Currently, there is a lot of uncertainty around Brexit – no one knows what will happen until we get the details of any final deal. However, it is worth noting that we will still be in the EU until March 2019 and part of the Single Market and customs union and subject to ECJ jurisdiction. In addition – provided a deal is reached – there will be a transition period until the end of 2020. So, in practice, nothing may change for a couple of years.
However, if there is no agreement under the Article 50 process, there will be no transition deal or implementation period. This leaves very little time to come up with alternative plans before March 2019 and is known as the ‘cliff edge’.
If there is ‘no deal’, there will be consequences across a number of areas. The UK would not be legally obliged to pay its ‘divorce bill’, which would impact adversely on the EU budget. While the UK might save money in this instance, relations with the EU would be damaged.
There would also be huge uncertainty over citizens’ rights on both sides of the border, while there would likely be new tariffs (and regulations) on goods and services travelling in both directions. There is particular concern over the consequences of a hard border between Northern Ireland and the Republic of Ireland.
In short, there is a raft of Brexit-related issues which are likely to affect UK retail – and they are complex. This post is not an exhaustive analysis of all these issues, but hopefully addresses some of the most important ones.
Macro-economic: Post-referendum, the UK economy has held up well, although growth has slowed and the consensus among economic forecasters is that the UK is in for a period of weaker growth, caused by business and consumer uncertainty. Lower growth has obvious implications for the labour market, consumer spending and confidence, the housing market and, of course, retailer demand.
Supply Chains: While one of the government’s central aims is to enjoy ‘frictionless’ trade with the EU, no one knows what the tariff regime will be or how rigid border controls will be. Retailers may therefore need to reconfigure their supply chains to fit in with the new trading framework post-Brexit. As at October 2018, there are concerns about progress on the final UK-EU trading arrangement, the possibility of a ‘cliff edge’ and the impact this might have on supplies. For example, the NHS is now making contingency plans to maintain the supply of medicines in the event of a ‘no deal’ Brexit. Other sectors may also start to plan for this scenario, so we may see more evidence of stockpiling. Silly though it may seem, it is entirely plausible that we see panic-buying among consumers as key dates approach. Expect scare-mongering in the press (justified or otherwise) around the security of food and pharmaceutical supplies. Retailers and consumers will be increasingly nervous!
Currency: Since the referendum, the price of Sterling has been volatile but remains down by 10-15% against the major currencies. This is a double-edged sword for retailers. On the one hand, it makes imports more expensive – so food prices have been increasing for example (around 50% of the UK’s food is imported, some 30% from the EU). On the other hand, it makes exports cheaper. So, UK-based online retailers selling into the Euro area currently have a competitive advantage. The recent weakness of Sterling has also helped to maintain the attractiveness of UK commercial property for international investors, although this has been of little benefit to the retail sector which is being driven mainly by structural change. Expect further currency volatility in the coming months, as the Brexit negotiations play out against an increasingly fraught and acrimonious backdrop.
E-commerce: While the recent weakness in the Pound is, on paper, good for UK exports, it may not be enough to offset the tariffs the EU normally imposes on a “third country” – which the UK will become on leaving the EU. Moreover, exporters cannot rely on the pound remaining at its current low level. However, UK online retailers could be subject to any tariffs (and other regulations) the EU decided to impose, which might prompt major companies to establish bases in the EU in order to sell goods there. Conversely, EU-based retailers selling in to the UK (a growing market of 65 million people, with the highest per capita online spend in the world) would likely face similar barriers – hence no one benefits.
It is also worth pointing out that we should perhaps not focus too much on selling into the EU, given that China and the US are the largest international markets for UK online sales (IPSOS/PayPal). The EU accounts for a steadily falling proportion of the global economy/population and there are many other larger and faster growing (and English-speaking) markets around the world.
Regulation: will remain a key driver of the retail sector going forward, not least in the areas of food standards, consumer rights, health & safety, employment, the environment and taxation. While the UK will technically be an independent country following Brexit, there could be a large degree of alignment with EU regulation, in order to maintain market access. However, it is important to remember that not all regulation affecting UK retail is EU-driven e.g. the new regulations on lease accounting apply globally.
Key tourist locations like Bath are benefiting from the weak Pound.
Tourism: The current weakness in the pound has also boosted tourism, both in terms of attracting more international visitors and encouraging more Brits to holiday at home. So, retail, hotels and attractions in key tourist locations such as London, Edinburgh, Bath, Oxford and the Lake District are likely to benefit. However, it is worth repeating that the Pound may experience a period of volatility, so the current advantage may quickly disappear.
Migrant Workers: workers from EU countries account for 8-9% of employees in the distribution, hotels & restaurant sector and around 9% in the construction sector (foreign workers account for around 50% of the Battersea Power Station workforce, so it can be much higher in some cases). A restrictive future immigration policy could therefore impact on the retail/retail property sectors by reducing labour availability and pushing up costs which are already increasing on the back of higher inflation and higher business rates. While migration to the UK will not cease after Brexit, companies may find it more difficult to bring lower skilled workers from abroad to fill roles in areas such as warehousing and agriculture. This may push up wages in some areas. However, the flip side is that this may encourage more investment in technology, leading to improved efficiency and productivity over time.
And finally… while the UK’s impending departure from the EU is currently dominating our domestic politics and the media headlines, technology is likely to have more of an impact on UK retail than Brexit or economic factors (arguably it is already). Indeed, there are some suggestions that a million jobs could be lost in retailing over the next decade because of increasing automation. This, and the growth of online retailing (which now accounts for nearly 20% of retail sales), are both major structural changes and have nothing to do with Brexit! Globally, many other retail markets are facing the same challenges.
So, what does Brexit mean for retail property?
While the nature of the deal we strike (or don’t strike) with the EU may have an impact, structural change is currently the main driver of the retail market – not Brexit. Until we know the details of the agreement, is it is difficult to predict how Brexit might impact on other key drivers such as the economy, interest rates, supply chains, jobs and so on.
Arguably, as a largely domestic function, retail will be somewhat insulated from the impact of Brexit – people will still shop. However, at the same time, the supply chain to the shop/warehouse could be significantly affected, impacting on product availability, pricing, margins and sourcing options. While it will be largely down to retailers to adjust, cost changes will put pressure on their ability to pay rent. There would also be an impact on space requirements for shops and warehouses, as well as access and delivery.
With online sales approaching 20% of the total, physical retail is struggling and, if anything, Brexit is likely to reinforce current trends. In performance terms, retail is the laggard of all the property sectors and is significantly behind on rental growth, capital value growth and total returns – a trend we do not see changing short term. Retail yields have already softened across much of (but not all) the market and a further outward shift is in prospect over the coming months.
That said, there are some bright spots. Central London shops, regional shopping centres and the best retail parks continue to experience steady retailer demand and rents are edging forward. Other retail segments we see as relative ‘safe havens’ in the current climate include Designer Outlet Centres and supermarkets. Elsewhere, however, rental growth is at best flat and at worst negative for much of the secondary market.
Retail investment volumes have already fallen sharply on the back of the general woes in the sector, notably for shopping centres and high street shops. Local councils accounted for around a quarter of shopping centre deals in the first nine months of 2018, in line with a drive to invest in their own towns by taking control of strategic (and sometimes failing) assets. There has also been a strong London focus, with the Burlington Arcade deal (£296.5m) and Shopstop Clapham deal (£130m) together accounting for 45% of shopping centre transaction volumes.
On a positive note, activity in the out-of-town market (food and non-food) has remained relatively buoyant. The retail park market has so far recorded three £100m plus deals, with a range of UK and international investors active, including a UK retail debut from South Korean investor Hana Financial. Recent supermarket transactions have included a number of stores on long index-linked leases to the major operators.
In essence, while overall investment demand has cooled, a number of investors are seeking to acquire assets in the less competitive environment, with well-let and well-managed schemes continuing to see good demand. While the institutions remain focused on the best stock and secure income, the more opportunistic buyers are willing to travel further up the risk curve in search of higher returns. No doubt some of these players will see opportunities around Brexit and will be watching carefully.
There have been some concerns among analysts about the retail-focused REITs – which trade at significant discounts to net asset value – that valuers have not been as aggressive as might have been expected. This may change in the coming months, as more evidence comes to light. However, our view is that not all retail can be ‘tarred with the same brush’ and parts of the sector are undoubtedly over-sold. This may offer mis-priced opportunities and equity investors should lean on their advisers to make the most of these.
In the occupational market, the worst of retailer CVAs appears to be over, although further corporate failures cannot be ruled out. However, a major theme for retailers going forward will be right-sizing, whereby even the best performing operators will continue to reduce their physical footprint. Inevitably, this will begin with less profitable stores in weaker, secondary locations – leading to a further polarisation in values between prime and secondary retail.
Despite the current structural challenges, we believe that the post-Brexit UK retail market will still be attractive to international retailers and investors. It will remain one of the most innovative and dynamic retail markets in the world, with some of the wealthiest and most sophisticated consumers. For expanding international retailers, the UK is likely to remain the first port of call for many, not least as a bridgehead to the European mainland.
At some point, there will be greater clarity around Brexit and the growth in online will begin to plateau; and retailers will have made more progress on re-configuring their estates to suit the omni-channel world. However, this may take some time and, until then, the earthquake currently shaking UK retail to its foundations is unlikely to subside.