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How physical retail stores will stay fit for purpose in the future

How physical retail stores will stay fit for purpose in the future

How retailers are reacting to shifts in the retail sector

The collision between these seismic structural shifts, rising operating costs and squeezed profitability has led to a broad polarisation in the retail property market.

On the one hand, these challenges have led to a host of high profile retailers such as New Look, Toys R Us and Debenhams either closing their doors for good or cut back on the number of stores as they restructure.

On the other, a furious churn of small independent firms continues to drive overall growth in the number of outlets occupied by retailers and leisure businesses alike. Since 2012, the overall number of retail and leisure units has risen by over c.60,000 units, an average 2.9% increase each year. The rate of increase has been more pronounced in leisure (+5.2%) units than in retail (+1.8%) during the period.

However, this conceals a polarisation in retail between independents and multiple retailers. Against the backdrop of these challenges, cost cutting plans emerged as the overriding priority for many retail boardrooms, with store disposals decisions a priority. Resultantly, there has been a consistent net loss of over 7,000 stores in the last six years, the largest fall occurring in 2018.

Figure 1: Total number of retail, leisure and restaurant units in UK

Total number of retail, leisure and restaurant units in UK

Source: LDC

However, this conceals a polarisation in retail between independents and multiple retailers. Against the backdrop of these challenges, cost cutting plans emerged as the overriding priority for many retail boardrooms, with store disposals decisions a priority. Resultantly, there has been a consistent net loss of over 7,000 stores in the last six years, the largest fall occurring in 2018.

“Since 2012, the overall number of retail and leisure units has risen by over c.60,000 units, an average 2.9% increase each year.”

The retail property market under threat

It’s estimated that around 37,000 units lie empty across high streets, shopping centres and retail parks in the UK, with almost a third (11,600 units) having been unoccupied for more than three years.

Store closure programmes have been part of a wider cost cutting exercise for many multiple retailers as they battle against rising costs and shifting consumer behaviour. Retailers have been forced to adopt a forensic approach to reduce costs beyond store closures, including reducing head count and simplifying business models.

As a result, the industry has seen a rise in the number of retail redundancies, as well as cutting back on hours worked and reducing employee benefits. In the 12 months to March 2019, 4,500 retail jobs have been lost every month and the number of employees in the industry has been steadily declining c.1% each year since 2015.

Figure 2: Total number of retail, leisure and restaurant units in UK – openings and closures

 

Source: Retail Economics

Pressure on retailers and business models

The urgency for legacy retailers to transform business models has been intense, leading to a rise in high profile CVAs in a bid for retailers to remain relevant.

Retailers are having to strike a delicate balance between rent reductions and closures when it comes to negotiations with landlords. Although retailers may favour closures, given that space is difficult to fill, landlords by-and-large have been more likely to give the green light to a retail CVA if it predominantly includes rent reductions.

Analysis by Retail Economics shows that nearly three quarters (72%) of the stores affected by publicly announced CVA-approvals in the past few years have seen rent reductions, with only 28% of effected stores facing closure.

Figure 3: Number of retail CVAs are at low levels by historical standards

Figure 3: Number of retail CVAs are at low levels by historical standards

Source: Insolvency Service

The impact on property dynamics

Nonetheless, a wave of CVAs has put downward pressure on rental values. Rents have continued to soften since late-2017 and fell into decline in late-2018 according to Retail Economics’ Cost Base Index.

In particular, landlords have struggled to demand higher rent on new lettings. Upward-only rent reviews historically dominated the property market, with minimal movement in rental values during lease terms. However, when rental values face a correction upon renewal or re-letting of a unit, the ability to achieve higher rent has declined in the last 15 years and was gained on just 17% of retail units in 2018 (weighted by rent passing).

Downward pressure on rents is unlikely to ease. Retailers are not just looking for cheaper deals however, they want greater flexibility too. Inflexible leases have often held back retailers’ abilities to transform at the pace the market demands.

Figure 3: Weighted lease length in retail

Weighted lease length in retail

Source: MSCI, Retail Economics analysis

 

As retailers pursue more flexible portfolios, lease lengths have been impacted over the past couple of decades, while there has also been a rise in the number of agreements with break clauses. It’s not all doom and gloom though. Creative destruction is at play, with the tenant mix in a state of flux as retailers invest in customer experiences and online.

Recent store openings and closures show that the property landscape is shifting from retail units to leisure-type facilities. Categories under most threat from net closures are financial services and fashion retailers, as both categories move to a more convenience-based and price-sensitive online environment.

Figure 4: Leases with break clauses

Leases with break clauses

Source: MSCI, Retail Economics analysis

There is still a strong place in physical retailing for value, convenience and luxury, which is supporting the polarisation in the market. The fashion market encapsulates the disparity. The mass clothing market is facing around six times the number of net store closures compared to the value and premium end.

Figure 5: Mass market faces greatest net change in store closures

Mass market faces greatest net change in store closures

Source: LDC

The evolution of UK retail and how we got here 

Today, retail environments need to cater for an ever-expanding range of needs, which are often immediate, meaning that convenience and competitive pricing will be most valued. As we head deeper into the decade, overarching issues like sustainability, the experience economy and AI integrated technology will continue to mould and shape how UK retailers are adapting in order to remain relevant and fit for purpose and we head into the 2020s… but how did we get here in the first place?

Things to do now

Found this short article interesting?

This work was conducted by Retail Economics in partnership with Alvarez & Marsal. It looks at the role of physical retail space in the UK and the various factors that have shaped the direction of retail property in the past - and those for in the future. The research includes a consumer panel survey and focusses on how shopping habits impact stores (present and future) and the likely scenarios that retailers will adopt in order to cope with the structural changes occurring. 

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