Investors hoping for a recovery in commercial property should beware that certain parts of this sector still have further to fall, according to Tritax EuroBox manager Nick Preston.
In particular, Preston is referring to retail property, which he said has twice the capacity it needs.
Tritax EuroBox owns a portfolio of warehouses in prime locations close to cities across western Europe, which are facilitating the online retail boom. As a result, it has sailed through the coronavirus crisis unscathed, with Preston noting the trust will not miss out on “a single euro of rent” this year.
However, this contrasts with the rest of the commercial property sector.
“If you’ve got income being generated from a retail portfolio or a shopping centre, the only thing you can be sure of is that it will be significantly lower than it was a year ago,” said Preston.
“And that is why investors are running scared from retail property. I’m sorry but I think it still has a long way to fall. My opinion is that we probably need just half the retail space we’ve currently got.”
Preston said “the writing was on the wall” for retail property long before the coronavirus crisis struck. Its problems started not with e-commerce, but with supermarkets moving out of town centres, then with local authorities zoning out-of-town retail parks.
The manager said this was made worse by the rise of enormous out-of-town malls such as Bluewater, which created huge amounts of excess retail capacity.
“Then with the rapid advancement of digital technology there was the advent of online retailing and Covid has seen that step up materially,” he added.
“In the UK, around a quarter of retail spend is online, when 10 years ago it was effectively zero. You’ve now suddenly got this avalanche of online retailing, which has shifted a huge proportion of spend away from the bricks & mortar stores, of which there were far too many anyway.
“It’s moved the sales point to sheds like ours. That’s bad for property investors in retail and it’s bad for retailers like Arcadia which have been sleepwalking towards crisis for a long time. Frankly, Arcadia was not fit for purpose in a 21st century retailing model.”
Yet while the outlook for retail property looks grim, Preston said this doesn’t mean that all shops with a physical presence are doomed.
He pointed to the example of Tritax EuroBox’s biggest tenant, Mango, which was one of the first fashion retailers to launch an e-commerce platform, back in 2000. It anticipated the shift online a decade ago and took an aggressive approach to repositioning itself for the digital age.
Preston said Mango’s success is not down to its online presence alone, highlighting its ‘omnichannel’ strategy whereby its online and physical presence complement each other rather than running in parallel.
“I think this is going to be the way forward for most retailers in the future, because retailing is adapting and changing and this has been massively accelerated by Covid,” he added.
“This omnichannel is really important, as there’s experience-based retailing in city-centre shops and big shopping malls where customers go, not necessarily to actually purchase but to understand more about the products and the other bits of the vibe, as opposed to just doing something rather dry online.
“As 2020 comes to a close it is now set to achieve record online sales figures, with the firm expecting to close the year with an online turnover up 40 per cent on 2019. This is partly due to the close to 3 million new online customers the firm added throughout the year, 900,000 of which were added during the months of lockdown, when turnover grew by more than 50 per cent. Arcadia forgot to listen to the needs of the consumer and did virtually nothing to take its business seriously digitally, hence it arrived at today’s position.”
Yet just as not every physical retailer is doomed to failure, not every warehouse capable of servicing online retail is a good investment.
Preston only buys energy-efficient properties with good transport networks that are close to cities or major population centres – meaning that even if a tenant leaves, the property will still be in demand. The manager also ensures the property is in a location with tight planning regulations, ensuring multiple competitors will not suddenly pop up nearby and undercut on price.
He contrasted this with the strategy used by some of his competitors which he referred to as “carpet bombing”.
“They literally just go out there and buy properties I wouldn’t touch because they are poorly located, they’re older and their configuration does not lend to them being re-let in the future,” he said.
The manager compared this indiscriminate buying to the mass expansion of retail property in the 1990s which created the problem of massive over-capacity that the sector faces today.
“You’ve got to be really careful, you’ve got to go with the experts who know what they’re doing,” Preston added.
“And also sector-wise, this is the retail point we were talking about earlier, I use the example of [Wile E. Coyote] from Road Runner running off the cliff and waiting, while there’s a massive vacuum underneath. This is the rental values that the tenants cannot afford to pay. And that means that income level is going to absolutely collapse.
“All of this stuff has been swept under the carpet for the last five years and is now coming home to roost when people are forced sellers into the market. I think we will see a lot more pain in that area.
“There is a place for retail, absolutely, but it’s fundamentally mispriced and misplaced at the moment. And that’s where the pain is going to come. I think we’ve got more blood to go on the walls, I am afraid.”
Data from FE Analytics shows Tritax EuroBox has made 4.21 per cent since launch in July 2018, compared with 18.44 per cent from its IT Property – Europe sector.
Performance of trust vs sector since launch
Source: FE Analytics
The trust is trading at a discount to net asset value (NAV) of 14.66 per cent compared with 14.24 per cent from its one-year average. It is yielding 3.94 per cent, has ongoing charges of 2.2 per cent and is 42 per cent geared.