What's happening to Retail Property?
For much of the last three decades in retail, aggressive expansion of physical space drove market share as retailers’ key strategies involved ‘land grab’, while the broadening of the grocery sector into non-food proposition created even fiercer competition.
A rapid increase in stores across high streets and shopping centres ensued, as well as the development of larger ‘big-box’ stores, frequently located in out-of-town retail parks. In part, large chain retailers and landlords were able to turn to capital markets to fund extensive real estate build-outs, leading to the development of new shopping centres, retail parks and lifestyle centres, which added to and cannibalisedthe traditional town centresthey encroached upon. This expansion led to oversupply in many regions across the UK, creating ‘clone’ high streets that lacked relevance to their immediate communities and over time suffered from underinvestment and local authority complacency. What’s more, mass marketing strategies focused on an aggressive pricing strategy with the aim of capturing market share, which often diluted profit margins, brand equity and anonymisedcustomer relationships.
This expansionary era dovetailed with vibrant economic growth, as households (responsible for 2/3rds of the economy) saw real incomes rise by c.3% each year from 1997 to 2007, and more sophisticated global supply chains drove consistent deflation across core retail categories such as clothing, electricals and homewares. Resultantly, the retail expansion strategy worked for decades.
Over the last few years there has been a reversal of many of these trends.This was a catalyst for consumers to start looking for cheaper alternatives at a time when improvements in technology brought-about heightened transparency in pricing, service and quality, and the discounters had a much firmer foothold in the market.
The rise of online
Digital transformation led to the emergence of more sophisticated multichannel propositions, supported by higher penetration of smartphone ownership and online shopping, ultra-convenient home deliveries and more efficient click-and-collect.
The composition of retail spending shifted rapidly online. In the past decade, the value of online retail has risen four-fold, worth an estimated £70 billion in 2018 and accounting for just under £1 in every £5 spent. For some sectors such as clothing, this proportion rises to over a third, which is particular pertinent in some town centres where clothing occupants comprise over 40% of the physical presence.
Forward-thinking omnichannel retailers and the emergence of pure online players offering strong online propositions exploited these trends, while benefitting from collecting vast amounts of consumer data. Efforts by retailers late to the party that mimicked the mechanics of offering an online proposition frequently proved dilutive, as additional infrastructure and investment were deployed to service the same customer and the same order.
But crucially, the fast-paced adoption of consumer technologies presented shoppers with an array of digital touchpoints which fundamentally altered the way they interacted in physical locations. A linear customer journey that had existed for decades quickly dissolved and reformed to a more complex structure. Shoppers now expect to be able to seamlessly transition between channels, redefining the boundaries between physical, digital and on the move.
The experience economy
Engaging in meaningful experiences has become a differentiator of choice for many consumers. An abundance of material possessions has left consumers attaching more value to experiences; evidenced by the reduction in retail spending from 30% of household expenditure in the 1960s, to 27% in 2004 and 24% in 2016. Our forecasts suggest that this will fall further to 20% in the next 10 years.
Although the shift towards experiences has arguable come at the expense of retail, its role in the customer journey is undeniable. While consumers claim to spend more time browsing products online than they do in-store, the relative importance in the discovery and research of retail products is more influential in physical locations, in particular flagship destinations where ‘experiences’ matter.
Retailers and landlords alike recognise that staging meaningful experiences are critical in the moments that matter: moments of discovery; moments of desire; and moments of action.
What’s more, consumers expect digitally enhanced physical environments (such as Instagram walls, Facebook check-ins and Snapchat codes) that inspire, excite and offer experiences that cannot be replicated online/
Against these seismic shifts, retailers have also faced a backdrop of spiralling operating costs. Successive rises in business rates, National Living Wage (NLW), National Minimum Wage (NMW), logistics, utilities and other central costs has put intense pressure on profitability. Indeed, the Retail Economics Retail Cost Base Index shows that operating costs rose by 2.4% in 2018. However, over the last five years, operating costs facing retailers have risen by 10.8%, with labour costs constituting more than half of the increase.
Indeed, consecutive increases in NLW and NMW and costs associated with the Apprenticeship Levy have driven an acute rise in labour costs which constitute around 46% of total operating costs. Wage hikes among lower paid groups have a ‘ripple effect’ across entire wage distributions as businesses retain wage differentials. We estimate that the increase in NLW costs the industry in the region of c.£1.5bn per year to implement.
Business rates also remain a significant burden on retailers who have a disproportionate exposure to property. Retail Economics estimates that business rates cost the retail industry an estimated £7.5bn in 2018, and in some parts of the country exceed retailers’ rental values.
How has the industry reacted?
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.
What’s more, landlords are finding it increasingly difficult to reoccupy empty units. Vacancy rates across high streets (11.5%), shopping centres (13.6%) and retail parks (7.1%) in the second half of 2018 all rose on the previous year. Retail park vacancy rates are now at their highest level since 2014.
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... [extract]
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