If you walk along any High Street today, three things are apparent – firstly, many of the household names which once adorned our thoroughfares have disappeared, secondly more people seem to be browsing as opposed to buying and thirdly there is an increase in the number of vacant shops. Now the reasons for this are not as easy to explain as one may think. Yes the current economic crisis has led to the collapse of a multitude of retailers, yes the vast majority of the population has less disposable income now and has little confidence in things improving in the near future and yes the absence of growth in the retail sector has curtailed demand from companies looking to expand into additional stores. However there are other sinister and more subtle forces at work here which will still be with us even when the recovery eventually kicks in.
The High Street, which was once a vibrant place to shop, where you could buy anything from a packet of sweets to a house, and everything in between, has become a very challenging market for occupiers. The retailers who we lost, such as Adams, Faith, Select, Zavvi, Woolworths, Land of Leather and Bay Trading, were laden with problems which were too difficult to solve within the limited time constraints bestowed upon them by their banks. Those who managed to survive, such as JJB, Birthdays, Borders and Oddbins, were only able to do so by restructuring their businesses, reducing their costs and vacating a large number of their shops. However the real champions, including Next, Marks & Spencer, Boots and W H Smith, who have also had their fair share of problems, have not only kept their heads above water but also evolved by moving on.
Retailers have recognized that peoples shopping habits have changed and the High Street isn’t always their first port of call. These days, supermarkets, which sell everything including food, clothes, sportswear, cards, gifts and general household goods, are winning the war against small individual shops and along with retail parks and shopping centers are taking away droves of people from traditional shopping streets which is focusing the minds of retailers on whether or not their stores have a future in town and city centers.
Several well known retailers, who have had to make sweeping changes to their businesses, have decided to gradually move away from High Streets and relocate to modern retail parks. Although a number of these retailers, such as Next and Argos, are still represented in town and city centers, I suspect that when their shop leases expire, they will not wish to renew and will head towards the retail and shopping parks. The advantages in this are that it is easier for shoppers to park, retailers are able to display more of their merchandise in these larger units, pro-rata rentals are cheaper and the development potential for out-of-town sites is far greater than it is for town center sites enabling developers to expand their parks, attract more tenants and improve the retail mix which ultimately draws in more shoppers.
Another change within the retail sector is the growing use of the internet. As more people shop on line, and simply use shopping trips as a means to compare prices, companies no longer feel it is essential to sell their goods from shops and again decide to take their operations away from the High Street. This can reduce operating costs by as much as 50% by saving on rent, rates, staff, utilities, fit out costs, shop maintenance and repairs. This impact of the internet and home shopping has yet to be felt by shopping centers, supermarkets and retail parks as these retailing environments attract high volumes of people and provide convenience, variety and a pleasant ambience.
As retailers migrate from our High Streets, landlords are left with vacant shop units to let. However, this is, and for a while will continue to be, a tall order to fill as demand from small independent retailers and national multiple chains is generally very weak and even more so for town and city centre shops. At present, there is little confidence amongst consumers and businesses that the economy will improve and the fear of a ‘double-dip’, in light of VAT rising next year, changes to CGT, increased government spending cuts and the threat of interest rates going up, seems more likely now than ever. With 39% of UK household wealth wrapped up in property, a drop in values, which the RICS has recently reported, lowers consumer confidence and reduces the amount spent on the streets. The British Retail Consortium has recently announced that consumers are staying away from big household purchases and spending growth has slowed almost to a halt. As long as the above conditions remain, and the threat of continued negative growth persists, which will be the case whilst banks keep the availability of credit scarce, businesses will be unable to expand, retailers will be unable and unwilling to acquire new stores and the retail sector will faces a very bleak and uncertain future. This view cannot be ignored especially since at the time of writing this article, the retail chain Confetti was placed into administration and had to close their stores in Glasgow, Leeds, Birmingham, Reading and London.
According to IPD, (Investment Property Databank), which is the world’s leading authority on analyzing the performance of real estate, retail vacancies have risen from 7.6% in 2005 to 13.3% in 2010. In fact, the number of vacant shops in the UK is now thought to be much higher than this latter figure since a large proportion of retailers currently occupy shops on a temporary basis and on concessionary terms and once these short lets and rent free periods expire, there is a strong chance that many of these occupiers will decide to vacate.
Whilst these types of vacancy levels remain, and the economy stays on its knees, the value of High Street retail property will continue to fall. I recall, not so long ago, but before we were facing these trying times, when you would have had to pay a yield of circa 6.5% to buy a freehold shop, let to a reasonable covenant, with 5-10 years unexpired. A similar investment today would probably sell for over 11% which translates to a fall in value of over 40%. This rate of decline is not uncommon throughout most UK High Streets which is putting pressure on freeholders who have seen, and in some cases are continuing to see, the value of their assets decline. As values continue to fall, and banks enforce clauses in their loan documents allowing them to carry out annual valuations of properties which are subject to commercial loans, borrowers will find themselves in breach of their loan to value covenants which banks are now more concerned about than they have ever been in the past. If a borrower is in breach, a bank can force a borrower to repay the entire loan amount outstanding and if this is not possible, the bank can foreclose and repossess the property.
As long as the supply of High Street retail units outstrips the demand, rents will continue to remain low and the prospects of future rental growth, which drives the investment market, will remain weak. Real retail rents are some 20% off from their peak before the credit crisis began. The latest report from Capital Economics, The Commercial Property Analyst, Q1 2010, has said that: “In our view, over the next few quarters, occupier demand is unlikely to be strong enough to erode this overhang of space. Accordingly, we expect all-retail rental values to fall throughout 2010 and, albeit at a much slower pace, into 2011. Retail warehouse rental values will decline by about 4% this year, a slightly smaller fall than in the shopping centre (5%) and standard shop (6%) sub-sectors, (with) further small declines across all the retail sub-sectors in 2011.” Furthermore, since there is such a vast selection of units for potential occupiers to choose from, landlords will need to offer large incentives, such as rent free periods, to entire tenants into their units. These factors will provide banks, which are already reluctant to lend, with even more ammunition to refuse loan requests when approached by investors who are considering buying High Street shops. Any lender will quite rightly so be concerned about the borrower’s ability to pay interest on the loan, and eventually repay the capital, whilst income streams remain uncertain and the prospects of attracting tenants remains weak.
In light of all of the above, many property owners who I have been in contact with over the past few months are seriously considering selling their High Street retail investments before they see even more value eroded. Those who have to sell, due to pressure from banks and cash flow problems, are being realistic in the prices they are seeking and at times are prepared to do quick deals with cash buyers. They may not necessarily get the best price by following this path but when people need money, and speed is of the essence, they are more interested in knowing that the deal can be done, and quickly, than trying to get the highest price. Those who are not under too much pressure to sell are also considering their options and thinking it may be better to sell now, even if it means realizing a loss, which may mitigate their downside, and reinvest the proceeds in the future when the economy is back on its feet.