UK Shopping Centres

It may seem counter-intuitive to analyse the investment credentials of shopping centres when volumes are depressed, and headwinds continue to buffet the retail sector. However, taking a purely analytical approach and focussing on available data, there is a persuasive case to be made for selective investment in the sector, based on:

Easing consumer headwinds: inflation now appears to have peaked and is reducing (Oxford Economics predicts CPI at 4.4% by year-end); real wage growth is emerging (which has driven household disposable income to its highest level in 17 months) – these factors will support real retail spending moving into the festive season.

Peaking interest rates: Oxford Economics predicts that the bank rate has likely peaked, with a lengthy period of inaction now in prospect, before falling to 4.75% by Q4 2024, reducing the cost-of-debt in the medium-term.

Occupier market resilience: retailer demand for space continues to be buoyant, albeit the ‘flight to prime’ gathers pace (many major occupiers are taking fewer stores, but bigger and better ones). The business rates revaluation boosted demand in many locations, and the continued slowing of online sales (from 38% at the COVID-peak to 26%) is boosting prospects for physical retail - rental tension and growth is evident in select locations.

Supply-side constraints: the demise of schemes in satellite locations, combined with a lack of development and the repurposing of older centres (a total of 13 former shopping centres are being redeveloped into residential-led schemes) has led certain tenants to refocus on the larger schemes, driving demand in prime (defined as top 30) schemes.

Recovery in prime performance: in prime destinations, sales continue to remain extremely resilient, often above pre-COVID levels (despite footfall remaining marginally below pre-COVID). Vacancy is also trending in the right direction for the best schemes.

Prime appears fair-value and primed for growth: quality shopping centre assets are extremely attractively priced, and could offer solid returns and significant growth potential in the long-term, following the rebasing of rents and values of the past few years (see Figure 1). There is also relative value in the sector when compared to retail parks - investors can buy shopping centres with better performance rankings than retail parks for a 300bps discount.

Accretive cost-of-debt: With the cost of debt remaining higher for longer, value-add and opportunity risk capital is king, and debt can be accretive for this capital in the shopping centre market.

Figure 1: Prime shopping centre yields, Q3 2023 vs LTA

_{Source: JLL}

This is not a thesis for wholesale investment in UK shopping centres, more highlighting the latent attractiveness of the sector based on available evidence and insights. Headwinds clearly remain – while the risk of further inflation / interest rate rises appears to be subsiding, the cost-of living crisis persists and short-term consumer spending is likely to be flat at best. Although the pandemic has accelerated the shake-out of weaker retailers, muted festive trading raises the risk of further administrations coming through in the next six months. And investors need to factor in possible future ESG implications, which are arguably not yet fully understood.

However, we think we can realistically make a case for the strong cyclical recovery of prime shopping centres (albeit from a low base, following severe rebasing of rents and values). And there are several other, non-cyclical drivers that could / should activate the investor market, including the accelerating move towards repurposing, and the requirement for social value - an increasing number of institutional investors are as interested in social return as they are in total return. Shopping centres also represent the most profitable renewable energy projects in real estate, according to a recent report - there is reportedly vast untapped potential to generate a significant amount of energy at shopping centres.

It is instructive to understand investor motivations for buying a shopping centre, which are by their nature large, complex buildings. Clearly this depends on whether a buyer is purely focusing on the cyclical recovery play, or at some degree of repurposing or complete redevelopment to residential, for instance. The schemes being purchased for redevelopment are more secondary and generally located in London/south-east. Prime schemes are unlikely to be comprehensively redeveloped for alternative uses, as the highest and best use remains retail.

Also, it is crucial to understand the key attributes of an ‘investible’ scheme. For investors looking at cyclical recovery, scheme relevance is key - does it have a sustainable function in the community, though dominance, appropriateness or physical environment - in addition to proactive management that ensures the shopper experience is constantly evolving?

We are not predicting a short-term boom in shopping centre transactions, and volumes are unlikely to recover in 2023. But pricing will stabilise and confidence improve as we move into next year - JLL’s recent investor survey showed that 40% of respondents expect major liquidity to return in H1 2024, with a further 45% expecting the recovery in H2.

There is a general consensus that pricing now more realistically factors in key income risks such as vacancy and rental discounts. Capital is available for the right opportunities, and the recent outperformance of prime schemes should ensure that investor demand is strong – the case for prime is clear.

However, there is significant value to be found beyond the prime market - dominant schemes in locations outside the top 30 with high occupancy rates are also displaying value at double digit yields, where over-rent has been eroded and occupational tension prevails.

As Jonathan Heptonstall, Head of UK Retail Investment at JLL, comments, “Shopping centres are now in a unique position where an investor has an opportunity to maintain a double-digit running yield. Rent collection in these centres has improved hugely. For these assets, it’s no longer about the typical PE approach of IRR and an ‘in and out’ strategy, there is huge value in a running return with flexibility around a hold period, particularly for equity investors in assets of sub £50m. If debt can be layered in then even better but at these yields, pure equity investment is still producing attractive returns compared to other asset classes. Yields are at historic highs, and tangible opportunities exist across the quality spectrum.”