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More retailers are turning to corporate voluntary arrangements to restructure their estates - but a dynamic landscape is no surprise for seasoned real estate investors.
The clamour over the changing UK retail environment has been hard to miss. The growing popularity of online shopping means footfall is down in many areas, while labour costs and business rates are also squeezing profitability.
In 2016, the Centre for Retail Research reported 30 large and medium-sized business failures, leading to the closure of 1,500 stores1. By 2017, failures had increased to 44, affecting 1,383 stores. And in the first nine months of 2018, a further 30 companies have failed, impacting another 2,118 stores. To put that in context, the numbers affected are still markedly lower than in 2008 and 2009, when the financial crisis hit over 12,000 stores.
With conditions challenging, some high-profile retailers and restaurant chains have been turning to corporate voluntary arrangements (CVAs) to restructure their commitments. Any company can propose a CVA to give it breathing room to restructure its debts, as long as the proposals are supported by 75 per cent of its unsecured creditors.
A CVA may also give a tenant company an opportunity to restructure lease obligations en masse, without the need to negotiate individually. Carpetright and New Look, as well as restaurant chains Jamie’s Italian, Prezzo and Byron Burgers, have chosen this route in the past year. The implications for landlords vary widely; the side effects might be minimal (allowing the tenant to pay rent monthly rather than quarterly in advance, for example), or as significant as a substantial rent reduction or the termination of the lease.
Time to restructure?
There are clearly cashflow implications in each of these cases, but landlords with a deep understanding of their estate will not be surprised by recent developments. It seems likely that sales through physical, store-based shopping will continue to decline as consumers increasingly buy online, and retailers will need fewer and smaller bricks-and-mortar stores. Retailers that do not have a compelling proposition to meet consumers’ growing expectations and are unable to invest in an online offer will struggle and ultimately fail.
For some time, a lot of retailers simply have not needed as many stores to cover the country because of their online presence,” explains Andrew Coles, director, real estate at Aviva Investors. “Many are shrinking their estates.
In this context, Aviva Investors began restructuring its retail portfolio almost two years ago; focusing on durable locations with strong economies, high store productivity and products resilient to pureplay ecommerce, and exiting locations that are vulnerable in this new environment.
“We anticipated these changes, as did some retailers, but the difficulty for them is not being able to respond as quickly as the market is changing. In most cases, retailers can only close stores when leases expire and so CVAs can become attractive to some as a way to accelerate the pace of transformation. Our disposal strategy has put us in an early, solid defensive position.”
But, of course, a CVA used to reduce rents only solves part of the problem.
While change caused pain for some, new opportunities are opening up for stronger retailers to replace tired ones with legacy stores. There are also prospects for new brand tenants to step in and acquire space on more flexible terms as landlords also adjust to the changing economic environment.
“Value retailers, coffee chains, value supermarkets, hotels, gyms and cinemas are all acquiring new stores, albeit in selective locations,” explains Darren Freed, director, real estate at Aviva Investors.
In the meantime, the weak pound has encouraged a record number of international visitors to the UK, so better-known tourist destinations in London and Manchester are trading well. Other hotspots include intellectual property hubs such as Cambridge and Oxford, as well as specialist retail destinations, including large prime shopping centres and prime designer outlets, for example in Bicester, East Midlands and York.
These locations illustrate how the retail market is evolving. The super-regional shopping centres such as the Westfield centres in London or Bentall Centre in Kingston upon Thames provide the customer with an array of choice and quality experience, while the prime designer outlets provide exceptional customer services with a branded value offer. In both cases, the stores provide the retailer with high sales volumes ands a customer proposition that cannot easily be replicated online.
It is in these locations and concepts that Aviva Investors is actively investing.
“Some stores have become a place where it’s not about you putting an item in a bag,” says Coles. “For the retailer, the physical presence is about showcasing the product. For the customer, it’s about the experience of retailing. So, you might visit a store to enjoy a day out, see the product, get advice, then go home and buy online later with confidence and commitment to the brand.”
With a designer outlet, the proposition is a little different. “Part of the draw might come through offers that can only be accessed when you visit,” explains Jonathan Bayfield, senior research analyst, Aviva Investors.
Experience and convenience
In Coles’ view, the market is bifurcating into experience-led sites and convenience-led sites, with shoppers showing little interest in an unexciting middle market. These changes raise the prospect of significant value generation around prime sites, alongside structural obsolescence in overdeveloped, lesser-quality locations.
There may be opportunities to convert retail sites to either smaller stores, leisure facilities or good quality residential. The latter re-purposing seems logical in the UK market where household formation is growing faster than supply, and where retail habits are changing rapidly.
“In the right locations, it may be worth considering change of use as an option that can really add value,” says Freed.
Meanwhile, interest in warehousing and logistics - providing the backbone for retailers in an ecommerce environment - has led to rapid capital appreciation for asset holders in the right locations. Here, Aviva Investors has also been concentrating its estate, focusing on a smaller number of core locations.
“We had quite a long tail of smaller assets in more fringe locations that we’ve been selling since 2015,” says Mike Green, head of UK industrial and logistics. In his view, focusing on fewer locations with larger lot sizes will produce the performance long-term investors are seeking; managing volume inventory close to consumption hubs is increasingly important in an age when more customers expect 24-hour delivery.
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