Learning the Lessons from Retail
Hindsight is a wonderful thing. As the Retail sector licks its largely self-inflicted wounds, much pondering as to where it all went so wrong. Questions are being asked now when it is, in many cases, too late – after all, who asks questions when you are the darling of the property world (as Retail was for so many years), delivering seemingly guaranteed rental growth and consistent annual returns in the high teens? What can offices learn from retail’s ungainly fall from grace?
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I’m pre-empting two schools of response to this exam question. One, retail and offices have nothing in common, the rise of online is specific to retail and irrelevant to offices. Two, on the contrary, they are both major real estate property classes subject to the same macro-economic forces and capital market cycles. To my mind, both schools of response are fundamentally wrong.
The rise of online is erroneously accepted as the sole cause of physical retail’s supposed downfall. The reality is infinitely more complex and ironically, a reluctance to look beyond the rise of online to the real root causes of malaise is an ongoing issue that is holding the retail market back. Offices clearly have their own structural challenges, not least the pandemic-induced rise in working from home. No one needs physical stores any more as everyone shops online, no one needs offices any more as everyone is working at home. Death of the High Street, Death of the Office. Both ridiculous notions, of course, but the tip of the iceberg in terms of wider structural challenge.
Just as retail has had to work out what a multi-channel world looks like, offices will have to work out what a hybrid (or should I say dynamic?) working model means in reality. I would venture that retail is further down its respective learning curve, but the journey is never-ending. Lesson one for offices? There are no constants, just a continually shifting reality, “old school” thinking and metrics have gone out of the window and the name of the game is to evolve and be proactive, rather than simply wait for change to come.
The rise of online was just one of the ’10 Structural Failings of Retail’ we have previously identified in our ‘Price of Change’ Research. To simply overlay these ‘10 Structural Failings’ on the office market and see how the template fits misses the point – retail and offices are fundamentally different asset classes, subject to their own dynamics and nuances (which is why I rubbish the second school of response, as outlined above).
That notwithstanding, there are still more generic lessons that I believe offices could learn from retail. To put forward four:
- The risk of oversupply. A build, build, build mentality from the 1990s onwards has come back to haunt the retail market. All accelerator, no rear-view mirror. No understanding of obsolescence or the process of managing down space. An obsession with development pipelines, scant regard for the life cycle of existing stock.
- (Un)affordabilty. Affordability is a far more measurable and quantifiable concept in retail (not the right forum, but happy to walk anyone through store contribution/sales density/effort ratios/ROIC etc etc). But how many “record rents’ set and celebrated in retail in the 2000s have proved sustainable to this day and haven’t been drastically re-based? Very few. Affordability PTSD means I wince when I hear the phrase “record rents”. I still hear it a lot in an office context.
- The dangers of under-investment/complacency. No one felt the need to invest heavy capex into a retail asset that was delivering fantastic returns. But nobody knew what to do when it didn’t. Too little money was thrown at the problem too late. A measured and staggered programme of capital expenditure over the lifecycle of the asset would surely have been a better approach. With tighter ESG regulation an inevitability (rightly), the need to continually invest will rise rather than recede. The notions of cash cows and geese laying golden eggs is diminishing.
- Occupier is King. Landlord and tenant relations in retail have historically been more fractious than in other property classes and the balance of power has shifted over time. Historically, retail landlords held most of the cards - at best, making no effort to understand their occupier base as long as they paid the rent, at worst, treating them almost with contempt. The pendulum of power has since swung the other way and many of these inequalities have been painfully re-balanced. A different occupier base maybe, but office landlords must surely learn the value of listening to their tenants and the benefits of close collaboration rather than conflict.
To return to the second flawed school of reasoning: the dangers of generalisations and assumption that real estate is just a commodity. There are good and bad assets in any property sub-sector and simply applying blanket assumptions based on sub-classes or geographies is very limited investment approach (and one that only works in a bull market). Deeply forensic, strategic, asset-specific stock picking is the way forward. Many retail investors have only learned this lesson the hard way.
Hindsight is a wonderful thing. But foresight is infinitely better.
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