History teaches us that as we go through real estate market cycles, the pendulum can swing too far.
Take the period post the global financial crisis, for example. Affected by an external event, the entirety of the real estate sector declined in value, panic spread and city centre London office yields moved out to around 10%. The pendulum had swung too far and it was clear that markets were fundamentally mispriced.
The retail property sector has been out of favour for the last few years, driven by structural trends that have been accelerated by the Covid-19 pandemic. We’ve seen all retail, regardless of the performance of an individual asset, lumped into the same bucket, and the market has reacted accordingly.
Applying the lessons of history, should we question whether the pendulum has swung too far on the downside for retail?
There is no doubt that retail property needed to reprice due to the oversupply of retail space. The convergence of structural trends, which have existed for some time, as well as the pandemic created the perfect storm for retail. The subsequent decline in retail values is, therefore, partially justified… but not entirely.
Sentiment plays a huge part in how markets react – investors are human after all – and investor confidence in retail is at an all-time low. But is there an opportunity for that to change?
While it is clear that ecommerce penetration remains at higher levels than before the pandemic, footfall on the high street since the reopening of the economy is on a positive trajectory, as are retail sales. According to CBRE’s Retail Occupier Survey 2022, occupiers continue to see the value in physical retail space, especially for the purposes of cross-selling products and engaging with customers, which is deemed more effective than online.
There’s also the social element; consumers will no doubt continue to shop online, but physical destinations with a strong mix of shops, food and beverage continue to draw consumers.
So, while there are still structural issues to be worked through, the conclusion that our towns and cities will still need physical retail space in the long term seems a logical one.
Turning to the economics, UK retail yields have expanded so far that even in the unlikely event that yields never come down again, investors can still access an attractive income return for high-quality retail assets that are well let. Add to that the potential for asset management and yield compression, and there is also the possibility of a substantial uplift alongside that income return.
In April, we published our updated house outlook, in which we maintained our view that prime retail would experience a strong recovery. In fact, prime shopping centres emerged as the second most attractive asset class across our European property market forecasts on a risk-adjusted returns basis for the next five years, due to the extent of the yield widening we have witnessed over the last two years.
As we go forward, we are already starting to see the retail sector – and not just retail parks – attract more attention. There is a sense that investors are willing to start looking at the opportunity retail could present, given where some of the asset class is repricing. Could this mark the start of the resurgence? Only time will tell.
Rob Wilkinson is chief executive of AEW Europe