European retail property recovery spells welcome news for investors

European listed real estate has enjoyed an incredible rally over the past 12 months, rising over 75 per cent from mid-March 2009. Direct property – that is bricks and mortar – has been enjoying a revival too. In the UK, for example, declining returns bottomed out in the summer and steadily improved through the remainder of the year. Having been hit hard as the market declined from mid 2007 to mid 2009, the retail sector has been the best performing sector of the UK direct property market, up by 20 per cent from the bottom in June 2009, outperforming the office and industrial sectors. It’s been a similar picture in continental Europe too. The recovery in commercial property has been welcome news for investors. The good news is we still see plenty of opportunities in the largest sector of all, retail, which includes shopping centres, unit shops and retail warehouses. Comprising close to 45 per cent of the listed property market in Europe, retail has been the sector of choice for us at SWIP throughout the economic downturn – and there is still a lot to like. Surviving a cold winter On the continent, the retail sector has braved the freezing winter we’ve just endured better than could have been reasonably expected. There are a number of reasons for this. The finances of continental European households are in much better shape; this should not have come as too much of a surprise, though, due to their relatively low levels of debt, especially when compared to us in the UK. There is far less use of credit cards on the continent and the level of mortgage debt is also far lower. Declines in consumer spending, therefore, have not been so severe. Retail rents in Europe are also generally much cheaper than in the UK, so are less of a cost burden for tenants. European rents are indexed annually to inflation; in the UK, meanwhile, rents are reviewed every five years. And European landlords typically have greater access to information on their tenants’ turnover, making it easier and quicker to spot those that are facing financial problems. Over the last two years, the UK market has certainly struggled, with a number of high-profile chains going into administration – Woolworths, MFI, Zavvi, Thresher, Birthdays and Adams children’s clothes – many through indebtedness. Arguably, this can be seen as a good thing for the retailers that are left behind; they competitive positions clearly improve through the removal of one or more competitors. The failure of Allied Carpets, for example, has left the door open to Carpetright to gain much of Allied’s market share. While these failures have led to a number of vacant units, this has been less pronounced in major towns and large shopping centres. Retailers on the continent, though, have proved much more resilient with very few retail failures to name. Despite declining consumer spending, some chains have even been expanding across Europe. Primark, New Look, H&M and TK Maxx are among the firms that have benefited from shoppers trading down on brands and looking for good value and large discounts on high street prices; these companies have been leasing new stores over the downturn. At the other end of the spectrum of retailers, specialist companies such as Apple with a strong brand, and Hobbycraft with a specialist product range, have also been gaining purchase. One of the long-term benefits of the retail market, whether on the continent or here in the UK, is a restricted level of supply. Town centres are generally protected by local government planning and conservation laws that restrict where new sites can be built. Where schemes do get the go-ahead, site assembly issues mean that a new retail scheme can take up to ten years to complete, which makes oversupply much less likely. On the other hand, offices can generally be redeveloped or built in a couple of years – and it only takes a matter of months to assemble an industrial unit. Internet sales are often cited as a threat to the future of in-store shopping, but most retailers still need a bricks-and-mortar presence and continue to seek good units, whether in profitable neighbourhood centres or as flagship stores in well-located, dominant retail schemes. E-commerce sales have been growing across Europe, and while they have more than doubled on a per capita basis from 2005 to 2008, they are still quite low, at less than 5 per cent of total spend, which includes online ticketing and other formats such as the online auction service ebay. Growing, liquid and full of opportunities A growing trend in the past year has been for companies in the retail and banking sector to become more efficient and make their real estate work harder for them. As a result, the retail sector has been responsible for 44 per cent of total European corporate sales over 2009, according to research by CB Richard Ellis (CBRE). This is happening for two reasons. Firstly, supermarket chains in France, Finland and the UK amongst others have recognised that they can take advantage of their covenant strength and lock in low rents for long periods by executing a sale-and-leaseback programme on their real estate. Secondly, financial institutions have also disposed of many high street bank branches, boosting the retail share of corporate sales significantly. In this second case, many of these sales have been forced by weak financial positions, providing interesting opportunities for real estate investors. These deals have been an important driver of the real estate market and especially the retail sector. The bond-like characteristics of sale and leaseback transactions are attractive in the current market because they match the preferences of a range of investor types for good covenants, long leases and a fixed or indexed rent. The outlook for European retail property The outlook for European real estate, of course, depends on the continued health of the economy. After a recent barrage of negative economic news stories, the news flow has changed to one of recovery and growth. The negative news stories included surprisingly disappointing quarter four GDP growth and scare stories that the problems in Greece might spread elsewhere in southern Europe. However this mood has passed as recovery fears have dissipated. We’ve seen a rebound in survey indicators, which have regained their upward momentum, and the apparent limitation of the sovereign debt crisis to Greece alone. Indeed the lasting outcome of the Greek debt crisis appears to be a weaker euro, which seems to have been welcomed throughout Europe. Economic growth is expected to average 1.3 per cent in 2010, but to accelerate to an above trend 2.1 per cent in 2011. Retail still offers bargains We believe the listed sector, retail – and European retail in particular – remains an attractive place to be. Many European retail companies still trade on discounts to their net asset value, and with dividend yields of 5 to 6 per cent, the income characteristics commonly associated with property exposure can be delivered quite admirably. For more information please visit: www.swip.com _{SWIP first began managing sustainable portfolios in emerging markets almost five years ago. Meanwhile, we have more than 20 years’ experience managing socially responsible portfolios in developed markets. The identification of companies focusing on long-term structural change will become increasingly important in generating outperformance. We are a recognised leader in the field of sustainable investment and provide clients with consistent, long term risk-adjusted returns from portfolios that incorporate ESG factors into our disciplined, fundamental investment process.}