Is the hot investment market in retail property based on valid assumptions?

Today I attended the bi-annual commercial property auction sector review by Acuitus. In light of the significant number of retail properties that are transacted in the auction room then it is an interesting barometer of the investment market. By way of clarity this does not include sales of large assets such as shopping centres or retail parks but generally retails to single shop units on their own or as part of a portfolio.

Acuitus and IPD (MSCI) have combined to produce some very interesting stats on the auction market, the latest figures that I will try and put in context of what we see at LDC in terms of vacancy rates, occupation profiles and market sentiment.

As one might expect the news for investors is very good and if nothing else there is strong evidence that we are seeing the start of a new and positive investment cycles with yields shrinking which means higher prices being paid. That said IPD’s UK All Property index shows that indexed capital growth is still -21.2% off its peak of 2007! Indexed rental values (source IPD), however, are just -5.8% off their peak which tells us that rental growth (all sectors) is alive and well.

So that is the good news at an all property level. When one looks at retail property then that dreaded word polarization, often used when I talk vacancy rates, is alive and well! This is seen in IPD’s segmented rental values index where Standard Retail – South East is +5.4% and Standard Retail – Rest of UK is -14.6%!

If one then takes this a step further and looks at total returns (income and capital growth) then for Standard Shops in 2014 the Total Return was a very healthy +16.7% (year on year) of which the vast majority was Capital Growth (+11.1% yoy) which when split further saw yield impact (rising prices – +20% on average lot size between Dec 2014 and Dec 2014) being +9.8% (yoy) with rental value growth at just +2.3% (yoy). These numbers were based on £14 billion of Standard Shops transactions in 2014.

What this shows is that investor demand is driving the market as people become more confident in the outlook, banks free up debt and there is a belief (rightly or wrongly) that the demand for shops will increase, demand will outstrip supply and rents will rise.

The two charts from IPD clearly illustrate the polarisation I allude to between regions but also the significance variance by quality of asset.

Standard Shops Capital Value Indexes by Yield Quarterly

Standard Shops Capital Value Indexes by Yield, Quarterly

Standard Shops Capital Value Indexes by Region Monthly

Standard Shops Capital Value Indexes by Region, Monthly

So how well founded is this investor demand and is it as a result of crowd frenzy, low interest rates, increased availability of debt, increased demand from retail and leisure occupiers or just too much money chasing too few assets which is driven by strong foreign investor demand?

With regards to occupier demand I would sound a word of caution especially for standard high street shops across the country.

Local Data Company (LDC) data in the top 500 town centres has shown a consistent decline in the presence of multiple retailers since 2011 and the trend continues. Independents, whilst having been net contributors to occupation have slowed down significantly and their churn (ability to close) levels are significantly higher than your average chain retailer.

In addition there was much talk today of investors liking to see 10 year leases for some degree of income guarantee but how does this fit with average lease lengths of independents who cannot often commit a decade out let alone the rise and value seen by occupiers of Pop up Shops? Are some locations only going to see seasonal occupation profiles, like many seaside towns, and what do investors think of that?

Finally, much of what goes before depends on the rebasing of rents (and dare I say it the 2015 business rates revaluation). If rents on a shop have not been rebased then I would say stay clear, as what we do know is that many locations are over rented or where business rates are considerably more than the current passing rent. Whichever it is impacts occupancy costs and therefore is a critical part on the decision as to occupy or not occupy a shop.

Whilst we see an improving economy, increased consumer spend does this mean that demand for physical shops will return to the investment peaks of 2007? I would say categorically no as now the role of the shop is to support the online offer which is now a significant cost and opportunity so any occupier will look to limit property costs especially when they are spending more on fit out (experiential shopping) than ever before!

Knowing where and why to invest in a shop is more important than ever before and is something we spend significant time and resource doing for our clients.

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