French retail property has been a great investment over the last two decades. Capital values have more than doubled since the early nineties. The strong returns have not only been driven by a significant decline in investors required returns (the capitalization rate), but to a great extent by rental growth. Until recently, annual rental reversions for French retail were determined by the cost of construction index (ICC - Indice du Coût de la Construction). Since 2001, the cost of construction, and likewise the retail rental values, have risen by a stellar 45%.
Now, if retailers’ turnover growth would have matched such strong rental growth, affordability would still not be an issue. The opposite is true however. France has seen tremendous construction activity in retail property over the past two decades, whereas retailers’ turnover saw only very limited growth. Kempen Capital Management estimates that the productivity of French non-food retailers has declined by 25% since 2001. As such, a 45% increase in rents coincided with a 25% decline in turnover. How long can French retailers afford to pay such high rents?
But that’s not all. Online retail sales are increasingly a threat to physical store sales. In France, roughly 12% of total retail sales were realized online in 2012, and that number is growing. In the UK for example, leading fashion retailers such as Next or department store chains such as John Lewis derive over 25% of their total sales online. The UK has been on the front foot when it comes to online retail sales and many retailers have already started to downsize their physical store network. Future focus will be on prime spots in high streets and large regionally dominant shopping centers. However, it appears that such regionally dominant centers in the UK are much better prepared for the future than their French counterparts.
The first larger dominant centers in France were developed in the late sixties, such as Parly Deux and Creteil Soleil in Paris. The traditional idea of anchoring a shopping centre with a large hypermarket and 2-3 big boxes such as FNAC or Darty now seems an out dated concept, not to speak of the out dated architecture. At Kempen Capital Management, we believe the UK centers that were developed about 5-10 years ago are much better prepared to be the “mall of the future”. Examples include the Bullring in Birmingham or the Westfield centers in London. Other than modern architecture, these malls are hosting and are anchored by quality retailers such as Apple, Selfridges and Hollister. In addition, such malls are offering an experience for the consumer and are offering more than just shops. Over 25% of these malls are occupied by the leisure and entertainment industry and quality food offering. Other than the European market leader in malls Unibail-Rodamco, most other French retail landlords are unable to cope with the modern retail requirements.
Kempen Capital Management expects that the values of French shopping centers should decline by 20-25% in order to be competitive again vs. their UK counterparts for European or Global real estate investors. Despite the financial crisis, capital values of French shopping centers are back at 2007 peak levels. It is just a matter of time before valuators will have to start marking down the value of French retail property.