The retail sector has undergone a seismic shift as consumer spending patterns have evolved and the proportion of online sales have increased. However, in 2021, we witnessed a recovery in investor sentiment and activity driven by stability in occupational markets across all retail subsectors across Europe. This article, taken from JLL’s paper of the same name, sets out the relative draw of the retail warehouse sector specifically and why current trends point to the emergence of a hybrid asset class and why retail warehouses are the most insulated retail format from emerging ESG risks.
Structural changes affecting the retail sector
Shopping habits had changed long before the pandemic. The rise of Google and the advent of Wi-Fi in the early 2000s and the launch of the iPhone in 2007 created the conditions for online shopping to flourish. In the UK, the most mature e-commerce market globally, online sales, defined by the Office of National Statistics, reflected just 2.8% of total retail sales in November 2006 which increased to reach 19.1% in February 2020. The pandemic hyper charged “internet sales” during national lockdowns peaking at 37% in January 2021. However, these naturally stabilised after the reopening of shops, bars and restaurants last spring to around 26% where they currently sit. This is good news for physical retailing. In Europe, online sales in 2020 varied from as little as 6% in Italy to 20% in Germany, averaging out at around 16%, which is broadly on a par with the US. China, which is responsible for around a third of online sales globally, behaved more like the UK at around 27% in 2020. These are averages and hide the wide spread of adoption by sector with apparel closer to 50% in online sales, compared to grocery sales which are around 13% in the UK and 10% in the US. Groceries make up a much higher proportion of total retail spending in the UK (ca. 30% vs. 18% in the US), so a small change in behaviour has a big impact on total “internet sales”.
Online sales and internet related take-up:
In 2021, approximately 41% of all Grade A logistics take-up was for dedicated internet fulfilment.
The US, Europe and Asia witnessed significant growth in online shopping in 2020 boosted by the pandemic. However, we have seen a slowdown in growth as restrictions have been lifted and certain consumer behaviours have returned to pre-pandemic patterns, although each local market is different.
GlobalData graph showing segment splits:
Retailers are faced with a dilemma, the need to ramp up capacity to meet online demand whilst protecting margin. Fulfilment costs differ by country and by sector. In the higher margin premium and luxury fashion sectors for example, the cost of delivery is less of an issue. In lower margin sectors such as fashion, groceries or convenience goods, fulfilment costs have a higher impact on profitability. Global supply chain disruption and a shortage of warehouse space has pushed up fulfilment costs for everyone from Ikea to ASOS. If the highest cost of fulfilling an online order is in transport, specifically the ‘last mile’, herein lies the opportunity, fundamentally, it's about placing inventory closer to the consumer.
Why invest in retail warehouses?
Retail warehouses in Europe are typically located on the edge of densely populated urban locations near arterial routes or motorways with excellent accessibility and logistics investors are picking up on this. Retail warehouses have numerous structural advantages over other formats. From a consumer perspective convenience is king. Out of town locations are easier to access compared to densely populated urban areas. Free parking is another big tick in the convenience box. They offer large, regular shaped floorplates providing consumers with more choice. For retailers, they are cheaper to occupy compared to urban shops with lower rent and service charge. With rising digital advertising costs, customer acquisition is becoming more expensive. Stores offer a cost effective opportunity to engage with customers, a human experience that customers don’t get online, to build brand awareness and loyalty and to experiment with new concepts. For investors the fundamentals are attractive. The supply imbalance is less pronounced in the UK, compared to other retail formats. New supply has been constrained and there are several acquisitive retailers in the market. We expect the UK vacancy rate to decrease below the long term average of 7%. We also expect to see modest rental growth in some locations in 2022.
The changing role of stores
Changing consumer trends point to a fusion of retail and logistics, a hybrid scheme that allows retailers to sell stock, engage with customers and fulfil online orders from the surrounding catchment. In 2020, Tesco became the first retailer in the UK to fulfil one million online grocery orders in a week, enabled by their store network, to make online delivery profitable for the first time, despite costly Covid measures requiring additional warehouse space and the hiring of extra staff. Click & collect orders increased from 11% at the start of 2020 to 25% by year end. The name of the game is getting closer to the consumer and Tesco have 3,400 stores nationwide. Supermarket Income REIT’s (SUPR) £1.6bn expansion into the UK grocery sector is based on acquiring food stores investments underpinned by a store based online grocery model. Retailers also need to get closer to the consumer to meet shorter and shorter delivery aspirations. For the grocers that infrastructure was already in place, at least to provide next day delivery. The rise of ultra-fast delivery start-ups such as DoorDash, GoPuff, Getir and Gorillas promising delivery times of 15 minutes have taken this concept to the next level. Operators typically pick, pack and distribute goods from dark stores and sell direct to consumers to avoid dependence on retail partners, delivering within a densely populated square mile. The exception is Gorillas who have partnered with Tesco in the UK but not in Europe, opting for a more vertically integrated approach. Judging by the $8bn of capital raised last year to fund their expansion, investors see an opportunity to take market share (and consumer data) from established grocers. The US grocery market is worth about $1 trillion. Getir, founded in Turkey in 2015, is now worth more than M&S, Morrisons and even Deliveroo.
We believe retail assets in densely populated urban areas, will benefit from demand for last mile space. Currently ultra-fast delivery is reserved for convenience goods, but more retailers are starting to explore partnerships. The Body Shop have partnered with Instacart to offer same-day delivery from all 165 of their stores across the US and Canada. In the UK, Uber and the electrical retailer Currys have agreed a trial to offer 1,800 product lines within 30 minutes - expect more partnerships between ultra-fast operators and established retailers to follow. The emergence of Click and Collect (or BOPIS “buy online and pick up in-store” in the US) further highlights the value of physical stores. Kingfisher, the European DIY operator, reported a massive 226% increase in Click and Collect orders for the financial year to 31 January 21, to represent 78% of total online orders (that’s £1.73bn in sales ordered online and collected in store). Kingfisher recognise the changing role of the store with 92% of online orders, whether for Click and Collect or home delivery, picked in store. B&Q are already operating micro fulfilment centres and we expect others to follow, enabled by greater use of robotics and AI. We believe retail warehouses are uniquely placed to benefit from this growing channel. In the UK, Marks & Spencer has announced a same-day delivery service, making it faster than the likes of ASOS by using their stores as fulfilment hubs to create a competitive advantage. Even the ultra-fast delivery operators are piloting click and collect from dark stores to reduce operating costs in the race to break even, which could evolve to become giant automated vending machines. Five years ago in the UK, the threat was too much space but now space is a point of difference.
Final comments
Retailers are grappling with the best channel composition to maximise sales and profit. The role of physical stores is becoming clearer. We believe that those stores with good accessibility, close to densely populated areas will prosper as online sales continue to rise. Despite doubts over profitability, convenient home delivery is here to stay. However, in many cases consumers prefer using a mix of physical and online channels through the customer journey and expect a fully connected online and offline experience. We believe retail warehouses have an important role to play in modern retailing. Based on occupational resilience during the Pandemic, retail warehouses have become an attractive investment proposition. Some of the renewed interest is due to current pricing relative to the logistics sector. However, we believe the business case is broader than just value. When underpinned by long term, structurally defensive qualities, the case becomes compelling. There are conflicting views around which channel is more environmentally friendly – in store or home delivery. The results depend on a wide range of factors and assumptions which can lead to varying results, but ultimately it depends how far the product travels to reach the consumer. Regardless of channel, positioning inventory as close to consumers as possible minimises distribution costs and CO2 emissions and we believe retail warehouses are well positioned due to their inherent accessibility. In a wider context, physical retail will always bring communities together and have far greater social impact than online shopping. In summary, retail warehouse markets across Europe appear to be in good shape which has led to renewed investor activity. However, the rationale for investing extends beyond traditional boundaries. The changes in consumer behaviour over the past two years show that ‘clicks need bricks’. Consumer preference is to utilise multiple channels, adeptly summarised by the Chief Executive of Currys Alex Baldock:
The secret sauce for us is online and stores together, because that is still how most customers prefer to shop.
We believe this points to the emergence of a hybrid asset class, fit for modern retailing and protected against ESG risks in the long term.
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