The weakness of the retail property sector has been a blight on otherwise strong performance from the listed commercial property sector. As investors look to judge the next developments in commercial property markets, it is worth considering whether we have hit the lows for retail property or whether there is more pain to come.
The problems of the retail property sector are widely documented. Retail property is facing a perfect storm of poor consumer sentiment and long-term structural change. People are nervous about spending and even when they are spending that money is increasingly going online.
The consequences of this weakness for retailers are profound. 21 companies have failed this year (to 9 April), with a closure of 727 stores. In 2018, 43 companies went bust, at a cost of 2,594 stores. 
Debenhams and LK Bennett have been the memorable casualties, but many more look vulnerable, with the likes of Boots exploring the closure of hundreds of shops. Company voluntary arrangements (CVAs) have become commonplace and many more retailers are in negotiations with their landlords to reduce their rent or change their terms.
This has been reflected in the listed commercial property sector. In May, LandSec (formerly Land Securities) – the UK’s largest listed property company by assets – saw the value of its property portfolio written down by £557m, led by a 15.5% drop in the value of its retail parks and a 11.7% drop for its shopping centres. 
Robert Noel, LandSec’s chief executive, painted a gloomy picture of the sector’s prospects. He said the background was tough, adding: “We see no near-term improvement in retail market conditions, with CVA activity set to continue.” He said the group had sold off many of its regional shopping destinations in 2013-15 and was continuing to sell down its retail assets.
Retail property prices are sliding in value and investors still don’t believe they are being written down quickly enough. Share prices have suffered and are now at extensive discounts to published net asset values, but they could fall further. Few have been blind to the problems faced by UK retail, but crucially problems are now beginning to be felt rather than just talked about.
Nevertheless, the structural changes in retail have brought new opportunities. Amazon’s fastest delivery times globally are now sub-10 minutes. There is huge demand for both retail warehousing and for so-called ‘last mile’ logistics – smaller warehouses on the edge of major cities to facilitate swift delivery. Equally, there are parts of retail that have so far proven less susceptible to the march of ecommerce. This has been the case with Primark, which doesn’t have an online offering, but remains hugely popular for low-cost clothing.
Part of the problem for the retail sector is that no-one yet knows the shape of the future landscape. Undoubtedly, there will be real winners, but the sector is in an experimentation phase and it is not yet clear how it will land. There is some evidence that the market is cycling back to bricks and mortar, for example. This was evident in 2017 when Amazon bought Whole Foods in a $13.7bn deal. 
It is our view that we will end up with stores that are about the experience, the feel and quality: destination venues. We have seen this with areas such as Carnaby Street, owned by Shaftesbury. It has negotiated with Westminster Council to adjust the street scape, curating a new high street. As such, it’s created a unique shopping experience for those who go there. This creates demand among retailers.
More broadly, landlords will have to do this type of asset management to thrive. Bicester Village, owned by Hammerson, could be considered a good example of this, where the environment is important in drawing footfall. Even where companies are running single buildings, they will have to give thought to the experience they create.
In our view, there are probably 50-60 shopping centres that are dominant schemes, in affluent areas, that will continue to see high footfall and strong trade for tenants. Here, the focus will have to be on maintaining and improving occupancy and doing so without the previous answer of adding more casual dining. There are probably another 150-200 “community shopping centres” that focus on matching the demands of the local catchment and serve the needs of the community. As long as they keep responding to the changing needs of the local area, they should also fare better than average. Then there are several hundred remaining where there isn’t enough demand to survive in the long term.
Solutions are emerging: a change of use to include elements of office and residential space creates demand. That takes time, planning permission and money, but for some centres there will be no other option. For those that can survive without diversifying use, landlords will have to adapt to the same idea of property as a service that we are seeing in the office sector. Could pop-up shops become more widespread, for example? This would require some flexibility on the part of the landlord, but it may be that experimental new shops could take a small space for three months to trial a new concept. We are already seeing evidence of this in the market, with Amazon recently launching a programme to give small online brands the opportunity to sell their products on the high street via pop-up shops.
The sector is in flux, rather than in terminal decline. It is important to keep looking at it and to analyse where winning concepts are emerging and how we can help support them. This is a time of change, but there will be opportunities as the dust settles.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
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This article was previously published on www.smithandwilliamson.com prior to the launch of Evelyn Partners.