The comeback kid

The Covid-19 pandemic lockdowns were arguably the severest stress test the retail real estate sector has ever been through. New clouds are now gathering on the economic horizon, but many of the survivors – both retailers and landlords – are better placed to navigate what comes next. By Judi Seebus

Shopping centres, high street retailers and food and beverage (F&B) establishments were finally able to resume business as usual in early 2022 after two years of operating in survival mode. Trading swiftly returned to pre-Covid levels as people flocked to stores and restaurants, eager to spend their pent-up savings on luxury items and meetings with friends and family. But although the general mood for retail is far more positive, it would be erroneous to assume that the “Roaring Twenties” are back, cautions Robert Travers, Head of EMEA Retail at Cushman & Wakefield: “All indicators point to an economic slowdown.”

Rising inflation and spiralling interest rates are already heralding possible fresh economic storms ahead, while the retail sector is still in the throes of a profound transformation to adapt to the omnichannel environment. That process was accelerated by lockdowns during the Covid-19 pandemic and online has now become a key component of sales for many retailers. A more recent development in the online market is that retailers are starting to charge for returns and are offering free in-store pickups to cut their costs as well as reduce the negative environmental impact, Travers says. “There are winners and losers, but those that have survived are in a much better position. Whatever comes next, I don’t think it’ll be worse than what we’ve just been through.” 

Food retail will see a further shift in consumer spending, from brand to home labels, and from upmarket grocers to discount supermarkets.
Herman Kok CEO of Dutch retail and urban real estate association Kern

The winners are undoubtedly convenience stores, supermarkets, sports stores and suppliers of products related to health and wellbeing. The F&B and entertainment sector is now also riding a wave of resurgent demand as consumers choose to eat out again and seek entertainment elsewhere after two years of watching Netflix at home. “Convenience stores will always belong to the mainstream retail sector since they fulfil basic human needs, but the margins are already thin. I think we will see a further shift in consumer spending, from brand to home labels, and from upmarket grocers to discount supermarkets that are better equipped for the emerging market conditions,” says Herman Kok, CEO of Dutch retail and urban real estate association KERN. 

The prime segment, with luxury labels such as Dior, and value brands like H&M are performing well thanks to ongoing strong demand.
SOPA Images

The recovery has stalled, but some winners are nonetheless apparent

Retail trendwatchers are struggling to find direction in the rapidly changing economic landscape. Union Investment’s Global Retail Attractiveness Index slumped 3 points year-on-year in Europe in the second quarter, after having rallied sharply in the first quarter (+12 points). Sentiment remains uncertain following the outbreak of the Ukraine war, which has put the brakes on the recovery of retail markets across Europe and has led to a series of closures by international retailers like H&M and Zara.If inflation persists, consumers will also have to make choices about larger, typically long-term investments that are easier to postpone, Kok adds: “The big question is how will inflation impact spending patterns? The home goods sector and DIY stores experienced a boom during the pandemic as consumers made larger investments thanks to the savings they amassed. I think we’ll see a correction in those segments.” 

Other winners who are now performing well include value retailers such as Swedish fashion chain H&M, which aims to double its sales by 2030 after its recent recovery, and Spain’s Inditex Group, which reported its highest profitability in a decade in the first quarter of 2022 thanks to its store optimisation programme in Western Europe and other regions. At the other end of the spectrum, luxury goods chain LVMH saw sales soar 44 percent in FY 2021 compared to FY2020, and 20 percent versus 2019. Retailers who were already struggling prior to the Covid pandemic and who have failed to reinvent themselves or take advantage of the changed market circumstances to adapt the size of their store formats and their locations remain under pressure, however. That applies especially to mid-market fashion brands positioned between luxury retailers such as Louis Vuitton and Dior on the one hand, and value brands such as Zara and Primark on the other, says Travers: “Those two poles have not changed. Retailers that don’t have a clear offer will have a tougher time.”

More competition for the best product, depending on city and segment

Online retailers may have emerged victorious from the Covid-19 pandemic, but the brick-and-mortar sector is making a comeback. Even “digi-native” retailers are seeing the value of a physical store, if only for marketing purposes, while a majority of retailers recently polled by adviser CBRE rate brick-and-mortar retail as more effective than online, particularly for cross-selling products and consumer engagement. 

Leasing activity has, in fact, been recovering for some time after hitting a low in 2020: new leases accounted for 75 percent of Cushman & Wakefield’s transactions in EMEA in 2021 as occupiers moved away from renegotiating existing contracts and signed up for new premises. “Good-quality stock is starting to disappear,” says Travers. “The structural vacancy rate is going down, depending on the city and segment, and we’re also seeing more competition for the best product. That will eventually have a positive effect on rental levels, but timing will be dependent on the depth of any economic downturn.” 

A key question in an omnichannel retail world is how rents should be determined. Turnover-related rents are already common in large swathes of Europe, particularly in shopping centres, and the phenomenon is now starting to gain acceptance in the UK, Kok says: “Turnover-related rents give landlords insights into who’s performing well, but the multi-million-dollar question is how turnover should be defined. There’s a lot of discussion on this topic and many different scenarios. High street retailers often pay a base rent related to footfall and the size of their premises, but a consumer may look at a product in a shop and go home and order it online. The market needs better definitions and reporting methods, which ultimately would create a higher level of transparency.”

Retail investment has become a more compelling story

Confidence is also returning to the investor community for the right retail real estate product and the sector is gearing up for increased deal activity, with equity-rich investors in pole position. While prices held up reasonably well during the pandemic for good-quality assets, especially food-anchored retail parks, overall the sector was heavily penalised and average shopping centre yields rose to 6–7 percent across Europe. 

With yields in most other real estate sectors such as residential and logistics hovering around 3 percent, retail is rapidly becoming a more compelling story, Travers says. “Investors were bullish on retail parks, which outperformed throughout the pandemic, and we’re now also seeing activity in the shopping centre market.” 

European investors are mainly spearheading the renewed interest in retail properties in Europe, with North American and Asian capital sitting on the sidelines due primarily to concerns about the impact of the war in Ukraine on markets across the continent. Some retail specialists are also eyeing opportunities to buy obsolete premises and convert them into mixed-use areas that include residential and leisure. Virtually all markets across Europe are witnessing a resurgence in retail investment, albeit from a low base, and now is not a bad moment to come into the market, Travers concludes. 

“You really need to look city by city and asset by asset. But that’s the beauty of retail – every market is different, and opportunities are so specific to sector and geography.”

By Judi Seebus

Title image: Getty Images

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