Structural changes in retail 4%62/,- +!1% /!& /+1 · 2018-10-03 · Structural changes in retail – why Europe and the US are different In the US, 46% of GLA in larger centres is

Structural changes in retail – why Europe and the US are different

Retail


The traditional consensus is that where the US retail market goes, continental Europe and the UK inevitably follow. But with the seemingly amplified, negative noise coming out of the US around department store downsizing, should we expect a raft of closures on this side of the Atlantic? Is it all over for US retail?

Let’s compare and contrast the two regions and cut through the noise.

Introduction


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As always there are two sides to every story. Much of this department store space will be re-let, re-purposed or will undergo change of use; the rest will remain vacant. A recent report from JLL in the US analysed what happened to recently vacated department store space, much of which was leased to new tenants (often at higher rents), including restaurants, entertainment venues, grocers and even other department stores and office tenants. However, the sheer quantum of space potentially being returned to the market over the next few years will be harder to absorb, particularly in more secondary locations. This is not surprising.

US Retail Unit Closings & Retail Sales Growth

Source: Credit Suisse (2017), Company Reports (May 2017), OEF

Structural change takes hold in US retail

Traditional department stores in the US are facing distinct headwinds, as consumers continue to migrate to discount department stores, specialty stores and online. Recent closure announcements (in particular from Macy’s, JC Penney and Sears) will soon release between 314 and 324 department stores into the market, with an estimated 3.4 million sq m (37 million sq ft) of space. This is a significant contributing factor to the headline-making spike in total retail unit closures forecast in the US this year.

And the outlook for Europe? Broadly speaking, we be-lieve that Europe’s retail market is more progressed in its response to structural change, and has very different market fundamentals and dynamics. While there will be further adjustments in the market, with some closures as retailers right size portfolios, we are unlikely to experience the volume of closures currently being forecast in the US.

In the following pages are five more significant market differences that contribute to contrasting real estate characteristics on both sides of the pond. We can learnfrom the other side, but we shouldn’t assume markets automatically mirror each other.

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The space differential is partly explained by the fact that shopping centres make up a larger proportion of total retail space in the US than in Europe. In mature Western European markets, where retail and leisure is an integral part of the urban landscape, there is generally a greater proportion of urban high street retail stock. The Westfield centres in London and Quatre Temps in Paris, for instance, complement the dominant, historic city centre retail offer. With urbanisation rates increasing across the world, appropriate, well-positioned, well-connected, urban retail, benefitting from mixed used adjacencies, will demonstrate resilience.

So, in the context of these numbers, the recent closure announcements take on a very different spin. The US has more shopping centre space than it perhaps needs, and in particular it has a surplus of relatively unproductive department store space. The US market is responding and innovating, unproductive space will be repurposed and reinvented. The European market is also adapting to change, but the space fundamentals here are very different, and as a result there is less downside (and downsizing) risk.

In an increasingly virtual world where spending patterns have shifted towards experience and where some spend has migrated online, certain retail markets simply have too much traditional retail space. In the US, for instance, there is 1,274 sq m (13,713 sq ft) of shopping centre GLA per 1,000 people. In the UK, there is 295 sq m (3,175 sq ft) of space per 1,000 people, and in Europe as a whole there is an average of 216 sq m (2,335 sq ft). These are huge differentials; put simply, the US has too much retail space.

Shopping Centre Stock/Capita 2017

Source: JLL, Akershus Eiendom, Sadolin & Albæk, 2017

Fundamentals: supply variances1.

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The US is ‘over-shopped’ partly due to a laissez-faire planning system. In Europe, planning legislation is generally much more restrictive when it comes to allowing new retail development, particularly in Western Europe. The contrasting development dynamics are the second reason why Europe is potentially less exposed to mass retail closures than the US market.

The UK market is a good case study. Here, the rigorous planning regulations have acted as a safety net, restricting the development of an excess of new retail space. Perhaps we would have built more had planning restrictions not been in place. In particular, historic town and city centres have been protected from over-development by the planning system. This is particularly relevant for the department store sector, which tend to locate in urban, high footfall areas (in addition to regionally dominant shopping centres). Planning has therefore acted as a brake on overall department store space expansion. This is in contrast to the US, where the relatively lax planning system led to a huge retail development boom, particularly in out of town locations, which housed many department store units. Centralised CBD districts, partly in an effort to reclaim shoppers, also have limited restrictions on planning in the US, and new space development is therefore much easier than in Europe’s historic city and town centres.

As a result, while there is likely to be some space rationalisation among department stores in the UK and the rest of Europe, it will be on a micro, case by case basis. For instance, where there is cannibalisation of a particular city market by a department store chain, we may see selective store closures, and we will see some stores downsize and retain a geographical presence. Wholesale closures, however, are unlikely to be on the same scale as the US.

Supply:fail to plan or plan to fail2.

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In the US, 46% of GLA in larger centres is devoted to department stores, compared with a global average of around 30%, and 27% in the UK. Partly as a result, department stores in the US are less productive than in Europe; sales densities in the US are on average less than half those achieved in Europe (based on a benchmark basket of stores from developed and emerging European markets).

In the US, weaker shopping centres are arguably more vulnerable to the loss of anchor tenants than their European counterparts. This is partly down to the quantum of space taken up by department stores, many of which are mediocre operators which are at the end of their lifecycle and being replaced by specialists or new unit store entrants. In addition, the closure of department stores can trigger a wave of rent loss from other tenants. Some US tenants have a clause in their lease to reduce rents should an anchor close a store. Thus, even though the loss of rent due to an anchor closing is minimal, the knock-on effect of reduced rents from the remaining tenants is a serious concern. This risk clearly only applies to schemes where department store units are not re-let. As we have pointed out, where demand exists, many vacant department stores will be repurposed.

In Europe, there is certainly not the same reliance on department stores in shopping centres. The majority of schemes in continental Europe are anchored by grocery stores, which still benefit from strong demand for the weekly shop. This could change of course, as shopping patterns evolve, but for now the impact of online on the grocery market has been minimal in comparison to non-food. In the UK, while shopping centres do tend to be anchored by department stores, the sector looks healthier. The poorer quality operators, such as BHS and T.J. Hughes, have already fallen by the wayside, while the remaining operators, such as John Lewis and House of Fraser, have done an excellent job in combining online and physical offerings. This is in direct contrast to the US, where some department stores have pursued aggressive and highly self-destructive strategies,that have marginalised them and reduced the pricing power for their brands.

Another factor is the emergence of alternative anchors, principally Food & Beverage, in today’s schemes as destinations and anchors in their own right. Restaurants are now a key ingredient for successful placemaking. Shopping centre owners in Europe are relatively advanced in terms of developing F&B anchor offers (in particular the larger owners such as ECE, Landsec, Multi, Hammerson, intu or Unibail-Rodamco). This is also occurring in the US, where landlords are reusing portions of former department stores to improve centres’ restaurant offerings (for instance at The Galleria in Houston, Fig & Olive and Nobu will each soon occupy a portion of what was once Saks Fifth Avenue). Total F&B space in the UK and Europe is slightly higher at between c.10-15% of shopping centre GLA on average, against c.8% in the US, suggesting that European landlords have been quicker to embrace the food trend. There is more opportunity for integrated F&B in the US. The risk in Europe is more around F&B saturation and cannibalisation of sales in some of the more developed schemes.

Department Store % of Total GLA

Note: Centres > 100,000 sqm (N=48)Source: Bloomberg (May 2017), Cistri (June 2017)

Occupiers: the reliance on anchor stores3.

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The sheer number of shopping centres in the US has almost made them a commodity. The retail offer tends to be relatively homogenous, particularly in the department store sector, and millennial consumers in particular are turning away from homogenous, commoditised products. In the UK and Europe, the lower density of retail (in addition to the natural diversity in the market) means that there are generally fewer lesser quality, commoditised retail places. According to Green Street, 36% of US centres are graded A - or above (the mark of a quality scheme) - in continental Europe the figure is 56%.

The European retail market benefits from a natural diversification that is hard to replicate in the US. This is partly due to geography, and the natural diversity resulting from national boundaries and the disparate city markets within countries. Europe is made up of many diverse markets, ranging from the mature to the emerging. Retail places in Europe benefit hugely from the cultural, economic and physical distinctiveness afforded by this geographical and market diversity.

The retail market in Europe also profits from the heterogeneity of the retailer pool. In addition to the pan-regional (and global) operators, the local and national retailers which are inherent in European markets certainly help to provide the diversity and vitality that retail places need. It also helps provide depth of supply and innovation.

This is a key point; diversity and vitality is one of key attributes needed by resilient retail places, alongside economic fundamentals, connectivity, environment, proactive management, identity, responsibility credentials and (for some retail places) culture and heritage. Many retail places simply lack the key attributes to succeed or these attributes have not been exploited. All of these, if

present and taken into appropriate consideration in retail place making, will guarantee success.

All of this we have explored extensively in our retail futures programs. So, certainly in the context of the diversity and vitality success attribute, the European retail market looks well placed. Transformation in the US is underway.

Diversification: commoditisation vs. natural diversity – embedded resilience 4.


Of course, the internet is having a seismic effect on retail on both sides of the Atlantic. However, in Europe, and the UK in particular, the speed and direction of online retail growth has been discernible for some time, and the industry as a whole has adjusted accordingly.

In 2012, JLL predicted that in the UK, online sales would hit 25% by 2020. Online sales are growing strongly, and currently sit between 12-15%, depending on the source. We may have over-estimated the overall proportion migrating online by this time, but we believe pure-play online retailers moving into the physical space, and the success and adoption of click and collect, will help further drive online growth. Figures for continental Europe are lower, and while that could imply further disruption, it certainly will not be the same for all countries.

Retail sales in Europe and US, 2008 vs. 2016

Source: Oxford Economics, Ecommerce Europe, Statista, 2017

Structural change: lessons from Europe 5.

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In the US, while online-only purchases account for just over 10% of all retail sales, the share is growing quickly. Across the board, consumption patterns are evolving among younger Americans, who are much more comfortable with an online-only experience than their parents. The relentless rise of online shopping is posing a huge challenge for retailers, shopping centres and developers.

By contrast, in Europe and the UK in particular, retailers have by-and-large adapted to the new world of omni-channel. A great example is John Lewis, which has adapted so successfully to ecommerce that online sales now account for over 40% of total sales, with mobile and click and collect sales growing strongly – not bad progress for a retailer that is over 150 years old. Other department store operators, including House of Fraser, El Corte Ingles and FNAC are also at the forefront of multi-channel retaining in the UK and Europe.

So, there is a persuasive argument that in Europe, in the UK in particular, retailers are further along the curve than their US counterparts, in terms of their response to the structural change that has swept through the retail industry and the impact of online. Click and collect will play an important role in driving profitable omni-channel retail – the store network, as we have learnt in Europe, will continue to be a vital cog in the retail distribution network.

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On both sides of the Atlantic, the major landlords are responding to the challenges presented by unprecedented structural change. Whether it be through repositioning offers in favour of F&B or alternative uses such as healthcare, incorporating flexibility into the mix, reducing exposure to fashion, maximising experience and destination appeal or focussing on active management, landlords have been generally robust in their response to the challenging market conditions. They are adapting to change and are innovating.

Landlords:not standing still

Simon Property Group: “Our apparel now is down to the low-40% as an allocation of our GLA. More importantly, when you look at our new deals over the years, we are doing almost 20% less in terms of allocation to the apparel and shoes sector. In food services, the allocation is going up substantially.”

Unibail-Rodamco:The company has focused on its biggest is best strategy, and on creating entertainment destinations to embrace the threat of structural change. “We want to create destinations where people can spend more time. The longer time people stay, the more they spend.”

Hammerson: “Our strategy is focused on prime retail destinations in growing consumer markets, ensuring that we remain one of the winners of retail evolution.”

Landsec:“In Retail, our commitment to creating an outstanding consumer experience, combined with the strength and resilience of our 16.7 million sq ft of assets, means we provide the space where consumers want to shop and retailers want to be, both now and in the future.”

Starwood Partners: When department store Lord and Taylor pulled out of Fairlane Town Center in Dearborn, Michigan, Starwood leased nearly 23,000 sq m (240,000 sq ft) to the Ford Motor Company, who renovated the space to accommodate nearly 1,800 employees. “Not only did this resolve the empty-space issue, but the Ford workforce boosted the scheme’s overall sales, particularly in food and beverage.”

Macerich: “While clearly the retail industry faces challenges, we continue to believe it is all part of an ongoing evolution of the shopper experience. Furthermore, we believe our high-quality portfolio remains well-positioned, as reflected in our strong releasing spreads and tenant sales.”


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The retail sector is going through structural shifts at the same time, in some markets, as witnessing challenging economic headwinds. Retail is not dying, however, it is evolving and embracing change, here in Europe and the US. This response to change is seen across many industries, and is certainly not exclusive to retail.

While there are undoubtedly challenges in the US retail market, the ‘doom and gloom’ is being overdone by some analysts. As highlighted in JLL’s recent paper, ‘Empty to Alive: The Next Use for Department Store Space’, recent department store closures have broadly been absorbed. While the scale of forthcoming closures is likely to be significant, retail property will adapt, as it always has. And responsive landlords and proactive management, both in the US and Europe, will certainly help mitigate the risks.

In Europe, there are also challenges and headwinds. But the market fundamentals, the supply-side situation, the more diversified nature of the market, the broader-base of alternative anchor tenants and the different online dynamics, suggest that the wholesale department store closures underway in the US are highly unlikely to be replicated in Europe.

Resilience wins the daydespite uncertainty and headwinds

Consumers shop in-store and online, they also eat and drink in restaurants and bars. Retailers need stores, and coffee shops and restaurants need space. For investors, the retail sector will continue to offer a stable and resilient asset class. It is imperative to understand the evolving drivers of change and how shoppers’ and retailers‘ requirements for physical space are evolving. It is about identifying ‘relevant’ retail and leisure, located in the right locations with increasing focus on micro-location and asset specifics. The right retail and leisure, underpinned by a proactive, forward thinking asset management platform, has a very bright future. The short-term, knee-jerk response to recent headlines for some is to ‘throw the baby out with the bath water’ - the shrewd investor will navigate the uncertainty, will identify resilience and value, and continue to invest.

Here and in the US, the real risk is the tarnishing of an entire sector through a lack of clear understanding of the fundamentals and changing backdrop. Owners and managers are experiencing and adapting to the impact on performance, which is not consistent across their portfolios. Out-performance is being achieved in certain sectors, geographies and asset types. The opportunity for investors will be to target defensive assets with sustainable income. This will be achieved through asset management, at a price point that does not reflect the relative performance. Applying a macro trend on a sector dominated by micro location factors will result in greater opportunities for the informed.

There is evidence that the future of retail already exists in select locations around the world. As American author, William Gibson, said: “The future is already here – it‘s just not evenly distributed.”

Jeremy EddyHead of EMEA Retail Capital [email protected]+44 (0)20 7399 5779

James BrownHead of EMEA [email protected]+44 (0)20 3147 1155

Colin BurnetDirector of EMEA Retail [email protected]+44 (0)20 3147 1185

capitalmarkets.jll.com

COPYRIGHT © JONES LANG LASALLE IP, INC. AND THE BUSINESS OF CITIES LTD. 2017This report has been prepared solely for information purposes and does not necessarily purport to be a complete analysis of the topics discussed, which are inherently unpredictable. It has been based on sources we believe to be reliable, but we have not independently verified those sources and we do not guarantee that the information in the report is accurate or complete. Any views expressed in the report reflect our judgment at this date and are subject to change without notice. Statements that are forward-looking involve known and unknown risks and uncertainties that may cause future realities to be materially different from those implied by such forward-looking statements. Advice we give to clients in particular situations may differ from the views expressed in this report. No investment or other business decisions should be made based solely on the views expressed in this report

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Structural changes in retail 4%62/,- +!1% /!& /+1 · 2018-10-03 · Structural changes in retail – why Europe and the US are different In the US, 46% of GLA in larger centres is