Peculiar trends in the UK commercial property market

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Whilst demand has plunged following the exodus of tenants, contrary to expectations, the market is currently experiencing a rise in commercial property rents, according to listed companies and published indices.

Sector performance

With the Brexit uncertainty continuing to impact business and investment sentiment, the UK has faced slower than expected GDP growth in the first quarter at 0.2%. This was felt by market players in the retail sector, with Toys R Us (UK) and Maplin entering insolvency, as well as others like New Look, Poundland, Marks & Spencer, and Mothercare closing dozens of shops. Having announced closures of 31 out of its 59 department stores, House of Fraser is also one of a number of retailers struggling amid falling consumer confidence, rising overheads, the weaker pound and the growth of online shopping.

Whilst footfall remains a challenge for physical retail, with further contractions recorded in Q2 and an average per annum contraction of 1% over the decade. Despite this, the Cushman & Wakefield Q2 retail update suggests that Consumer Confidence has held relatively strong, with the Index for Q2 averaging -8 (GfK), marginally above the long-term average of -10.

Retailers like New Look and House of Fraser have been using company voluntary arrangements (CVAs), a form of insolvency proceedings, as a way to close stores and overhaul their businesses. However, landlords argue that CVAs are being abused as a quick way to cut rents, shedding undesirable leases for the benefit of equity shareholders.

The retail paradox

Despite the significant fall in demand, we are currently observing increased rents on retail property, according to published indices and listed companies, such as CBRE, claiming that rents for shopping centres were up 1.4% in 2017 and 0.1% in the first quarter. MSCI, the index provider, also reported retail property rental growth of 0.9% for the three months to the end of March and 1% for each of the two quarters before that.

Rental growth in this sector in the midst of store closures can be explained by the fact that such figures are calculated using “headline rents”, which do not take into account the incentives provided by the landlords to the tenants. The latter may include a rent-free period lasting from six months up to one year, which has now become more relevant given the shorter leases and more frequent lease breaks, as well as cash incentives offered by the landlord for fit out purposes. Furthermore, there is no standard way of accounting for changes in rents. With the IFRS not specifying how to calculate the “estimated rental value”, none of the reported figures account for stores that are completely empty, whether for refurbishment or because of a failing tenant.

As a result, rental figures are not a good indicator for the state of the retail property market, given their inability to reveal the total cost of renting a store, which is likely to be falling when conditions for landlords are tough and tenants.

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