Retailing is going through a structural change and asset values are tumbling as the effect of falling rents and a lack of investment appetite feeds through to the market value of the properties. The impact of the covid restrictions has been to accelerate these changes but also to disguise the positives that the new retailing environment offers. Shopping centres need to change and centre owners need to transform their investments into destination retail to unlock the potential of data and brand cash flows.
Shopping centre valuations
The market value of a shopping centre is an estimate of the price that an investor would pay for the asset in the (current) open market. The conventional rent-based method of valuation, used by all UK property valuers, only looks at the actual and estimated cash flows generated by the occupation of individual shop units and they fail to capture the additional cash flows that can be generated through brand awareness, data targeting and customer loyalty. Yet, these elements are part of the owners’ own assessment of worth. Property valuers need to recognise the new drivers of value and reflect these within the estimate of market value.
In terms of investment, yields have moved out to reflect the uncertainty in the market and the erosion of retailers’ covenant strength in the current market, but are the rents being agreed capturing the impact of online sales, data collection and brand awareness? The shop window is now much bigger than the physical footprint of the shop, so how does the valuer know the real worth of the space occupied? And, in fairness to valuers, often the benefits and details of the new revenue opportunities are not being made available to them; they can’t value cash flows that are unknown to them; hence valuers’ reluctance to change their rent only based valuation models.
The changing face of retail
Retailing is changing. In the UK, pre-covid, 20% of retail sales were online but research shows that, of these sales, 30% are also related to physical stores (i.e. a consumer looks at options in the shops and then orders online). So, given that the rent paid for physical space is historically a reflection of what the space is worth to a retailer, how does this fact impact upon rents? Online sales generated by the ‘shop window’ of the physical store isn’t part of store’s turnover. Similarly, ‘net turnover’ agreements means that unwanted online sales are returned to the store, thus reducing the turnover rent. The relationship and interplay between online and physical sales needs to be made more open. Shop owners and retailers have been sluggish to adapt to the inevitable impact of online and evolution in consumer behaviour.
There is a need for owners to embrace the role of digital retailing and work with tenants to exploit and expand the benefits of data capture for the benefit of both parties; brand awareness opportunities and customer loyalty schemes. But at the moment we are, at best, at a crossroads for the structural change in retailing and specifically for shopping centres or, at worst, we are, with covid, experiencing a perfect storm.
The shop window is now much bigger than the physical footprint of the shop, so how does the valuer know the real worth of the space occupied?
There is so much noise in the market at the moment (retailer failures and covid-19 rental retention) that it would be easy to lose sight of changes that are happening and the opportunities that are arriving. While the loss of any retailer is sobering, it should be remembered that the majority of retailers and restaurants that have gone into receivership are the same ones that were already struggling pre-covid. The impact of the pandemic has just accelerated the natural selection of the retail environment.
Shopping centres need to become retail destinations to benefit from the new digital economy and its interface with the physical shop front. They need to augment the traditional cash flow of rental, whether in the form of a base rent and/or turnover, with the new cash flows created by brand management, data collection and targeted marketing – and a mix of the through customer loyalty programmes, which is a proven driver of value creation.
The interplay between worth and value
So, the worth of a retail destination is being enhanced by new cash flow streams apart from the rental. It is similar to the distinctions in the hotel market between basic hotels that only offer accommodation and spa or sport hotels that offer a whole range of additional cash-generating benefits. Property valuers were quickly able to capture these additional benefits as the model used for valuing such assets (the profits method) looked at all cash flows so that the worth of the asset to the operator was reflected in the rent. This is not the model used for valuing shopping centres, which is still based on the investment method.
And there is the rub. One the reasons that there is an inertia in changing the valuation model to better mimic the worth analysis is that, at least, the current valuation model works with the information currently available to the valuer. To instigate a change, for the benefit of all the stakeholders in the market, the players involved need to work more closely together so that the cash flows that aren’t currently being captured by the valuation are made available to the valuer.
A window of opportunity
Valuation models will not change overnight, but the impact of covid-19 measures has given us a window of opportunity. Valuers are struggling to determine property values at the moment as there is so much uncertainty in the marketplace. Even within the existing investment method, there are unknown cash flows. Equally with no occupational transactions or investment sales in 2020, it is difficult to determine market rents and market yields. So valuers are looking to all stakeholders to help with assessments of market value. This is an opportunity to lobby for a change in valuation model so that market value is reunited with worth.
