A stronghold for investment

For years, the research team at Henderson’s have been citing the defensive qualities of European retail property.  A minor downturn was all we needed to prove the case. But we hadn’t anticipated the severity of the recent recession – a downturn so severe, in many countries, that no part of the property market proved defensive.

The recent recovery in values has been more targeted, focussed on prime assets and on core markets. This is to be expected in an upturn, where the focus will be on highly cyclical markets with investors seeking strong short term performance through early market entry.

However, given the recent crisis, you would expect investors to be looking to reduce volatility of returns, and so should be looking for assets that offer long term rental growth prospects and defensive qualities. It is our belief that European retail – with a more stable rental growth profile – will offer lower than average volatility to performance over the medium to longer term (in the absence of another major economic shock).

The retail warehouse sector suffered a sharp outward yield correction early in the downturn – due to perceived risk associated with the sector, and the undeniable correlation with the housing market. Prime retail park yields across Europe range from 6.5 to 7.5 percent, having softened from 4.5 to 5 percent in core markets. So surely the sector should be a target for bargain hunters seeking yield?

In broad terms, we have been advocates of retail warehousing in Europe for the affordability it offers modern retailers and the associated growth potential. This remains true, with rents are now significantly cheaper following recent declines; our prime retail warehouse series show rental declines averaging around 10 percent in 2009, greater than that for shopping centres.

There are, of course, further risks to the occupier market, pertaining largely to muted economic growth and depth of the occupier base – the latter being specific to this sub-sector. However, long term projections for the sector should assume this trading format continues to attract a wider range of occupiers.

It should not be assumed that European retail warehouses will ever look or perform like those of the UK. But it can be envisaged that they continue, once current economic uncertainty has abated, to prove increasingly attractive to shoppers and retailers alike. Cost conscious retailers will continue to reappraise their portfolios, seeking better value locations. We estimate that, on average, retail warehouse rents are around 25 percent of those commanded by prime shopping centres, before taking into account the significantly lower service charges.

Medium term rental growth looks attractive as we forecast rents to return to pre-recession levels. Growth will be further supported by scarcity of supply in some areas, coupled with growing demand.

In assessing risk, some investors will look at market size. In many European markets – even many core countries – the concept of a modern retail park is still immature and the invested universe remains relatively small. In the case of retail warehousing though, its modest market size, and supply side story, is its strength.

For good quality schemes, the current discount on yield for retail warehousing outweighs any underlying risk. Before too long we should see yields for good retail warehousing start to harden, especially as investors struggle to find value elsewhere. And as such we expect retail warehousing to be an outperformer in 2010 versus other core market sectors.
In conclusion, European retail warehousing should satisfy bargain hunters looking for short term ‘cyclical style’ appreciation, as well as those seeking for longer term stability of performance. Yet asset selection will be key in choosing the correct asset with strong retailer covenants.

Angela Keane is senior research analyst at Henderson Global Investors