Retail real estate investors grapple with  E-commerce

Copyright: David Lawson - Property Week March 2000

Thank goodness for the Internet. Bars and dinner parties have too long been dominated by house prices, Red Ken and the price of Beanie Babies.  Don't expect such excited chatter around the boardrooms of retail investors, however. A collective panic is emerging about the potential for disaster as customers switch from shop windows to computer screens.

  Not everyone  is writing off the sector. 'Go  back 15 years and imagine the reaction if someone predicted that 30% of retailing would desert town centres,' says Martin Barber, chairman of Capital & Regional. 'But we are still here. The high street has adapted, just as it has so many times before.'

  There are plenty of Jeremiahs to contradict him, however. Prophets of Doom or Profits in the Boom, a  summary  by Chesterton International of the potential impact of e-commerce, would throw dinner parties into chaos with its collection of contradictory but equally convincing opinions harvested from both sides of the Atlantic.

  Looking to the US for a lead can be frightening. Up to 17% of American shopping space  will be made redundant in the next five years, according to John McMahan, director for the Centre for Real Estate Enterprise Management.  Broker and attorney Mark Borsuk has also spent years warning that the Internet will rip through the sector, leaving redundant malls for conversion to apartments, serviced offices  or even multi-storey mausoleums.

 On the other hand, Dennis Yeskey, of Deloitte & Touche Real Estate Services told the IDRC World Congress in New York this month that traditional retailers had grabbed 62% of online sales  rather than being elbowed out by upstarts.

 Big names like Wal-mart and JC Penney are setting up parallel operations to their stores, while Internet icons like Amazon are  planning  bricks-and-mortar operations. Gateway computers now has 180 shops and is aiming for 400.

  Closer to home, Littlewoods chief executive Barry Gibson says UK sales will dive 10% in the next decade and be a 'disaster for bricks and mortar retailers'. Geoff Ruddell, European Internet retail analyst for Deutsche Bank is just as succinct: 'Be afraid. Be very afraid,' is the title of the report  he has been sending around the City. He also backs it up with figures, calculating that a mere 5% drop in sales could cut pre-tax earnings by 62%, which in turn would lead to huge pressures on rents.

  Investors are not blind to the threats. Market heavyweight David Hunter, head of RREEF  Investment Managers, says UK values do not reflect e-commerce threats, and has trimmed holdings in high street shops  to 8.5 per cent below the IPD  benchmark.

  But there are nuances even within  this gloom. The UK has  less shopping space per head than the US and much tougher planning laws, so it has escaped the hefty oversupply which has meant US centres have been losing money for a decade. In fact, Hunter is investing in prime locations.

  Paul McNamara, head of research at Prudential Property, which owns  25 shopping centres, says rents  will be depressed  by only 1 to 1.5 per cent a year, dropping to around 0.5 per cent in the North, where PC ownership is lower.

  This unevenness may  be a far bigger headache for investors than the overall impact Ruddell insists will threaten the sector. Different products will be affected in different ways: books, travel services and groceries, for instance, face a far bigger threat than 'touchy-feely' goods like clothes. Landlords should already be looking at the mix of tenants in their centres, rating them by threat to loss of trade. Many are already under pressure from continuing deflation and thin margins, says Ruddell.

  Quality will be redefined not just in security of individual tenants but their attractiveness. 'Centres and high streets will  no longer be a place people must visit, so they must learn to attract them,' says Angus McIntosh, director of European Research at Insignia Richard Ellis.

 He points out that the Internet will drive down shop prices - if only because people will be able to track down the best bargains quickly. But this saving will go on leisure, and these must be integrated into centres and high streets to both retain income and make them attractive for shoppers.

 'We will need a new kind of research which concentrates not on whether rents are going up or down but rates the quality of experience for shoppers,' he says.

 Even individual shops must change, says Rosie Feenan, head of UK research at Jones Lang LaSalle. 'The primary role of retail property will be about arresting attention. It must look, sound and feel great,' she told a packed audience of investors at a briefing in London's Millennium Dome earlier this year.  'Stay longer, buy more' will be the driving force.

 The Internet will provide a complementary force. Simons Property Group, one of the world's largest investors, has put 120 of its centres on a branded web site, enabling customers to search down to individual retailers. This kind of integration throws up problems such as calculating rents for online purchases from physical stores but JLL has come up with a 'wired' lease it hopes will straddle that gap.

  Barber does not see all this as a problem but part of the normal role many investors have ignored for too long. He is not ignoring the Internet: in fact, C&R is working on a complementary strategy which will link bricks and mortar with e-commerce, including web  'portals' for its shopping centres.

 But he told a Henry Stewart conference on retail values and the Internet  earlier this year that the current fears merely revealed existing flaws rooted in the history of  the sector.

 Institutional investors have created a network of in-town shopping centres over the last 20 years which appeared ideal investments because of long leases, solid covenants and service management charges that were paid by the tenants themselves. 'But the management process was so extended and lacked entrepreneurial bite, that over the years most of these centres deteriorated in the retail hierarchy,' he said.

 'They also  did not adapt to the dynamic changes required by retailers. It is amazing to think that 30 years ago, Arndale was the brand to which most shoppers aspired. Today, of course, it is a joke.'

  The modern investor should be far more hands-on, acting as a partner which helps its tenants rather than just collecting rents. It must promote each centre to compete with rivals and the Internet threat. C&R is even dropping the 'Properties' from its name, emphasising the view that the old model of landlord and tenant is obsolete. In the drive for performance, investors must evolve into service providers, particularly the interface enabling tenants to link into the Internet, he says.

  'When we bought the Trinity Centre in Aberdeen in 1993, some 90,000 people were passing through each week. In 1999, while the Aberdeen population remained static, this had risen to 240,000. Is it a surprise that the rents are two and a half times higher?'

  In other words, the threat from the internet should be kept in perspective and answered by efficient and entrepreneurial management. That includes high-quality research on local demand and demographics, careful tenant selection, leisure activities to create a shopping 'experience', continuous  advice and support and pressure on local authorities to ensure good management of surrounding town centres.

 'Everything should be aimed at increasing the profitability of tenants,' he says. Over the last couple of years C&R has increased marketing and promotion spending on five of its centres to a third of the service charges, increased footfall by 7.5% and cut void costs by 13%. Yet total service charges have fallen 0.7%.

  There is also a point when investors should realise that property skills are less important than business skills to enhance values, says Barber. That is why he is transferring six of his 'stabilised' centres into a joint fund with PRICOA, releasing capital to develop the remaining four.

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