Varecon 01

Ltd

The share price in Debenhams, a quoted UK department store group on the London Stock Exchange, fell by 5% on 9th September. The fall was attributed to a downgrading of the stock by HSBC bank’s equity analysts from ‘hold’ to ‘reduce’, on the basis that the group is ‘structurally challenged’. The problem, it seems, is that its average lease length of 22years which, the analysts argued, reduces its flexibility to deal with the evolving and increasingly competitive omni-channel market. In other words, being stuck with (implicitly unrequired) buildings may damage profits. The group’s position was contrasted with that of Next, a fashion retailer, which has average lease lengths of seven to eight years and with Marks and Spencer, a fashion and food variety store operator, which has virtually wholly freehold ownership. The two ends of the spectrum provide flexibility, but not the middle ground although, apparently not enough to prevent their share prices falling, albeit by lesser percentages on a dat when most stocks fell. In the 1970s and 1980s, the standard UK lease length was 25 years. In the boom years before the early 1990s recession, landlords started to think about offering shorter leases to give themselves more control (for instance, for redevelopment) and to avoid too much value accruing to the tenant. After the recession, the positions started to reverse, with tenants seeking shorter leases or leases with break clauses, so as to avoid acquiring what may become liabilities at some time in the future. Generally, landlords prefer longer leases as providing greater security of income, but tenants are now very resistant to that, and ten or 15 year leases have become common. The HSBC case on Debenhams illustrates a growing distinction between offices and retail units. The former are cost centres and requirements on micro factors, such as location, size and structure do not change significantly for most occupiers over the medium term. Retail units are, however, profit centres, only worth retaining in the portfolio if the location and size is optimal for current trading requirement. It is no surprise, therefore, that tenants’ requirements for flexible shorter leases (and lower rents) have been led by the retailers, with office and even logistics operators taking a more sanguine view. Even so, Debenhams’ space requirements, as a department store operator, can really only be accommodated by one or two buildings in a typical town centre. Even a short lease does not provide much optionality. Except, of course, if the group’s management needs to consider a rather more dramatic restructuring of the business, perhaps closing part of its operations, in response to competition from online sales. The UK has, globally, a lead position on online sales. Physical shop numbers are shrinking and the sector experiences some of the largest number of profit warnings and of companies liquidating. While retail sales continue to grow quite strongly, virtually all of the growth accrues to the online retail operations. In such circumstances, physical stores can become a liability rather than an asset. Institutional investors have become very conscious of the risks to their tenant base in recent years and many have been reducing their exposure to the asset class. Of course, that does not stop some investors, including the property companies, seeking ways of providing a shopping environment that combines leisure with shopping and attracting a disproportionate share of the shoppers. In the end, however, the pool of shoppers is not expanding and competing for them is often a question of allocation of capital and trying to achieve a return on it. Prime, by its definition, continues to attract shoppers and retailers, but it is a shrinking part of the sector, with the only real exception being those areas, such as the West End of London, which attract tourists buying high-margin goods. In no other sector do investors need to understand the dynamics of the businesses at a micro level and some even utilise fashion and technology consultants and researchers to help optimise their performance. It is effectively a zero-sum game between investors and tenants. Companies like Debenhams can acquire the flexibility that the analysts suggest that they need, but shorter leases, more frequent moves, and lower rents all represent losses for the landlords. That is economic obsolescence at work and it is unstoppable. The rest of Europe is merely lagging.

Prime, by its definition, continues to attract shoppers and retailers, but it is a shrinking part of the sector