“The City just hates anything that is retail at the moment – it is an unloved sector with a lot of unloved names.”
These are the words of a top institutional fund manager and he is not exaggerating. It has been a horrible start to 2018 for the retail sector, with administrations from Toys ‘R’ Us and Maplin, the electronics retailer, and other smaller retailers putting thousands of jobs at risk, writes Deirdre Hipwell, retail editor and mergers & acquisitions editor at The Times.
Company voluntary arrangements – the insolvency process that allows retailers to cut rents and offload stores at landlords’ expense – are also becoming increasingly common, with CarpetRight, the flooring retailer, the most recent chain to carry one out.
All this doom and gloom comes amid a host of other issues retailers have to navigate, from rising business rates and wage bills to falling consumer confidence, post-Brexit trade concerns and the volatility of sterling.
And yet while City fund managers may dislike the retail sector, private investors continue to snap up shops across UK high streets despite the industry’s many well-publicised problems.
Research results
Research from Property Data, the specialist property information group, shows that £878m of shops and shopping centres, valued individually at between £1m and £10m, were sold last year. Private investors were the second-largest investor, by buyer type, accounting for nearly £200m of those deals, or more than 20% of the investment total.
Between 2013 and 2017, private investors splashed out more than £1bn buying retail assets valued at £10m or less – a significant amount of investment in a structurally challenged sector.
So it is no surprise that retail stock continues to dominate the commercial auction rooms. Flick through any recent commercial property auction catalogue and there are swathes of listings for Costa coffee shops, Spar stores, Savers Health and Beauty outlets as well as betting shops, estate agents, tattoo parlours and nail salons, among others. From London and quaint market towns to secondary regional towns, it appears there is no retail lot that a private investor will not consider – if the pricing is sensible.
Andrew Parker, managing director of SDL Auctions, a national auction business headquartered in Nottingham, says: “There is an abundance of secondary retail assets that are selling well now and three years ago you couldn’t give them away. People have different expectations, of course, so a Costa Coffee shop at a yield of 4% is quite sufficient, but for a shop with a less certain tenant, such as a nail bar, then you might want a 10% yield. There is a really strong market for assets with a 10% yield given that interest rates have been low for so long.”
Rising demand
Parker adds that there is also rising demand for mixed-use assets – buildings with both shops and residential space, or shops with office space above that can be converted to flats using permitted development rights. Demand for these mixed-use buildings has been driven particularly by investors who have been turned off buy-to-let properties because of high stamp duty charges and are looking for commercial opportunities instead. “Mixed use can be a safer investment now as you could still be getting income from a tenant in a flat, even if the retail tenant on the ground floor has gone bust,” says Parker.
There is always a risk a retail tenant will go under, given the pressures of the sector, and it is up to the buyer to adequately assess that risk. This explains why shops let on longer leases to desirable chains, such as WH Smith, Costa Coffee or Boots, are in high demand from private investors.
Philip Waterfield at Strettons, a London-based property auction house, says private investors will always target shops let to big-name retailers generating reliable income. “A small investor owning a Costa coffee shop in a village can walk past it every day and say ‘that’s my Costa’,” he says.
However, Richard Auterac, chairman of commercial auction house Acuitus, says that investors need to be cautious at a time when so many national retailers are trying to shed non-core and unprofitable stores.
“Many stores [let to multiples] are clearly over-rented and if they have less than three years left on the lease they will be hard to sell,” he explains. “So an investor needs to not only think about what happens if they have to drop the rent but also whether they can find another tenant if they have to.”
Changing times
It is easy to forget, but not so long ago, stores let to Blockbusters, a global chain, were seen as great investment. But a substantial number of private investors lost out heavily when the video and DVD retailer collapsed into administration. And Prezzo, a restaurant chain that a few years ago every private investor would have coveted in their portfolio, recently pushed through a painful CVA closing 100 outlets.
Assessing where future rental income could come from must form a key part of any private investor’s buying decision, particularly when purchasing a shop with only a few years left on the lease. Auterac says: “At the moment there is a 250 basis points difference between a four-year lease and a 10- to 13-year lease, so there is a significant difference in value.”
SDL’s Parker says investors should be cautious about stores let to off-licences, given the pressures on margins in that sector where recently Conviviality Retail, owner of Bargain Booze, went into administration. Small, independent book shops should also have a unique point of difference on the high street if they are to survive against the likes of Waterstones and Amazon books online.
In general, high street businesses that can demonstrate they are less exposed to internet commerce, and will still have a reason to exist in a few years’ time, are more desirable than retailers staring Amazon down. This helps explain why outlets let to stretched clothing retailers, sharply exposed to online fashion retailers, such as Boohoo and Asos, have been less of a favourite among investors of late.
Branch closures
Bank sale and leasebacks agreed in the early noughties will also be nearing the end of their leases soon, at a time of widespread branch closures. This could present a headache for landlords if the banks exit the properties, which are sometimes fortress-fronted and have vaults within, making conversion to alternative uses potentially quite expensive.
The situation is not hopeless in retail, however. Market experts say there is still growing demand for space from e-cigarette shops, health supplement retailers and convenience store operators, such as the Co-op. Stores let to Iceland are in high demand as are outlets occupied by the Kwik-fit car servicing chain or let to independent funeral directors. Even smaller hardware stores seem to be holding their own on the high street.
There are always new types of retail businesses emerging, too. Auterac points to Acuitus’s recent sale of a shop in Edinburgh that was let to a “community repair hub” and “social enterprise” business fixing and selling secondhand items. “It sold incredibly well – a 7.6% yield – and we thought that people would not understand the concept of the tenant,” says Auterac.
“No fools” these days
George Walker, a partner at Allsop, says there are “no fools” among private investors today. “If you have a Dorothy Perkins store with three years left on the lease, you won’t have many takers for that. It was different in the noughties when you had people sticking their hands up in auction rooms not knowing what they were doing, buying assets with 85% finance,” he says. “Private investors have become much more advanced now – they may be concerned by the retail sector but they are still finding shops a reliable source of income.”
Finding shops let to good tenants may be one thing, however, but the location is just as important. Auterac says that “anything in London will sell, regardless of the type of tenant or length of lease”, while outside the capital it is imperative to invest in “hot spots” of wealth or areas with strong local economies.
David Pearl, chairman and chief executive of Structadene, which has a substantial commercial and residential portfolio, says he will not even consider buying outside the capital at present. “It is not the right time to buy retail at the moment and I am really worried about the high street,” he says. “If you can get a Costa or a WH Smith on a decent lease it might be okay, but anything less than five years on the lease, even at a 7, 8 or 9% return is dangerously risky. We have been bitten a few times on those types of assets.”
Pearl adds that buying outside London is particularly challenging at a time when rents are falling and being rebased. “Retailers are very savvy now and are really driving hard bargains. I feel I have enough outside London and I am just keeping my hands in my pocket right now,” he says.
Why buy retail?
Buying a shop can be more attractive than buying a small office building as retail assets tend to be much less capital-thirsty investments. Retail tenants often carry out the fit-out of shops themselves to make the space relevant to their business, even in buildings that, in some locations, may be decades or even hundreds of years old. They may even ask for a slightly longer lease, in order to amortise their fit out costs, which can be attractive to small landlords, especially those using debt to finance a purchase.
By comparison, an office building can quickly become redundant as business needs and regulations around office occupation change, potentially resulting in expensive capital expenditure for landlords. Small retail and industrial parks are bigger lot sizes and also be capital intensive, particularly if purchased for their redevelopment potential.
However, the physical structure and fit out of buildings aside, the most important attribute for any private investor to consider when buying a retail asset in this challenging market is to consider the location of the property, the quality of the covenant and the length of the income.
James Stratton, a retail investment director at Savills, says that private investors will always favour shops because they are tangible assets that most people can understand fairly easily. “The man on street who has some money to invest can understand retail, especially if they are buying in their home town. They can go and stand outside a shop for a couple of hours and see if it is busy,” he explains. “It is the obvious go-to investment asset other than buying residential.”
