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QD view – time to back retail recovery?

With the re-opening of the economy seeing consumers return to physical retail and the important role stores play in omnichannel retail strategies becoming more apparent, is now the time to look at retail again?

Pricing has already started to recover in the retail park segment of the market (where investor appetite is strong for reasons we’ll come onto later), while NewRiver REIT (NRR) chief executive Allan Lockhart believes we are reaching the point of stabilisation in the shopping centre sector – where values have been in free fall.

This was the basis for Lockhart’s confidence in declaring a target 10% total accounting return for the company, during a capital markets day this week. The company has been fighting fires for a number of years now, but seems to have got the blaze that had once threatened to be fatal under control.

Much of this has been due to the £222m sale of its pubs business, Hawthorn, in August, which has cleaned up its balance sheet and put it in good standing. The sale has allowed NRR to reduce its loan to value (LTV) ratio to 39.8% from a worrying 50.6% at March 2021. The only debt on its balance sheet now is the £300m bond, which matures in 2028.

Crisis averted, the group is now looking ahead with confidence. Through not wanting to catch a falling knife in the years prior to the pandemic, investor activity in the sector had been shrinking and then due to the pandemic last year, dried up almost entirely. Liquidity has now returned, especially in retail parks where around £2bn has been transacted so far this year and real capital value growth is being witnessed.

In the shopping centre sector, Lockhart says valuations are close to stabilising. Indicative valuations for its shopping centre portfolio at September 2021 endorse this view, he states, as does market evidence that transactions levels are comparable to 2015 (by volume if not value).

The group’s retail portfolio values fell by 9.4% in the first half of its 2021 financial year (March – September 2020), and then again by 6.1% in the second half (September 2020 – March 2021). It forecasts a circa 3% fall in the six months to September 2021 – but mainly from its ‘work out’ shopping centre portfolio, which it said it would dispose of by 2023.

From the embers of the fire, NRR is now looking to rebuild. Focus on ‘resilient retail’ will play a large role in this process. Characteristics that underpin resilient retail assets, in its view, are:

  • Location;
  • Convenience;
  • Retail supply (not an oversupply of retail);
  • Online compatible (fulfils role in omnichannel supply chain – ie click-and-collect and returns);
  • Occupier (strong mix and demand);
  • Affordable rents;
  • ESG;
  • Asset management (low intensity);
  • Optionality (alternative uses); and
  • Liquidity (low capital values and wide investor pool).

In essence, it will be retail parks and shopping centres that exhibit some of these characteristics. NRR will look to more double its exposure to retail parks over the medium term to 50% (from 21% currently) by disposing of non-core assets (£290m over the next five years) and redeploying the capital into mainly retail park assets.

Retail parks have received strong investor demand this year due to the growing importance they play in retailers’ omnichannel offering through click-and-collect and returns. Retail parks are often located on the edge of town/city centres, offer free parking and have large footprints. Those that are let at affordable rents provide substantial growth potential.

NRR’s core shopping centre assets (currently 30% portfolio weighting, with a target of 40%) have performed well during COVID, according to Lockhart. The portfolio is almost 97% let and has a rent-to-sales ratio of less than 7%. This is an important ratio in determining rental growth prospects, with the industry-wide recognised ratio of 9% deemed as affordable.

A smaller focus (10% target portfolio weighting) will be on regeneration projects, essentially residential-led redevelopment of surplus retail space. It says it would either sell assets with planning permission in place or partner with a residential developer to bring the projects forward.

With values seemingly close to the bottom, now could be the time to look at retail property again. NRR has put itself in a strong position to rebuild, cleaning up its balance sheet and focusing on assets that plays an important role in omnichannel retailing. Trading on a 40% discount to its pro-forma net asset value (NAV – after the sale of the pub business), it could be an attractive entry point.

QD view – time to back retail recovery?

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