COMMENT “Every problem is an opportunity in disguise.” So said John Adams, the second president of the US, and as national lockdown continues and Debenhams stores now close their doors for good, it’s obvious that the retail market has no shortage of problems.
Despite increased risk, this is making many investors curious about where the opportunities lie in retail. The sell-off has meant that yield pricing is now unrecognisable compared with just a few years ago, and increasingly attractive against other property sectors. But with generic repricing, and income performance diverging widely between assets, you need a view of future cashflows to understand the opportunities (and threats). The question we are asked most by investors and lenders is: where do retail rents go from here?
Delving deeper
Of course, there isn’t one simple answer. Complexity is part of the value opportunity – the task is to discern the winning assets from the losers. To do this, we have to look deeper than traditional metrics. It’s not so much a case of tearing up the old rule book, but more understanding what the old rules mean for a changed game.
Tenant turnover is the key metric for many investors, and a source of frustration as the UK market typically has limited visibility. The feedback gleaned from across our UK-wide portfolio of 30 assets and more than 900 tenants can indeed provide a helpful indicator of sustainable cashflow, but that doesn’t provide the whole answer. Tenants can trade well in an asset that is set for steep rental declines.
Even where there are turnover rents, this doesn’t necessarily mean that tenants will stay, and pay the same in the future. Physical condition can also be misleading – almost “box fresh” assets which present very well can also be on the cusp of steep value decline. So how do we reveal the opportunities in the space and mitigate risk?
Sense of purpose
We’re finding that the best way to filter opportunities is by starting with an asset’s purpose. For example, is it a local centre that should serve its immediate community? Is it a retail park for specific shopping missions? Or is it a super-regional shopping centre that should provide a day out experience and draw from a wide catchment?
Once we understand purpose, we can assess how well the asset fulfils this role. The key is to use the right data, alongside practical commercial experience, to create a full picture. Our research and analytics team has developed a process that combines both aspects to systematically “screen” assets for risk in areas such as:
- Dominance: how much market share does the asset capture? Is it the “go to” location for its purpose?
- Supply: is there a general oversupply of retail in the area? What and where is this space?
- Competition: how much is there and how does it compare? Is it succeeding at the expense of your asset?
- Consumer trends: how are shoppers really using the asset and how is this changing?
- Footfall and engagement: are visits to one operator up significantly, masking a decline in others?
- Robustness of tenants: using relationships and understanding of tenants’ corporate strategies to flag the risk of an empty unit.
- Affordability of rents: how does likely tenant trade compare with occupational costs, adjusted for brand or category?
These indicators cannot be viewed in isolation, but together can provide red, amber and green flags for the likelihood of success, informing an income underwriting exercise.
We may assess the key tenants to be robust, but is the mix sustainable? Is the overall proposition working for shoppers? What are the potential solutions if one or more tenants left the scheme? From a lending perspective, what are the possible “critical events” in the cashflow, where a number of factors could come together to reduce income and value?
Clearly, one question leads to many more. So where do retail rents go from here?
While there is no simple answer, we have built a platform with the expertise, data and tenant relationships to tackle it head-on. We believe it is possible to be systematic, and to mitigate risk with a fresh approach. This applies to anyone interested in the outcome of retail – whether investors, lenders or non-performing loan buyers, with existing retail positions or not. After all, picking the winners in an out-of-favour sector is not easy. And not all problems are opportunities in disguise.
Jonathan Cole is investment director at Ellandi
