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There hasn’t been any shortage of news stories about the challenges faced by traditional retailers recently, or about the effect on the landlords who own the properties in which they trade. But is it all bad news? And what does the future hold for Britain’s high streets and out-of-town shopping centres? And, importantly, what does this mean for investors in retail property?

Firstly, some background. The UK commercial property market is a diverse category, encompassing everything from office blocks to petrol stations. Over half of commercial property is rented, with the landlords being (roughly in order of size): overseas investors, UK collective investment schemes, UK institutional investors (insurance companies and pension funds), UK listed property companies and REITs (Real Estate Investment Trusts), unlisted companies, individuals, traditional estates and charities. Of the main commercial property sub-sectors (retail, offices and industrials), retail is the largest by value, making up around 38% of the total.

House of Fraser, Toys R Us, Homebase, Carpetright and Poundworld are just a few on the list of UK retailers that are either struggling or have sunk completely over recent months. All have been caught up in what has been described as a ‘perfect storm’ of challenges hitting the sector: rising costs in the form of higher business rates, an increase in the minimum wage and the low value of sterling, in addition to the relentless growth of online shopping. Against this background, landlords are having to be more adaptable than ever, working with retailers to help them remain profitable. For example, they may negotiate a rent reduction in exchange for a longer rental term, or invest in a property to make it work better for the retailer (while also enhancing its capital value).

However, there are also parts of the retail sector that are proving to be far more robust in the face of these challenges, such as the supermarkets and the discount sector – areas which are less sensitive to economic and technological change. There are also many individual success stories, for example Lush, which sells ‘fresh’ cosmetics from its unique, contemporary stores, and Next, whose high street presence has been supported by its successful online business. Shopping as a leisure activity also continues to be an extremely important part of the picture, albeit with increasingly sophisticated consumers expecting ever more interesting dining and leisure experiences (crazy golf, anyone?) alongside their favourite shops.

However, where a retail site is no longer viable for its original purpose, it should be remembered that many are still highly valuable, located as they usually are close to high-density residential areas and transport networks. They are therefore ripe for re-development – for example as flats, offices, hotels or logistics hubs – which may or may not complement a portion of retail too.

So what does this all mean for investors? Overall, it’s estimated that property accounts for around 6% of the total investments made by insurance companies and pension funds. While notable, it’s a figure that’s significantly less than these institutions’ investment in equities and bonds, reflecting the smaller size of property as an asset class, but also the higher cost of investing and relatively low levels of liquidity – it can take considerable time to buy and sell property directly.

Investing in commercial property offers attractive returns that over the long term have tended to be higher than gilts but lower than equities. And while parts of the retail sector may be experiencing a challenging time at the moment, other areas of commercial property are doing well. According to the RICS UK Commercial Property Market Survey for Q2 2018, industrial space is experiencing solid demand and rents are expected to increase.

Part of this reflects the reverse side of the high-street’s woes – the success of online retail is driving demand for warehouses to store and process goods. Meanwhile, in the office market, rental expectations for prime office space are generally positive, although less so for what is considered to be the secondary section of the market.

So in conclusion, it is a testing period for the owners of retail property at the moment as the retailers themselves face a ‘perfect storm’ of challenges. However, it’s most certainly not all bad news; there are areas of traditional ‘bricks and mortar’ retailing which are doing well, while landlords may also look towards alternative uses for their retail space. And for investors exposed to the commercial property sector as a whole, it should be remembered that it’s a diverse category, encompassing not just retail, but offices and industrial space as well.

Written by

IAIN MCGOWAN | Head of Fund Proposition

Investment markets and conditions can change rapidly and, as such, the views expressed in this update should not be taken as statements of fact nor be relied on when making investment decisions. Forecast are opinions only, cannot be guaranteed and should not be relied on when making investment decisions.

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