Issued 8th November 2018
In the dark and gloomy world of physical retail, outlet centres are the one shining light. The sector has grown year on year for the past 10 consecutive years. One of the biggest asset managers in the sector, Realm, has recorded 18% growth in sales across its portfolio in the past three years alone.
By contrast, in the shopping centre market, swathes of high-profile retailers are closing stores, putting shopping centre landlords and asset managers through the mill. With the erosion of income and drop in mall valuations, hundreds of centres are on the edge of administration.
So why are outlet centres seemingly immune to the retail malaise and what can shopping centre owners learn from them?
Realm’s managing director Colin Brooks puts its success down to the turnover rent leasing model it applies across its seven outlet centres. He says that the fundamental advantage with turnover rents, which typically range between 8% and 12% of store sales, is that the asset manager has as much of an interest in the retailers’ success as the retailer. This creates an extremely hands-on approach to asset management that negates the landlord-tenant friction that can occur.
Brooks is adamant that the model is the answer to shopping centre landlords’ woes and can be replicated across the sector. The model is used across Europe, he notes, dismissing the UK’s “archaic institutional model of 25-year leases”.
He elaborates: “Nobody could get their heads around outlet centres a few years ago – short leases, turnover rents; there was no comparables so people didn’t know how to value them,” he says. “Today, outlet centres are seen as the model to follow. It has been the most robust and resilient sector since the recession.
“The way retail has changed – especially in recent years, when retailers have been reducing their store estates – means tenants don’t want to sign 25-year leases. It is forcing property owners to think about how they can make it work and what flexibility they can offer customers.”
That flexibility is achieved through shorter leases as well as the rental model, which gives everybody a vested interest in the success of the store, Brooks says.
Another huge advantage of turnover leases is that they give landlords and asset managers real-time sales data from every retailer in the portfolio. It is this access to data, as well as strong sales performance, that has piqued the interest of institutions. The majority of the top 20 outlet centres in the UK are now owned by institutions or listed property companies that Brooks says want to invest in the sector “because they get the data”.
Realm, which manages the London Designer Outlet at Wembley as well as centres as far north as Inverness, analyses sales figures from every shop in its portfolio every week to see what has or hasn’t worked and whether a store is performing to its potential.
This real-time data feeds in to the outlet model’s hands-on asset management approach. For example, when Realm’s in-house leasing team signs up a new retailer, it tracks performance through sales data from the moment that retailer starts trading and can tell quickly whether or not that leasing decision was a good one. “The responsibility lies with the leasing manager,” Brooks says.
Brooks insists this approach can “absolutely work” for shopping centres. It creates a partnership between owner and retailer where everybody is aligned. That’s where turnover rents can be a dynamic management tool.
He concedes that it’s “slightly more difficult” for full-price retail, where customers can try something in store and buy it online. “Would that be included in the turnover of that store?” he asks.
“I understand both sides of the argument. A retailer has spent a lot of money on getting their online offer right, so why would they agree to give some of the turnover of that sale to a landlord? But I also see that the physical store played a big role in them making that sale. That is the conundrum we are looking at. It is difficult to differentiate and securely monitor that data.”
However, he believes this obstacle can be overcome. Indeed, his hope is that in 20 years’ time, shopping centre management will be “pretty similar” to the way Realm is managing outlet centres now.
Realm is already transferring its asset management skills to more traditional retail assets. TH Real Estate brought it on board at the Milsom Place shopping centre in Bath in September in a bid to turn around the fortunes of the failing 61,000 sq ft, 30-unit scheme, which had a 60% vacancy rate when Realm was appointed.
Brooks says TH Real Estate recognised that its traditional approach to asset management wouldn’t work there. “We will apply skills to something totally different,” he says. “We have a blank canvas. We need to think carefully about creating the right mix. One option, depending on the retailer, is to de-risk it and offer a turnover rent only in year one, so if it doesn’t do well they are not over-rented.”
Food and beverage will also be key with this scheme. “The tourism Bath gets is the cream on top for us, but we have got to get it right,” he elaborates. “We have to be taking money all through the day. To create a mix that’s vibrant from 10 in the morning to midnight – that’s tricky.”
Brooks believes the core asset management skills used in the outlet sector can be applied to any shopping centre where the owner is re-gearing to a turnover rent model. And as such he senses “there will be opportunities for us to morph into shopping centres”.
The retail sector turmoil will “reach a consolidation point”, he believes, predicting that company voluntary arrangements will stop and a “norm will arrive on the high street”. But he concedes that more casualties are to come. “If you own a UK top 100 centre, you’ve got good real estate. However, if you are in the next tier down, you may have a challenge on your hands.
“Ironically, I spent the first chunk of my career moving fire stations, libraries and the like out of shopping centres; now I imagine landlords would happily bring them back in, given the chance.”
“If you own a UK top 100 centre, you’ve got good real estate - if you are in the next tier down, you may have a challenge on your hands”
The turnover rent model has been hugely successful in the outlet centre market but questions remain over whether it could save ailing shopping centres. The sticking point is how much of a role physical stores play in online sales and whether landlords should capture a slice of those sales through turnover rents.
What is clear is that the model gives retailers flexibility in their
leases and provides landlords with dynamic management tools that can
drive income – and that is certainly what shopping centres need right