Retail’s struggles were well documented before the events of 2020 really upped the ante. As the UK continues to navigate Covid-19, what opportunities are there for the real estate sector to build a sustainable strategy around the repurposing of retail? Might the answer be found in urban logistics?
Covid restrictions have lit the burners beneath e-commerce. Online groceries have seen a massive surge in demand, leading to a huge storage requirement and a focus on supply chain modelling, including last-mile delivery. This has led to a renewed interest and uptake in the logistics sector, triggering both the creation of new pure logistics funds and mixed funds looking to increase their exposure in the short to medium term.
Lenders with retail on their books are also looking to their borrowers for new strategies, including restructuring, releveraging and repurposing, at the very least hoping to minimise exposure to business rates and service charges on any voids.
When you consider the figures, it’s not surprising. In the market this year we are regularly seeing terms of more than 10 years in the mid-big-box segment (which are becoming rarer in other sectors, including retail and offices) with impressive yields of 4% or lower on prime assets.
The industrial and logistics sector has not only shown resilience in terms of occupancy and income recovery in these challenging times, but it is also this sector which is poised to capitalise on two current mega trends: the anticipated need for gigafactories to produce batteries for e-vehicles; and bigger, better and smarter research and development facilities for vaccine manufacture, storage and distribution.
Where?
Repurposing retail in order to locate distribution hubs near to populated urban areas speeds up last-mile delivery, allowing online retailers to challenge bricks-and-mortar retailers and sweep up those customers who want their goods in real time. In 2018, a British Property Federation report estimated that each new home built requires 69 sq ft of warehouse floorspace – a figure that will have sky-rocketed this year – and of course Christmas 2020 is expected to be the biggest test so far in terms of online fulfilment. A central location can also provide an “on tap” workforce, particularly if the infrastructure surrounding the hub is strong.
London will undoubtedly lead the charge purely from a valuation perspective. For retail to convert to logistics you need to have a significant value for it to work – for example, Prologis’s acquisition of Ravenside Retail Park in Edmonton, north London, as a last-mile hub. With the recent resurgence of retail parks, this may more often mean looking at secondary or tertiary shopping centres, although many local authorities would resist such a change of use if such centres were located in a town centre.
The recent changes to the Town and Country Planning (Use Classes) Order 1987 did not affect B8 (storage and distribution). A change of use application (from E to B8) will be required in addition to any planning permissions related to physical changes at the site. Local planning authorities are more likely to want diversity of uses – now facilitated by the breadth of use class E – to maintain the town centre as a community focus.
Locating logistics hubs near to housing will also ring alarm bells for planners. Noise, air quality and delivery movements (in and out of the facility) are likely to be controversial with residents and politically charged. Even if the principle is acceptable, operational restrictions imposed by conditions may make the facility unviable.
An urban site will probably mean a smaller area to play with, although current sites do often have inefficient footprints, so there may be scope for an imaginative architect to optimise the square footage. Vehicle circulation is key, so that is likely to mean a smaller building footprint while allowing enough turning, loading and parking space for deliveries and pick-ups, particularly if HGV deliveries are contemplated. These locations do tend to be well-connected and – subject to getting the planning, building configuration and costs to stack up – you can expect to see more vertical land use in these urban locations. Some retailers are also repurposing themselves, with retail at the front of the unit and urban fulfilment centres at the rear.
Planning, electric vehicles and Brexit
What might appease the planners? Given the economic outlook and rising unemployment, the regeneration angle should be maximised. Moreover, done properly, repurposing isn’t just about reusing existing buildings, it’s about building back better (a theme emphasised in the Planning White Paper), with environmental, social and corporate governance issues at the fore. With the built environment currently contributing approximately 40% of carbon emissions, as the UK government strives to achieve its net zero targets by 2050 it will be looking directly at the property industry to contribute and in a big way.
The government has recently launched its “green industrial revolution” and brought forward the ban on the sale of new petrol and diesel cars and vans to 2030, but is there more that can be done to accelerate the transition to zero-emission vehicles? Could empty retail units present an opportunity for industries supporting electrification of mobility to be part of a city-specific or national pandemic recovery response? There will clearly be technical issues to work through, not least ensuring sufficient power to the site and surveying load capacities of existing buildings, but a long-term view and approach may be needed to save the UK from swathes of unoccupied retail space.
What will key infrastructure look like in the future? Could charging points be as important as a good road or train network? Arguably the current polices from the government (including the further devolution of powers away from central government to encourage more city-wide ultra-low-emission zones and clean air zones across the UK) create a positive ecosystem for the greater adoption of battery electric vehicles. If you add to this the potential for car scrappage schemes, parking incentives, fast lanes (through the newly announced green number plates), benefits-in-kind company car taxes, further capital allowances, plug-in grants and incentives around the location and building of charge points, the conditions for great adoption by consumers and business-owned fleets will be present.
If we can further add incentive to landowners to host BEV charging points through tax incentives, this could “turbo charge” BEV adoption and really help cities post pandemic. And in turn the move to BEVs may open up new opportunities for logistics to repurpose, or at least reconfigure, current petrol and service stations.
Not forgetting that Brexit is also likely to increase the appeal of repurposing opportunities near ports. As the government continues to negotiate the Brexit deal, getting our ports strategy right is regularly described as being key to our future outside of the EU. For logistics that may be finding sites for the implementation of storage solutions, product finalisation or full processing. Ports that are closely located to their main market make for reductions in carbon as well as minimising the risk of disruption through transport congestion. The government’s newly announced Freeports policy could also offer turbo-charged opportunities around existing sea, air and rail ports as early as next year.
The competition?
An urban location with good connectivity attracts more than just the logistics sector. The build-to-rent, multifamily and data centre developers are often vying for these opportunities too and, in many cases, can offer a premium price per sq ft. We know, even in this year’s disrupted market, that mixed-use, community-focused developments are a serious contender in this space. In a customer-focused model, logistics should arguably now form a key part of any such development strategy.
We have seen that happen, for example, on new office developments in the City. Consolidated delivery management systems mean that goods can be stored in a dispatch centre outside of a city, with tenants using a digital goods management system to call for those goods when they actually need them, delivery being scheduled for off-peak times with low/zero-emission vehicles. It would be no surprise if we saw more industrial and logistics developers teaming up with developers who have traditionally not operated in this space.
How?
If prices are rising, how can logistics assets deliver more bang for their buck? Certainly, efficiency is key – of space (think cubic, not square metres) and of working practices (think automation). But going up carries different challenges – vertical space requires lifts and the right structure to support considerable loading, which is unlikely to be the basis on which a purpose-built retail unit will have been constructed. Getting fire safety right will also be key.
The modelling will be interesting too. Over the past few years, we have seen an explosion in the number of serviced/flexible office offerings, with even institutional landlords now seeing the concept as a key part of their office strategy. The pandemic has certainly served to shine a light on the benefits of flexible office space going forward. Flexible serviced logistics models are now also in play. The diversity of occupiers and their particular requirements makes this model a challenge but investors who have successfully implemented flexible offices will have a strategy in place, including a slick (potentially online) leasing model, and the ability to cope with the intensive management demands.
In terms of funding, while there is support from the banks, valuing is tricky, particularly where big boxes are built to suit. We have seen Covid-19 make that harder and doubly so for repurposing. Retail rents may have to be rebased to allow for a more palatable yield differential on the paper trail.
Verity Waington is a partner and Victoria Duxbury is an associate director – knowledge development lawyer of the global real estate group at Bryan Cave Leighton Paisner (with special thanks to the planning and zoning, retail and consumer products, and infrastructure teams)