‘Cyclical and structural changes continue to challenge the retail sector, which has gone through significant adjustment both before and during the pandemic. We expect repricing to create new opportunities for value-add and opportunistic investors. Stock selection is important, and retail investment remains the purview of owner-occupiers, privates, and dedicated investment funds. Rising vacancies in existing portfolios can provide a fresh opportunity to extract value. In order to be successful, retail requires to be part of a wider mix of uses that brings people together.’

The retail sector has gone through a major correction that pre-dates, but was exacerbated by, the Covid-19 crisis. A combination of over development and a shift from bricks-and-mortar shopping to e-commerce caused a ‘retail apocalypse,’ leading to a large number of store closures, especially in markets with a high supply of physical retail such as the US and UK. A lot of investors were burnt in the process, leading to much lower investment volumes and a significant repricing of retail assets over the past five years.

Nevertheless, retail has shown signs of a nascent recovery, supported by a revival in occupational markets. In 2021, total investment in the sector increased by nearly 50% globally, and last year, despite falling by 13%, transaction volumes broadly matched the five year average. This was driven by a rebound in activity in the US, where total investment in the retail sector in 2022 was nearly 30% above pre-pandemic levels, falling just short of the previous record total set in 2015. However, the rest of the world experienced a continued slowdown in deal flow, especially in the last quarter of 2022, which was 66% down on the same period last year.

A resilient consumer

A strong labour market and accumulation of household savings have supported a resilience in consumer spending that belies the wider cost of living shock. Retail sales volumes across the OECD group of economies rose by 1.2% in 2022, following a 8.9% surge in the previous year. This compares with an average of 1.9% per annum in the decade leading up to the Covid-19 pandemic.

Notably, people have returned to physical retail, driven initially by revenge spending, but also by the desire to socialise. Globally, while the online share of retail increased from 10.3% in 2019 to 14.9% at the peak of the pandemic, it has since fallen back to 12.2% in 2021; only 0.6ppts above the value predicted by historical trends. This dynamic continued in 2022, particularly in more mature e-commerce markets where online penetration has mostly returned to trend. 

Another supportive factor for physical retail has been the rebound of international tourism. According to the UNWTO, more than 900mn tourists travelled internationally in 2022 – double the number recorded in 2021. In Singapore, one of the hardest hit retail destinations by Covid-19 travel restrictions, vacancy eased to a three-year low in the second half of last year as retailers were encouraged by an increase in footfall to take up more space. The relaxation of zero-Covid policies in China will unleash three years of pent-up travel demand in the second half of this year, which should boost sales in high street destinations with a high reliance on Mainland Chinese tourists such as Hong Kong (78%), Seoul (34%), Tokyo (30%), Singapore (19%), and Sydney (17%).

The current economic environment is going to have a negative impact on spending, particularly on discretionary items. Consumer confidence in many economies is anchored at record lows, but retail asset prices have corrected to such an extent that much of the bad news is probably already priced in, offering renewed opportunities to investors.

Prime shopping centre yields in Europe have moved out by about 90bps since 2019, and range from 5.25% in Germany to 8% in the UK (Chart 19). This is consistently 200-300bps above prime office or logistics assets. Yield softening has been less dramatic in the luxury and convenience segments of the market, at 20bps and 50bps respectively. Luxury shopping is generally more experience-led and shows little correlation to the business cycle, providing some insulation to online penetration and declining household incomes. Food and convenience stores have appealed to investors in this cycle due to their defensive characteristics; the share of investment in retail parks, food anchored centres, and big boxes increased from a five year average of 27% to 34% globally last year.

Prime, redefined

Understanding the occupational market is key for retail investment strategies. What is considered prime has narrowed significantly, more so than in other sectors. The rapid pace of structural change has brought with it a high risk of obsolescence. Some shopping centres, considered prime just five years ago, are now secondary at best.

In Europe and the US, prime is primarily destination high streets and some shopping malls (e.g., in the US west coast); very specific locations with good footfall and a tenant base synonymous with stronger covenants (luxury brands, technology, leisure etc.). Destination retail streets have become more important than city centres. In Asia Pacific, malls retain cultural significance as a place to meet and socialise, in addition to high streets, and within this, the role of retail is changing; offering unique experiences that cannot be replicated online is the key to success.

Meanwhile, brands are returning to city strategies where there is an opportunity to reconnect with customers, looking more at gateway cities in Europe (e.g., Dublin, Hamburg, and Southern European cities) and the US, where recent domestic migration trends have boosted the attractiveness of secondary cities such as Atlanta, Dallas, and Houston. Some retailers are consolidating their store networks, focusing on the strongest locations, but also considering more localised areas with renewed demand for convenience shopping, following the rise of hybrid working. Prime rents are sharply down on pre-crisis levels (around -30/35% in Europe, and -15/30% across core Asia ex-China markets), so it has become more affordable to take space in the best locations.

Finding value in a challenging market

In 2023, we expect budget constraints to put pressure on consumers and create renewed challenges for some retailers (particularly those contingent on discretionary spending), which are exposed to rising costs and rent indexation in some markets, especially Europe. The pressure on profit margins may force some to close stores, especially those indebted retailers from the non-food sector. Landlords and tenants are increasingly collaborating through data sharing, turnover rents, and flexible leases, in order to improve the performance of stores, share risks and opportunities, and ensure the viability of retail businesses.

However, high vacancy in some markets provides an opportunity for landlords to rethink the tenant mix. Complementary uses can enhance footfall and support the existing retail offer. Residential, hotels, student housing, coworking, leisure, and life sciences are all considered fit for this purpose. Such strategies offer a more diversified and resilient source of income for landlords.

Discount and convenience stores are likely to continue to outperform and increase market share in an economic downturn. Combined with other non-discretionary items like food, these defensive assets are becoming part of core/core + investment strategies. Prime high street will also remain attractive, particularly with a luxury covenant, although there is limited liquidity in this space, and so competition for the few assets that do come to market will support pricing.

There will be more liquidity around other high footfall locations; particularly for premium assets, but perhaps missing the strongest covenant, especially where the yields offer an attractive return and there is value-add potential. Well-located secondary high-streets, retail warehousing, and shopping centres will also attract buyers as the yields move out, but these assets probably need an investor with a strong conviction and experience in active management.

A number of investors will, however, continue to reduce their exposure to the retail sector, providing the market with assets that can be interesting for value-add and opportunistic investors looking to reposition them, or repurpose them altogether. More liquidity may also stem from sale and leasebacks from retailers that own their real estate assets, but many investors will be reluctant to pile into the retail sector, particularly those already exposed to consumer spending through logistics.