Batten down the hatches

Lending rates have almost doubled, investors are nervous and retailers are facing a slowdown in consumer spending and a downturn in trade. All this could herald a crisis for investors in retail parks, who are finding it hard to justify the level of rent hikes they had become used to and are therefore finding it hard to shift parks with the returns that they have come to expect in recent years.

Savills executive director Simon Hope says this has served to halt activity, because the market is in a falling period. “We have had a 15- or 16-year bull run, where interest rates, bond rates and capitalisation rates came down,” he says. “Borrowing money at a forward interest rate of 3.9 per cent meant there was an extra positive return on cash. Now the rate has moved from 3.9 per cent to 6.2 per cent or 6.3 per cent, it is not as attractive. At the moment, unless you have got to sell, you won’t. And you won’t buy either.”

Wilkinson Williams director Paul Wilkinson agrees. “Money has largely been taken away and those people who do have cash are sitting on their hands, waiting to see what to do, because they don’t know where the market is,” he says.

Part of the uncertainty has come about because of increasing polarisation between the primary and secondary parks and difficulties in the lettings market. Vacancy rates in retail parks are running at about 7 per cent this year, higher than for many years.

Prime schemes have been steady and continue to attract fashion retailers, which view out-of-town schemes as a cheaper route to expansion than traditional high streets. Footfall is generally sound and parks with a grocer on-site remain lucrative. However, there is some concern about the impact that rises in interest rates have had on consumer spending, as well as on the prices that can be achieved for parks.

Cushman & Wakefield capital markets group retail warehousing associate Justin Houlihan says: “In the open A1 market, there are still deals being done.

The Arcadia brands, for example, are still expanding out of town, so investors see more value in these schemes. Margins are not what they were, though: rents are moving forward, but not at the rate they have historically.

“There is a lot of institutional interest in parks with a food store. People really do believe in the rental growth there.”

By contrast, trading and therefore letting difficulties have been more pronounced in secondary parks. According to a report published by Savills earlier this year, retail warehouse annual rental growth had at the time slumped to 2.5 per cent, from 6 per cent in 2005.

The consumer spending slowdown has hit bulky goods retailers hardest and these retailers are bread-and-butter tenants for landlords of secondary parks. Several furniture retailers have halted expansion, while others have collapsed altogether, leaving a surplus of large units in their wake. Aside from this, potential entrants from overseas are giving the UK
a wide berth as consumers tighten their belts.

The problems have been compounded by the very nature of secondary parks, which tend to have inferior access and be situated in less affluent areas. Houlihan says: “There’s no question that there has been a readjustment in pricing in the past three to four months. The bulky market has been less buoyant and tenants tend only to be looking at the best schemes. We aren’t seeing bulky operators rolling out aggressive expansion programmes, as they might have in the past, and this has contributed to the slowdown.”

Wilkinson points out that secondary parks valued at£30 million or more are the most difficult to sell on. “These schemes are highly rented and it is difficult to do deals past these rents, which is putting investors off.”

Vacant units, poor sales densities and little profit mean that it is almost impossible to justify rental increases on secondary parks, so, with little in the way of growth prospects, why invest in retail warehousing?

Despite the seeming doom and gloom, industry veterans insist that there is money to be made from retail parks, provided investors are prepared to do their research, tighten up asset management and lower their expectations on returns.

Historically, investors have been less concerned with the finer detail of lettings and more interested in the differences between primary and secondary schemes. And this is where some have tripped up. Hope says: “We have seen unsophisticated lines of money. Investors thought that one asset in suburban Manchester would perform as well as prime parks.”

However, this misconception is beginning to be addressed, with most investors now researching leases thoroughly to protect their investment. Houlihan explains: “Investors are taking stock in relation to where they will spend future funds. The occupational market and the perception of rental growth prospects will continue to be major factors in the process, together with retailer trading figures and forecasts.”

Doing research is one aspect, but what if you are stuck with a park with little or no prospect of growth ?

The key to increasing park value is driving spend on your park, says Hope. “There is 160 million sq ft of retail space in the UK and there has been significant consolidation to the market leaders. We are not seeing a fresh injection of demand from new entrants, which would drive rents. Landlords must proactively manage their assets. To drive footfall, landlords have to market locally and improve signage. They have to ask questions like: ‘Is there a place for coffee bars on retail parks now?’ Parks have to be at the forefront of shoppers’ minds.”

Other landlords are addressing the problem of large vacant units by converting them into smaller, more attractive sites with wider appeal. The resulting smaller units tend to achieve new rental levels, assisting landlords in driving park rents up. Wilkinson says: “We have noticed the creation of more smaller units where the market is more active. Smaller units will help to drive values forward and landlords will also need to tweak planning and recognise the increasing importance of mezzanine floors.”

So what are the short-term and long-term prospects for retail park investments?

Short-term investors will have to hold on or accept falling return rates. The Savills report shows that retail warehouse returns are running below those of the IPD All Property Index for the first time in many years. The office sector is proving more fruitful, which means that the pool of retail park buyers will be smaller and have tighter fists.

“The softening in pricing will be hard to swallow for many landlords who have enjoyed the continuing rise in capital values over the past five years,” says Houlihan. “As with other sectors, we are heading into a period of accepted lower returns, so asset management will remain the key focus to ensure returns stay at healthy levels.”

Hope warns: “If inflation backs up in a more serious way and interest rates kick in, there will be more pain. Investors may be forced to drop values. We are in for an interesting time this quarter.”

However, the Savills research predicts that the retail park rental growth rate over the next five years will average at about 3 per cent a year, outstripping average retail rental growth of between 2.5 per cent and 3 per cent. Similarly, Savills expects returns in the sector to fall between 6 per cent and 7 per cent a year – a marked slowdown on historic performance – but it believes returns will remain substantial enough to ensure that retail warehousing will be the best-performing sub-sector of the retail property market over the next five years.