Ainslie McLennan, Co-Manager of the Janus Henderson UK Property PAIF, examines the structural changes taking place within retail and the impact on physical bricks and mortar stores.
The UK retail sector saw falling investor sentiment and negative headlines throughout the course of 2018, driven by economic and political uncertainty, a trend which is likely to continue in 2019.
Adapting to changing consumer behaviour
Our long-held view has been that the retail sector, particularly traditional retailers and high street assets, would come under pressure.
Structural changes continue to see a shift away from the high street towards online sales. Back in January 2008 internet sales accounted for 5% of all UK retail sales but the growth in ecommerce has led to this figure rising to 18% according to the Office for National Statistics as at August 2018. Some retail-based businesses have responded well to managing this change by engaging with customers and changing the experiences and services that they offer. Others have struggled and this has led to an increase in tenant bankruptcies and company voluntary arrangements (where new terms are agreed with creditors to help them to continue to trade).
The issue of polarisation continues with economically-resilient retail locations getting stronger and weak areas no longer viable as retail destinations. Therefore, the identification of prime locations, positive demographics and due diligence on occupiers remain key. For a number of years we have been diversifying away from traditional areas of the market as we seek to maintain an appropriate, broad mix of assets that we believe to be best suited to the conditions ahead.
A physical presence
While the wider retail industry has been impacted by structural declines, footfall in retail parks with warehouse style assets has been the most resilient amongst major retail formats in recent years, as shown in the chart below. This trend is not uniform across all assets, but go past any well-located retail warehouse park and it is clear that many of these assets have benefited from having a convenience offering and the growth in ‘click and collect’, which allows savvy retailers to remain located in stores that are internet compatible.
Footfall in out-of-town supermarkets has also benefited from the convenience and accessibility for shoppers. Food remains a relatively defensive sector, with many supermarket chains having experienced robust in-store sales growth during a period when the clothing and footwear segment of the market saw sluggish growth.There are, however, challenges facing supermarkets. The ongoing price war between the ‘big four’ and the discounters (such as Aldi and Lidl) is likely to exert downward pressure on inflation, thus hitting nominal sales growth.
UK store footfall growth (% change year-on-year)
Source: BRC, Q3 2018, figures are calculated using 3-month moving average data.
Survival through evolution
Retail will survive but not as we know it. Successful town and city locations are likely to be multi-use, combining retail with residential and leisure facilities, such as gyms, cinemas and restaurants, which factor in wellbeing and sustainability. Fewer shops in the future will force retailers and stores to be far more engaging and interactive to attract consumers and personalise their shopping experience. Landlords will need to take account of these requirements to attract the next generation of retailers.
Artificial intelligence (AI) is one example of retailers adding value through a physical presence. Clothing retailers may soon be embracing AI-based technology such as installing 3D virtual fitting rooms with touch screen digital mirrors that allow customers to ‘try on’ different colours and styles without changing garments.
Source: Getty Images
AI is also likely be used in future to increase efficiency and space by tracking customer behaviour in shops by analysing aisles or promotions that are attracting shoppers and what is not. Meanwhile, Amazon, the e-commerce specialist, plans to take market disruption full circle by expanding into physical grocery retailing in key inner city locations with cashless and cashier-free free stores. Motion-tracking AI would be used to record and charge customers’ accounts for what they have taken from the store.Technology is key to the future or failure of retail and companies that are successful in tomorrow’s world are likely to be the most adaptable to change.
Purley Way, Croydon, is a large retail warehouse park in South London and an example of how engagement with retailers and local authorities can add significant value for investors:
- The portfolio owns approximately nine acres of land adjoining Purley Way, with retail units let to John Lewis and Currys.
- Planning application submitted to develop 35,000 square feet of retail warehousing on a vacant site situated between the John Lewis and Currys units.
- Proposed development 90% pre-let ahead of securing planning permission.
- Inflation-linked lease agreements signed with Aldi (25 years) and Smyths Toys (15 years) to occupy the completed development.
- Additional 2,500 square feet of development for which planning permission is expected to be granted in the first half of 2019.
- Significant valuation gain from an otherwise redundant portion of the site providing further portfolio diversification.
Source: Nuveen Real Estate, 31 December 2018