Frances Baker, Property Director at River Island on the health of retail

Report of 'death of the high street' are definitelt overblown, but the retail markets clearly faces a number of challenges. As a major high street retailer what do you see as the key ones? 

The most obvious challenge is the change in the way people shop and the rise of web sales, whether they are undertaken on mobile devices or via a PC.

Growth in sales on mobile devices is increasing at the greatest rate of all methods. The reasons people visit high streets now are different to the pre-internet world – they may be shopping in the traditional sense but are just as likely to be returning a purchase either bought from another store in a different location, or from the web, or picking up a click & collect purchase.

Costs are of course fundamental, and the business rates issue is increasingly in the press and now, of course, being considered by Parliament. Although we are able to manage rents on new leases, most retailers, including us, have some legacy leases with excessive rent liabilities which, exacerbated by rates, can have an overwhelming effect on the viability of a company.

The rise of e-commerce is obviously a huge driver of structural change in retail, but the whole online supplanting physical stores thinking seems increasingly hackneyed. What is your view as an established multi-channel player?

Not sure “hackneyed” is quite the right word – that suggests it is not a reality. There is no doubt that online shopping is growing at the expense of visits to physical stores. The point, as I have referred to already, is that they serve different needs and can be (and should be) complementary.

Shoppers now want absolute convenience and instant gratification. They don’t really care which channel they use to shop and will use stores and online for different or interchangeable reasons.

Our challenge as a retailer is to make sure that the customer experience is seamless and pleasurable, whether it is in store or online. This means not only encouraging store staff to understand that the web is not a threat, but simply all part of the service to the customer, but also ensuring that the web helps drive footfall to stores if it is more convenient.

What is your property strategy at the moment? Are you still acquiring? 

Yes, we are still acquiring, but only where we can do flexible deals for profitable stores and despite the fundamental understanding that ultimately we don’t need as many stores as we have now.

The key driver is the growth of kidswear, which has expanded across the age ranges up to 12 and including a newborn range. Frequently, we are adding space to existing stores, although we have, on occasion, relocated completely to cheaper locations, where, even with a reduced turnover, we will be able to make a better profit. We are also working on some consolidations where we only need one store in a town.

The key point is that no store is sacred. If a store doesn’t make money, and we are able to exit, we will. The old idea that we MUST be in certain locations simply has no validity any more. With an online store and a wholesale business, we can expose ourselves to customers without an expensive physical flagship, if that flagship is not profitable.

You branched into childrenswear a few years ago and opened your first standalone River Island Kids store last year. How is the childrenswear side going and what are your plans going forward? 

Kidswear is doing very well and is definitely the growth area of the business. In 2018, the increase in physical space increased sales by 9% YOY in this division, although the online growth was more than 3 times this level.

Livingston, Ballymena, Hull St Stephens and Romford are all stores where we have added additional space adjacent to our existing stores, allowing us to regear the leases, create space for kidswear and ensure profitability for a period, whilst also building in lease flexibility.

The relationship between some landlords and tenants can, at times, be a strained one. What opportunities and mutual benefits do you see through closer collaboration with landlords?

The obvious benefit is the ability to keep shops open! In the current climate, both parties can be rather defensive of their positions and sometimes there can be an apparent lack of trust between landlords and tenants.

Whilst most tenants do acknowledge that it is hard to do the deals that are needed to keep a shop in profit in the context of the valuation methods adopted by the investment market, the reality is that the only way retailers can keep stores open in the face of declining sales is with flexibility and reduced rents.

There are other factors which can cause tension – even something as simple as opening hours. I have frequent calls from our managers in big shopping centres asking if it is ok to close earlier than the official centre opening hours as the costs of keeping the store open are often greater than the sales that can be taken.

I acknowledge that in order for local changes to happen our store managers need to engage with centre managers, but it would be helpful for all teams to have support at Head Office level from both sides.

Our experience is that centre managers can take the request to close earlier as a personal affront, but the reality is that we all need to manage costs – shorter opening hours will also save costs on the service charge.

The challenge of capital expenditure is also something that perhaps needs to be considered. Most retailers expect considerable contributions to their shopfitting costs, yet this can be challenging to landlords when they might only be getting a turnover rent.

Perhaps we need to all review how we work out what is profitable, whether that be lower rents, less capital or cheaper shopfits. It is almost as tricky an issue as fixing the way that shopping centres and ultimately share prices are valued.

Turnover rents are often seen as a logical, transparent and fair way to structure rental deals yet they are far from commonplace. Do you see that changing and what are your views on turnover rents generally?

They are actually becoming increasingly commonplace, but it is taking some time to modernise the turnover provisions in leases in the same way that other lease terms have modernised. I think they are only good if there is trust between the parties.

Until very recently, there were often lengthy conversations around the value of a store to the web business. Like most retailers, we keep the two separate. Most landlords now agree that click & collect sales are not allocated to a store, and equally web returns are not deducted from store sales figures.

Many landlords have provisions in their leases requiring tenants to provide sales information. We struggle with this, unless we have a turnover lease – so they certainly provide a mechanism for information.

Personally, I also think that there needs to be an acknowledgement that the historic view of a turnover rent being 80% of the open market rent is ridiculous – turnover rents are a way of making a store viable for both parties. Again, the historic valuation issues around property assets has a bearing on this, but that is almost as difficult to solve as the business rates issues!

The balance of power has historically been perceived to be with landlords, but the playing field is arguably now more level. Are you seeing any other changes in leasing structures? 

Lease flexibility is the key change. We are able to negotiate short lease terms with either Tenant only, or occasionally mutual, break options at regular intervals. In poorer locations, rolling breaks can be agreed. The degree of power that lies with tenants is entirely dependent on the quality of the location (not surprisingly).

Some retailers are also able to negotiate leases paying a percentage of turnover to cover all occupancy costs, so rent, rates and service charge. This is clearly beneficial for a retailer, who will be able to flex their expenditure depending on the level of turnover. And the advantage to the landlord is that they have the lights on.

Incentives are still key to retailers, as often the contribution to shopfitting is fundamental to make a deal work. However, this is increasingly an issue for landlords, who are being asked to contribute potentially several hundred thousand pounds, whilst still conceding a break option after 3 years.

Based on your experience are there any lessons that the UK could learn from overseas markets and are there best practice structures that could potentially be adopted here? 

The length of leases in other markets is generally much shorter than in the UK, although this is becoming more in line. The Belgian system, where leases are for a term of 9 years with Tenant only break options every 3 years, is attractive. Rent reviews don’t exist, but rents are indexed annually.

In Ireland, lease terms are longer, but upwards and downwards reviews are included as a result of a change in the law after the 2007 crash. The US also has short leases of 3 years on average.

However, in Europe and the US, contributions to shopfitting are not as standard as in the UK, so some consideration needs to be given to rental levels reflecting a tenant’s requirement to write the capital expense off over a relatively short period. This would arguably depress rents further.

CVAs amongst retailers are understandably a very contentious issue. Landlord clearly have their view, but how do you see it from the retailers side of the fence? 

I think they create as much tension for retailers as landlords – it is fundamentally unfair that a company, often loaded with debt and possibly operating inefficiently, can create a situation where they reduce their rent roll and operate on a lower cost base than a well-run company with no debt that is unable to create a situation to launch a CVA.

Business rates - most landlords and retails agree that the current system is inequitable. What your views on business rates and what alternatives are there?

This is obviously extremely topical and we (River Island) are increasingly active in trying to lobby Parliament for changes to the system. Quoting the BRC, “retail accounts for 5% of GDP, 10% of business taxation and 25% of business rates.”

The facts show that the system is skewed particularly against the retail sector, where the mechanics of the valuations prevent any rapid reflection of market reality. It is also far too complex – with six different reliefs available, not including transitional relief. All these reliefs need to be funded by other areas of the rating system.

Within the context of a cost neutral solution, in the short term, the removal of transitional relief should ease the pressure for retailers, but will necessarily increase costs for other sectors, most notably what the Government call “Central”, which covers electricity, gas and water supply networks, railways, telecommunications etc. Offices and Industrial, who currently overpay rates by a smaller margin than Retail, may also be marginally worse off.

Annual revaluations would also assist in keeping the tax relevant and moving with the market. The latest 2017 List incorporated a significant change to the Appeals system.

The fact that there are still 120,000 appeals outstanding from the 2010 List goes some way to explaining why a change was considered necessary. However, the Check Challenge Appeal system that has been implemented is unworkable and effectively prevents any appeals to the VO’s view of Rateable Values.

The Digital Sales Tax announced in the 2018 Budget, and due to be implemented in April 2020, was, according to Jake Berry, in some way, to try to ensure that we can level that playing field”.

There is no real indication that this will come close to doing that. In addition, many substantial high street retailers have significant digital businesses, so it is possible, in the absence of any real detail, that they will be penalised further if there is no reform of the business rates system.

Some people believe an increase in VAT will assist, and this is certainly fairer, but I suspect politically less attractive.

If you had just one key message to pass on to Landlords what would it be? 

I think we all need to look to the future and accept that fundamental changes need to be implemented to keep physical stores relevant to the modern world!