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Eurozone retail: structural headwinds begin to creep into Europe

UBS-AM has downgraded total returns for the eurozone retail sector, which continues come under pressure by shifts in consumer behaviour and spending.

Rental growth in the eurozone is forecast to be marginally positive (0.1%) over the next three years, with growth turning negative in Belgium, Finland, France and Netherlands. France and Germany are expected to be the weakest performers due to lower income return and negative capital growth. At the other end of the spectrum, Spain (1.3%) and Portugal (1.9%) are expected to outperform the market due to stronger local demand conditions.

Overall, UBS-AM expects total returns of around 3.9% in the eurozone over the next three years.

Gunnar Herm, head of real estate research and strategy for Europe at UBS-AM Real Estate & Private Markets, explains:

“Retailers are becoming increasingly cautious with their expansion strategies and many have already started to rationalise store networks. Generally speaking, retailers are moving towards a model of fewer, larger stores located in strong retail centers to drive overall brand awareness but also footfall and profitability. From these larger stores, retailers are able to showcase their brand more effectively, offering a broad selection of products and services, whilst integrating online through ‘click and collect’.

“There is a specific need to innovate, introduce or increase experience and social interaction within stores and retail centers as this is the USP of physical retail. As such, the polarisation of retail continues with increasing momentum. As a general rule, larger more dominant retail centers are doing relatively well as it is much easier to introduce experiential elements. But convenience retail concepts are fairly resilient if they closely meet the needs of local catchment areas.

“Overall, the retail environment is facing ongoing structural challenges, albeit less so than the UK (and US). Important distinctions to be aware of between the UK and eurozone markets are the differing lease lengths, space per capita and a less mature e-commerce marketplace. Retail space per capita in the eurozone is generally much lower than the UK and leases are already much shorter and more flexible than the UK, which has enabled retailers to adapt to changing consumer behaviour. Arguably, retailers have been able to adjust to changing consumer behaviour in recent years.”

Hamish Smith, senior property economist at Capital Economics, explains:

“Investors have lowered their expectations for rental growth [across certain eurozone retail markets]. We have previously set out why there are good reasons to believe that prime retail rents will, at best, plateau in an increasing number of markets.

“Furthermore, with structural challenges in the form of increasing online competition coupled with the cyclical slowdown, the risks to rental growth are to the downside. As such, we think that investor concerns about their ability to generate rental growth, or even just sustain current rental levels, will trump the benefit of lower risk-free rates, meaning that more retail markets are likely to see upward pressure on yields.”