see a modest increase in retail sales over the next few years according to Oxford Economics. Likewise, with one or two exceptions (e. g. Milan), there is little immediate risk of retail rents in Europe being undermined by a wave of new schemes. In general, developers remain cautious and PMA estimates that the total amount of shopping centre floorspace in France, Germany, Italy and Spain will only grow by around 1.5 % p. a. between 2015 – 2020, compared with 5 % p. a. between 2000 and 2008.
Retail real estate under threat
Although both consumer spending and new building are likely to support retail rents in continental Europe over the next few years, they are only part of the mix. Investors also need to factor in a number of long-term structural forces which are independent of the economic cycle. Probably the most important is the internet which is expanding rapidly as an alternative channel for retailers. While there are some synergies between physical stores and online retailing such as click & collect, or the “halo effect” whereby a store can help to promote a brand, the reality is that most online sales are at the expense of conventional stores.
So far the internet has made bigger inroads in northern continental Europe, where it accounts for 8 – 12 % of retail sales, than in southern Europe where it accounts for 3 – 4 % of retail sales (source: Centre for Retail Research). However, this will probably change over the next few years as online retailers like Amazon expand their operations in southern Europe and as Italians and Spaniards become more comfortable with using credit cards and making electronic payments.
To date the biggest impact has been on high street shops, department stores and shopping centres, primarily because of their reliance on clothing. Clothing and footwear account for between 40 – 50 % of floorspace in many shopping centres, but over 15 % of clothing sales in Germany, for example, are now online. By comparison, food stores and out-of-town retail warehouses have been less affected because consumers still wish to touch items like food, furniture, DIY and homewares before they purchase and because these stores are typically convenient for click & collect sales. However, there are exceptions. Demand from electrical retailers for retail warehouses has fallen as sales have migrated online and retailers like Carrefour and Casino are downsizing their large hypermarkets as they have lost non-food sales to the internet.
Three other structural changes are shaping European retail real estate. The first is that Europe’s big cities are generally seeing faster economic and population growth than surrounding towns and rural areas. This continues a long-standing trend of increased urbanisation as large “gateway” cities such as Berlin, Madrid, or Paris are a magnet for international and internal migration. The UN suggests that the urban population of western Europe excluding the UK will increase by 35 million, or 12 % between 2014 and 2050, while the rural population will fall by a similar amount.
Secondly, younger Europeans in their 20s and 30s appear to be less materialistic than their parents and are more inclined to share goods and spend their money on experiences such as eating out, leisure and travel. Steve Howard, Chief Sustainability Officer at IKEA, has suggested that wealthy countries have now passed “peak stuff”. While this may be borne out of necessity – youth unemployment in the eurozone is still very high – it probably also reflects an increasing emphasis on sustainability and the responsible use of natural resources. The silver lining from a landlord’s perspective is that the increase in eating out is supporting the growth of bars, restaurants and coffee shops. A survey by CBRE found that around a quarter of the people who visited shopping centres in France and Germany in 2015 went solely to eat, or drink.
Finally, there is the growth in longhaul tourism, particularly from emerging market countries. The number of Brazilians, Chinese and Russians visiting Europe has more than doubled in the last five years (source: Eurostat). While recent terrorist incidents may discourage tourists in the short-term, growth is likely to resume as living standards rise and the number of people who can afford to travel increases.
Retail is detail
Where are the opportunities in European retail real estate? Our strategy is to focus on five sectors which either complement, or are relatively resistant to online sales. First, larger shops over 750 square metres in big city centres and tourist destinations. While city centres are generally benefitting from the growth in tourism, retailers particularly favour large “flagship stores”, because they allow the display of their entire range of goods and can be used to host events which promote the brand and complement online advertising. The flagship concept was pioneered by luxury goods retailers, but has since been adopted by mass market fashion retailers (e. g. H&M, Primark, Zara) and by consumer goods companies (e. g. Apple, Nike, Samsung). The main issue for investors is that competition for shops in Europe’s big city centres is intense and prime yields are currently between 3.0 – 3.5 % (source: CBRE). We therefore prefer to buy stores in central locations which are regenerating (e. g. Kreuzberg in Berlin, Canal Saint-Martin in Paris) and where yields are higher.
A second bright spot are shopping centres which dominate their catchment area. The diversion of sales online means that retail real estate is becoming “a winner takes all” sector. Shopping centres which have a wide range of retailers and leisure facilities and are therefore a destination in their own right, continue to trade well and see rental growth. Big shopping centres in most European cities have lower vacancy than neighbouring medium-sized centres (source: PMA), although size is not everything. Much also depends upon location, which retailers are in the scheme and the mix between retail, bars & restaurants and other leisure attractions. Shopping centre owners also need to engage in social media, to publicise events, provide targeted information on store discounts and respond to visitors’ comments.
Thirdly, we favour smaller supermarkets and convenience stores which are relatively immune to online sales. The sub-sector is also gaining from a shift towards higher frequency shopping and away from the “big weekly shop” at a hypermarket. In France and the Netherlands grocery chains such as Carrefour and Ahold have spotted this trend and expanded their network of smaller supermarkets, particularly in the main cities. In Germany, Italy and Spain the sub-sector is dominated by discounters. Here, Aldi and Lidl are gradually closing their smaller stores and focusing on slightly larger supermarkets of between 1,000 – 1,500 square metres where they can stock a wider range. Another interesting trend is the growth of specialist organic food retailers such as Biocoop in France and Denn’s in Germany. Schroder Real Estate already has a significant investment in convenience stores in the UK and is now replicating that strategy in continental Europe.
Fourthly, we also see good opportunities in out-of-town retail warehouses let to retailers selling bulky goods (e. g. DIY, floorcoverings, furniture, homewares) where the main attraction is their relative immunity to the internet. However, in addition, retail warehouse yields tend to be relatively high at 5.5 – 6.5 % (source: CBRE), because in many countries they are perceived to be more like an industrial asset than retail. Although spending on bulky goods is linked to some extent to house prices and we avoid locations with weak housing markets, it is interesting to note that in Germany, for example, a lot of DIY is done by tenants, because they have strong security of tenure.
Finally, we favour logistics warehouses, which although not retail real estate, are clearly benefitting from the rapid growth in retail sales. In general, we prefer modern, mid-sized warehouses close to city centres, where supply is restricted. We are cautious about large warehouses on motorway junctions, because there is usually a plentiful supply of land and occupiers often have the option of moving to a new unit at the end of their lease.