FSP Retail Blog

Sustainable Investment – Trading Risk

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With schemes in the hands of administrators, debt driven ‘fire sales’, the high cost of filling voids, continuing deterioration in the financial health of occupiers and worries about the future of the UK economy, beleaguered investors can be forgiven for feeling unenthusiastic about retail property.

Given the right knowledge however, it is still very possible to acquire assets with growth potential and to create conditions which will stimulate sustainable income growth.  This Product Focus is the second in a series of three, covering Corporate Risk, Trading Risk and Income Growth.  The series is intended to illustrate how appropriate pre acquisition research and good asset management can have a positive influence on income growth and potential exit yields.

If Corporate Risk is the risk to specific shops which arises through the overall financial performance of the retail chain, Trading Risk (sometimes known as Unit Risk) is the risk which arises through the performance of individual outlets within a specific asset.  This most commonly occurs where the trading performance of a particular store is such that the level of rent which can be sustained by its turnover is less than the passing rent on the unit. 

While some healthy multiples may be able to support this situation for a number of years (either in the hope that the situation improves or because it is important to maintain market presence), Trading Risk becomes particularly important when Corporate Risk is high.  The spate of pre pack administrations between 2008 and 2010 saw huge numbers of unprofitable stores closed, with towns such as Blackpool, Coventry and Bradford becoming top targets for the accountant’s axe.

Whilst these closures may have felt inevitable, it is possible for asset managers to understand the specific trading risk within assets and minimise potential for store closures by taking steps to ensure that sustainable rents are on balance higher than passing rents.  For potential investors, knowing the scale of trading risk and understanding how much growth is required to improve turnover to sustainable levels should be an essential element of pre acquisition due diligence.

Understanding Trading Risk

The key to understanding Trading Risk at an asset is understanding turnover.  A small number of locations collect occupier turnover statistics however, for those less information rich, the most common approach is to undertake an audit to estimate selling floor space and turnover.  From detailed analysis of individual occupier’s accounts, FSP project typical rent to sales ratios and these are used to estimate the sustainable rent for each unit in the asset.  When compared with passing rents, the degree of variation in the sustainable rent indicates whether a retailer is ‘vulnerable’, ‘viable’ or ‘thriving’ in terms of Trading Risk.  Results are then plotted on a scheme plan to visually indicate the location of specific units and potential problem malls.

The diagram below from a project in the Republic of Ireland illustrates how assessments of each individual unit in a tenancy schedule can be aggregated to indicate the proportion of total scheme rental income subject to Trading Risk.  In FSP’s experience, typically about one third of shopping centre rental income is currently Vulnerable (i.e. sustainable rents are 25% below passing rents) suggesting that the particular scheme might expect increasing vacancy difficulties in the near future.  However, the analysis also shows that a 12% increase in turnover would be sufficient to return the scheme to a more ‘average’ level of risk.

There have been many occasions where strong performing stores have been closed as a result of failures elsewhere in a chain and it is therefore important that assets are considered in terms of both Trading Risk and Corporate Risk.  FSP uses a Viability Matrix to show the combined impact of Corporate and Trading Risk on scheme rental income.  On the Viability Matrix below, Corporate Risk is shown along the vertical axis and Trading (or Unit) Risk is shown along the horizontal axis, with the ideal balance of rental income (indicated by the Percentage figures) being located in the bottom right hand corner of the matrix.  Asset Management activity can then be focussed upon the those occupiers who account for the 23% of rental income who fall within the Head above Water & Vulnerable, Healthy & Vulnerable and Very Worrying & Viable cells.

The combined assessment of Trading and Corporate Risk is a tested and successful approach which locates retail risk within assets and establishes the scale of improvements required to successfully ameliorate unsustainable occupiers.  Deployment of the methodology has achieved notable success including the reduction of rental risk from 43% to 7% at one prime asset, the migration of sustainable rents from 20% below passing rents to 10% above and a 76% growth in rental income over 4 years. 

The final Product Focus in this series will discuss the main techniques used to identify opportunities and achieve this Income Growth.  More information can be provided through FSP’s consultants

Retail Data, Research and Consultancy

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In business, the only reason to spend money is to increase profit.  The expenditure is either to reduce costs or to improve revenues.  The most successful FSP work yields returns that are many multiples of its cost.  Internal FSP analysis shows a clear and direct link between client returns and the depth of FSP involvement, the strength of the client relationship.

There is a distinction between data, research and consultancy.  The difference can be illustrated by analogy.  Data can be compared with the soil, research with the seeds that grow from the soil and consultancy with nurturing the seedlings from germination into healthy plants.  Consultancy is therefore a service that cannot be done in isolation.  The provision of a service immediately creates relationship.  Continuing the analogy, both in specifying the seeds to be planted and in creating the environment within which the seedlings can grow, there needs to be liaison with the landowner or his manager.

Running a business is a team effort.  New members need a time of induction and familiarisation.  Why should it be different for external service suppliers?  Since few of us have experience of working with a gardener, perhaps another analogy would be helpful.  Most people prefer to have their hair cut and styled by a specific person with whom they have an on-going relationship. 

As I write these words, a colleague is holding her monthly drop-in “surgery” in the offices of a client.  As part of the service, FSP makes time available to answer questions and contribute ideas on topics raised by members of the client team.  It’s a great way to build relationship to the mutual benefit of both parties.  It allows the FSP input to be more fully explored and more widely applied when there is a strong and on-going relationship.  It is no coincidence that the FSP work for this client is worked harder and has thus yielded returns that are amongst the highest.

Sustainable Investment - Corporate Risk

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With schemes in the hands of administrators, debt driven ‘fire sales’, the high cost of filling voids, continuing deterioration in the financial health of occupiers and worries about the future of the UK economy, beleaguered investors can be forgiven for feeling unenthusiastic about retail property.

Given the right knowledge however, it is still very possible to acquire assets with growth potential and to create conditions which will stimulate sustainable income growth.  This Product Focus is the first of a series of three, covering Corporate Risk, Trading Risk and Income Growth.  These will illustrate how appropriate pre acquisition research and good asset management can have a positive influence on income growth and potential exit yields. 

Path to Failure

Corporate Risk is the risk to specific shops which arises through the overall financial performance of the retail chain.  The spate of administrations between 2008 and 2010 saw a number of good performing local stores closed as a result of corporate failures such as Woolworths, Bay Trading, Barratts and Faith.  However, as the chart above demonstrates, the financial trajectory of the majority of larger organisations is known and analysis can therefore be quickly undertaken by FSP to assess the threat of corporate risk to rental income for any retail asset.

Positive Stories

Although corporate failures have produced many headlines, the retail industry is not all doom and gloom.  As well as those flat or downward financial health trajectories shown for Barratts, Faith etc., a significant number of retailers are healthy or have an upward trend.  These include LK Bennett, Iceland and Urban Outfitters, shown by the above chart.  Clearly, understanding where the balance falls between those stronger and weaker retailers is an essential step in assessing the financial position of individual assets.  A key part of FSP’s service is therefore to quickly link corporate health to passing rents in order to pinpoint potential income risks.

Stronger Assets?

FSP has matched Corporate Health to key occupiers in order to illustrate the current position for major retail asset classes.  The chart shows the financial health of the top 100 occupiers (by number of outlets), present in major shopping centres, retail parks and factory outlets.  For all three classes, the proportion of Very Worrying retailers is below FSP’s retailer average while the proportion of Healthy retailers is above average.  Although the balance will be different according to the particular tenant line up in individual schemes (which must therefore be carefully scrutinised), this indicates that there is less risk and stronger income growth prospects in these asset classes than elsewhere on the high street.

Although this is a relatively sunny picture, about one third of retailers currently fall into the Head Above Water category and higher concentrations can be seen for the three asset classes than for FSP’s database of monitored retailers.  It is therefore very important to understand direction of travel and assess the Trading Risk of specific stores.  For example, amongst Retail Parks, Head Above Water occupiers tend to be traditional bulky goods occupiers whilst Healthier occupiers tend to serve the more profitable fashion, personal goods and grocery markets. 

Where turnover supports a lower Sustainable Rent than Passing Rent, unprofitable stores may become targets for future closure, particularly where urgent corporate restructuring is required to alleviate Head Above Water health.  To reduce this ‘Trading Risk’, turnover growth is essential and FSP will develop the concept of combining Corporate and Trading Risk with Asset Strategy in a following Focus review.

The classification of individual retailers by Corporate Risk is available through FSP’s SnapShop on-line directory or through FSP consultancy projects.  For more information, please

And Finally...Dying for a good pizza

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FISH

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• the consumer’s own ‘thinking age’: i.e. how young or old do I feel? 
• the image the consumers wishes to project with the merchandise they are seeking to buy: i.e. stylish or safe?

	Young	Assured	Family	Classic/Old
Town Centres	14%	20%	51%	15%
Shopping Centres	24%	20%	46%	10%
Regional Malls	20%	31%	40%	10%

Geoffs View - The Retailing Outlook

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Unless landlords take the initiative, town centre retailing will die out within a generation in a large number of middle sized UK towns.

The migration of shopping away from town centres is accelerating. It is going to the more efficient and convenient supermarkets, to out-of-town retailing and to the internet. Without action, the UK will follow the United States into suburbanisation with largely lifeless town centres. To be vibrant and viable, town centres need to find a new role providing an enjoyable experience that cannot be matched on-line or by the grocers. In towns that fail to do so, retail rents will continue to decline.

Meanwhile, the grocers are expanding aggressively. Tesco plans to add 2.4m sq ft, 26 additional Tesco Extras and 181 Tesco Express. Asda hopes to add 3.75m sq ft of non-food space in 150 new Asda Living stores. Not much of this additional 6m sq ft will be in town centres.

The internet is getting more powerful. In the UK, according to FSP research, more than 50% of shoppers already make some use of the internet in their shopping. In the US, more than 40% of US retail sales are influenced by the internet. This is expected to reach 50% by next year.

A recent survey of comparative high street and internet prices emphasises the web’s cost advantage. On a basket of 10 fast-moving consumer goods, including an i-Pod, trainers, a watch, coffee maker and a TV set, the average cost in 11 town centres, that included Manchester, Nottingham, Sheffield, London and Bristol, was 31% higher than the lowest on-line price. Not a very balanced comparison but in price conscious times, the difference is striking.

Retailers meanwhile are under the pressure of an uncertain outlook for consumer expenditure. The common response has been to move towards a multi-channel offer, exemplified by John Lewis and Next. The Partnership has made the Commercial Director responsible for both store expansion and the multi-channel offer. Next has announced that its further expansion overseas will be solely via the internet, not through stores.

The current focus for most retailers is to cut operating costs. The opportunities to enhance gross margin through the globalisation of the supply chain are largely exhausted. Staff and occupancy costs are their two largest operational costs. With excellent customer service the key advantage over on-line retailers and grocers, training and retaining good shop staff is essential. It is therefore no surprise that the pressure to contain occupancy costs is immense. The shedding of uneconomic stores through pre-pack administrations and CVAs is an alternative way to reduce operating costs.

With retailers having no overwhelming need to trade from town centres, landlords and the local authority have the responsibility to maintain town centre vitality and vibrancy. A new environment calls for a new form of response and perhaps the BIDs vehicle will be sufficient. Let’s hope so.

Ain’t No Soylent Green

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With celebrities like Jamie Oliver helping to increase the popularity of home cooking, the supermarkets have become quite adept at providing a wide range of herbs and spices for the UKs budding chefs. There are some ingredients, however, that would prove difficult for even the revered Heston Blumenthal to come by…freshly ground black people, for example!

Penguin Group Australia have allegedly had to fork out £12,000 to fix a typo in cookbook The Pasta Bible due to a recipe for spelt tagliatelle with sardines and prosciutto calling for ‘salt and freshly ground black people’!

The books are not being recalled, so expect to see a couple turning up on eBay any day now!

Future of town centres hinges on planning policy

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Managing Director Geoff Nicholson comments in Retail Weeks' Letters To The Editor on an article from issue 12th March 2010. Link unavailable.

The recession was triggered by failure to control market trends, which are driven by often short-term investor interests, not by consideration of longer-term social benefits. So Catherine Tobiasinsky’s plea (RW, last week) that planning policy should not subvert market trends in breathtakingly short-sighted.
Yes, in-town retailing has been under pressure from out-of-town locations. But the economic and social costs of allowing town centres to die are incalculable. The Preston Tithebarn issue is nothing to do with its in-town location and everything to do with its potential impact on neighbouring towns.
It is the charge of the planning system to reconcile the demands of the market and social need. It makes sense, for the interests of society, to flavour in-town development. This is not to claim out-of-town schemes are never appropriate: the two are not mutually exclusive.
The bleak outlook for in-town retailing reflects the historic failures of planning policy. But to advocate its abolition is to remove all hope for a better future for town centres.

Geoff Nicholson
Managing Director
FSP Retail

Why not add your comments below?

Secondary Shopping Centres – The elephant in the room

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To the Royal Institution, founded in 1799, to witness the retail property industry discussing secondary shopping centres in a suitably historic setting. There was much to marvel at, not least that the group on whom shopping centres depend was entirely unrecognised. Shoppers, who ultimately pay the rent, were effectively ignored.

Ray Morgan, Chief Executive of Woking Borough Council, implored shopping centre developers to consult “the local community”. Since this appears to be code for talking to the local authority, this does not qualify as taking shopper views into account. Richard Akers, Chief Executive of Land Securities Retail, and BCSC President-Elect, was the sole exception. He acknowledged that as landlord, Land Securities carries out substantial consumer research which could be, but generally is not, shared with tenants.

The useful question to be answered is not, “Why does the property industry ignore consumers?” but rather “How can the property industry take consumer preferences and behaviour into account?” Viewed in isolation, research is expensive; viewed within the context of the decisions based on research results, the return on research investment can be multi-fold. Of course FSP has a vested interest but can show solid evidence that consumer research is justifiable, even necessary, in maximising ROI on many retail property assets.

What matters in considering the cost of research, as for most goods and services, is not the initial outlay but the cost per use. The FSP experience is that broadening the application of research results in a dramatic reduction to the cost per use. This requires an ability to take a strategic view – standing back far enough to comprehend that it is an elephant.

Fashion Police

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Hugo Boss workers never fear, for Danny Glover has got your back.

The Lethal Weapon star has reportedly appealed to Hugo Boss AG to reverse its decision to shut down a suit plan in Ohio after taking a tour of the operation earlier that month. Glover also led a boycott of Hugo Boss formal wear at the Oscars this year, writing to every nominee asking them not to wear the label.

Unfortunately, though Glover’s attempts were no doubt appreciated, Hugo Boss has said the decision still stands. 

Oh dear.

Glover: You’re too old for this…*

 

*Alternative endings include ‘Chuck Norris would’ve done it better’

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