LGIM has long held the view that the UK retail sector is facing some severe headwinds. But that’s not to say there are no opportunities in the sector – it’s just important to be highly selective when making acquisitions.
Reading the headlines over the past several months, you’ll have seen a string of retailers announcing administrations, store closures and profit warnings. Some of this is down to factors that have emerged relatively recently – in particular, import cost inflation following the post-EU referendum fall in the pound. But the problems for UK retail pre-date this; profit margins have come under increasing pressure, dropping by around 30% relative to their pre-global financial crisis levels.
Instant access to price information, while great for consumers, is tough on the sellers
Whilst it isn’t the only factor, it is hard to overstate the role of the internet in the transformation of retail. On the one hand, instant access to price information has forced greater transparency into the market. Although this is great for consumers, it’s tough on the sellers. And the increasing proportion of sales which are fulfilled through home delivery has reduced retailers’ dependence on their store networks. Of all the growth in retail sales in the past decade, just a third has come from sales through stores, whereas two thirds have come via online sales.
Stripping out online sales, retailer sales have barely grown in the past decade
Whilst physical stores still play a major role, many retailers are signaling that their networks will shrink, and increasingly be driven by their ability to support the online sales channel or by showcasing the retailers’ brand. For owners of property, this has led to fragile demand for retail space. In many weaker locations, it has become more difficult to secure tenants and rents have fallen as a result.
We think these issues are an ongoing challenge for UK retailers and therefore the prospects for retail property. But we can’t ignore the role that retail continues to play, both for the market as a whole and in client portfolios. Whilst we are underweight, we still own a lot of retail. The long leases that are still common, often linked to tenants with strong credit ratings, also mean that these assets can play an important part in generating income.
Retail assets can play an important role in generating income
And whilst we’ve presented a simple narrative above, the facts on the ground show wide variation. For example, around 9% of shops owned by institutional investors outside of the South East are not earning any rent at present. By contrast, more than 99% of supermarkets are income-producing. So there are wide disparities in this market that put a great deal of emphasis on stock selection.
Against a complex backdrop, there is a range of factors that we look at when making buy, sell and hold decisions. But here are three that top the list:
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