A couple of weeks ago I wrote on these very pages about reasons to be cheerful. This week, I’m going to do a complete about turn, and talk about reasons to be anything but.
This isn’t because I’ve just got back from eight days running across the Alps, breathing lovely fresh air and have had to return to the suffocating pollution of London streets.
And it is not because our political system becomes more and more farcical day by day (not a day went past on my run where a European didn’t have a little chuckle on us Brits’ behalf). It’s because I believe tales of retail’s demise have not been exaggerated enough.
News this week that South Africa’s largest listed REIT, Growthpoint Properties, was considering taking a major shareholding in, and recapitalisation of, Capital & Regional, coupled with Orion potentially looking for partners to make a takeover bid for intu, could be viewed as investors getting ready to call the bottom of the market. Indeed, that’s not too far from the truth when it comes to Growthpoint.
While they say they don’t believe that values have completely bottomed out, they do believe they are close enough to the bottom to look attractive.
However, from the discussions I have been having over the past week, I’m not convinced the bottom is even close to being in sight.
While the flurry of CVAs is expected to dry up a little next year, this should not be taken as a sign that retail is over the worst of it.
This is just the beginning, and good luck to anyone who wants to get bank financing for a retail acquisition. Now is not the time to be worrying about the struggling retailers. Now is the time to be worrying about what the profitable retailers are going to do.
“It’s the strong that are going to kill you. The strong have unprecedented power,” I was told emphatically this week.
Across the board, retailers are asking landlords for rental cuts. Big rental cuts. And if they don’t get them, well, they will just walk away. Retailers just don’t need as many stores as they once did. The days of a national retailer needing 200 stores to cover the UK market are long gone. That number is now expected to be less than 50. So where does that put the power? Yep, in the hands of the strong retailer.
Rental deflation is only just starting to be factored into values. So those single digit reductions in portfolio values we have seen over the first nine months of the year will soon, I bearishly believe, shift into double digits.
And it won’t stop there. More value destruction will come. Those retailers asking for rental cuts are also asking for shorter leases. If you want anything longer than five years, don’t even bother having a conversation. It is just not going to happen.
Short leases mean no income longevity. And forget about the saviour that is upward only rent reviews. If the lease is only five years, there is no rent review and certainly no upward shift. No income longevity means no security of value. No security of value means, well, maybe no value?
And the really scary part of all this is that it’s not just another of real estate’s cycles. This is not trying to call the bottom of the market just before it starts to tick back up. This is a structural and fundamental change to the retail world.
So while the return of some potential M&A activity in the retail world may well have the appearance of some investor confidence in the sector, I’ll wager a bet that there’s more pain than glory to come just yet.
