Summary:

• Clicks’ drive retail growth at expense of ‘bricks’– for some time to come
• Imminent lease expiries – a catalyst for swift change
• ‘Protecting rental values’ becomes the new ‘rental growth’
• Valuation adjustments – coming soon
• Relative winners still emerging

‘Clicks’ drive retail growth at expense of ‘bricks’
Online retail to strengthen during 2012…
Online retailing has been the clear winner throughout 2010 and 2011, against a backdrop of a weak economy, stubborn inflation, unemployment, falls in real retail sales, and general uncertainty. The benefit of a wholly integrated online offer as part of an optimum retail model is clear, the effects of its impact on physical space will begin to hit home during 2012.

Occupational requirements fundamentally change …
Occupier requirements have fundamentally changed. By targeting growth through online sales and through international expansion, most mature, domestic non food retailers will be net reducers of space in the UK. For new expanding retailers it is simply a case of stores in fewer locations.

Too much space….
The result is a significant over supply of space in UK towns outside the top 50.
 

Imminent lease expiries – a catalyst for swift change…
50% of high street and shopping centre leases to expire by 2015…..
In shopping centres and on the high street we are coming to the end of the 80’s 25 year leases, the 90’s 10 year leases and sub 10 year leases of the last decade. According to our latest research, up to 25% of existing high street and shopping centre leases are due to expire by 2013 or 50% by 2015 (versus approximately 5% and 15% for retail parks by 2013 and 2015 respectively).
With a reduction in demand for physical retail space relative to 10 years ago, and retail requirements gravitating towards fewer retail locations, polarisation has been playing out, albeit relatively slowly until now. We have not yet seen the true effect of this shift in demand on our retail landscape, but the next 24 months are likely to see a swift and dramatic playing out of this polarisation as lease contracts expire.

Retailers to have more leverage on rent negotiations going forward…
These lease events will trigger a) rent reductions and b) increases in vacancy rates, as retailers walk away from sub-optimal stores. Long leases have protected rents in previous downturns, as retailershave had little chance to negotiate if more than 3-4 years from lease expiry. With shorter 5 year lease lengths and break clauses becoming the norm, upward only rent reviews could become the exception to the rule.

‘Protecting rental values’ becomes the new ‘rental growth’
Pockets of rental growth forecast for 2012 …
Average retail rents are still below peak levels. Demand is weak outside prime and is unlikely to return until fundamentals recover. In some instances, due to changing occupier requirements, retailer demand may simply not return.
As retailers look for good value rents, we will still see some growth on retail parks offering space at £15- £40 per sq. ft. often as a result of regeneration of DIY stores for value, food and non food retailers.
Restaurant demand is similarly strong, both in and out of town, as the distinction between retail and leisure becomes blurred.
Regional high streets and secondary shopping centres are most susceptible to significant rental income erosion, although London will continue to be a robust market as demand simply outweighs supply.

Business rates – a significant headwind in non prime…
Whilst new deals will reflect market value and will have to adjust downwards (or should), business rates remain the elephant in the room. Set at 2008 valuations, the 2010 rating revaluation is outdated and needs attention prior to the next VOA revaluation date of 2015. Based upon average rental declines from 2008 to end 2011, a 45% business rate contribution calculated at 2008 valuation now equate to over 50% of rent today. In harder hit markets, business rates will equate to 90% to 100% of adjusted market rents in 2012.
Market forces will come into play on rents – business rates remain a barrier and a significant headwind facing occupier affordability. The only way to address the imbalance without the VOA undertaking a whole re-rating exercise is to reduce business rate contributions from 45% (of 2008 rateable values) to a maximum of 30%.

Development to return, but not as we know it…
Whilst most commentary has focussed on the lack of town centre regeneration we are witnessing significant plans to redevelop older stock in the out of town market. Many original 25 year leases from the late 80’s/ early 90’s are coming to an end, which is coinciding with a change in planning landscape. Localism gives Local Authorities greater autonomy in determining how they generate new inward investment and income which is being reflected in a more commercial approach to granting planning permissions for retail and leisure development, sometimes to the detriment of the traditional retail centre.

Valuation adjustments – coming soon…
All of the above points to downward rental revisions for secondary locations during 2012. The degree of these rental adjustments will obviously depend on strength of the retail offer and occupier demand on a location by location basis.
So, whilst prime stock may be more resilient, secondary stock will see further investment yield decompression, to reflect: deterioration in rental prospects, capital expenditure assumptions, plus a continued absence of readily available bank debt, in order to achieve target IRR’s.

Conclusion – structural change about to play out….
So, quantitative easing and historically low interest rates in particular have provided a cushion for consumers and have softened the landing for UK retail over the recent years since the global economic downturn. Have we hit the bottom? We do not believe the structural and significant change facing aspects of our market have fully played out. 2012 will see more divergence between winners and losers and true values will be realised for secondary property.
Traditional and somewhat predictable retail real estate cycles are a thing of the past. 2012 will be a year of realisation and the first year of positioning for the new order.

Relative winners for 2012: London, prime, leisure, retail parks with development opportunities, convenience retailing.