Notwithstanding some decent macro numbers this quarter, the outlook for UK high street retail looks poor.
Barely a day goes by where we are not reminded of the struggles of the UK high street. It remains one of the most popular topics of the financial and popular press and, notwithstanding some decent macro numbers this quarter, the outlook for UK high street retail looks poor.
One reason for the weakness has been falling real incomes and a sluggish UK economy, not to mention Brexit concerns. However, we believe a more structural story accounts for the majority of the falling footfall, and that’s the rise in e- and m-commerce: online shopping has reached c.22 per cent of all non-food sales in the UK as at January 2018, versus just over 10 per cent in December 2012, and the value of online retail sales in the UK was £67bn in 2017, roughly double the £33bn of 2012.
This structural shift has been a boon for logistical properties and businesses, as goods need to be delivered via a network of connected logistical hubs before reaching our homes. It has been a disaster, however, for many retail properties, owners of which have seen tenants (the high street retailer) struggle to pay rent. New Look, for example, reported a poor set of results in March, with UK like-for-like sales down -11.7 per cent for the year. Such weakness is typical of the UK high street retail sector and has resulted in a number of Company Voluntary Arrangements (CVA’s), including Poundworld, Fabb Sofas, Claire’s, Toys R Us, and others. We met with a property company recently who suggested that some retail space is now trading at c.50 per cent of the value it was at 10 years ago.
However, in every crisis there lies opportunity, and while simply underweighting a weak sector can aid portfolios in their relative performance, we seek solutions that will generate positive absolute performance: after all, one can’t eat relative returns…
AEW UK is a Real Estate investment company running various funds that invest in a broad range of UK property, and are looking at the weakness in UK retail as an opportunity for profit. They highlight that the supply of town centre real estate is finite, and while demand for retail property in these locations is falling (and thus driving down property valuations), demand for office and residential space in these central locations remains buoyant. As such, one strategy the company is able to pursue is purchasing town centre retail properties and applying for change of use permissions with the council, which, if granted, will increase the pounds-per-square-foot value of the (now no longer retail) property. During our meeting with management the team highlighted Imperial Arcade in Brighton and Beales in Bournemouth as two examples of potential change of use candidates within their portfolio.
Physical retail will always have a place in our society; there is something to be said for the tangible nature of physical retail space. Indeed, we are not advocating writing off the high street altogether. However, it makes sense to fully consider shopping habits and adapt to change. Bill Grimsey recently published his second report reviewing the UK high street, in which he too argues that town center locations could be adapted from ailing retail to office and residential space. A combination of out-of-town retail parks combined with warehouse logistics could serve the needs of the consumer, while a regeneration of town centers with office, residential and service-offering space could help maintain a sense of community.
As we have demonstrated, a number of opportunities may arise from what is perceived to be a ‘crisis’ situation. At Waverton we are spending an increasing amount of time analysing the Real Assets universe, looking to identify idiosyncratic return-drivers that can diversify a traditional balanced portfolio.
James Mee is a fund manager at Waverton Investment Management