R for the High Street – The Property Chronicle
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R for the High Street

The Analyst

Shopping centre with glass shop front in foreground

The R rate has become synonymous with the COVID-19 pandemic.  If R is above 1, infections rise exponentially, if R is below 1, the virus eventually disappears.

The impact of online spending on retail rental growth is also exponential and can be expressed in a similar form: the R rate for the High Street. The High Street R can be used to explain the accelerating fall in high street rents and rising cap rates post the Global Financial Crisis (GFC).

The R for an infection will naturally wane as the susceptible population declines.  Similarly, in time, the growth of online retailing must also decline. This gives hope to investors for better rental growth prospects ahead, although for some retail property, rents will have fallen below that achievable for other uses and are likely to be converted well before this point is reached.

However distant the inflection point is from today, the expectation of improving rental trends would be expected to translate into a slow reversal of the rise in cap rates, even as online sales continue to grow.

High street rental growth and household spending

Retailers have suffered during the COVID-19 crisis, firstly due to the lockdown and then to the reluctance of shoppers to return to the high street. Many retailers had already been struggling due to the increase in online shopping and the pandemic has proven to be their death-knell.

Going forward, shoppers will return, but the rapid growth in online shopping is also likely to continue. Rental levels are therefore unlikely to return to pre-COVID levels anytime soon.

A similar effect was seen after the GFC.  Until the end of the last decade, shopping centre rental value growth had a direct relationship to household spending growth: falling in the recession of the early nineties, but then recovering strongly. 

After the GFC, rental value growth on shopping centres did not recover in line with the growth in household spending. This period coincided with the rapid development of non-store retailing. Firstly, online sales predominantly replaced mail-order, but then ten-years of further double-digit growth eroded store-based retail sales. The result was firstly a failure of shopping centre rental growth to keep up with household spending growth and then a precipitous decline in rental values.

High Street R

We can quantify the expected impact of online sales growth on high street rental growth using the growth rate of online retail sales divided by household spending growth:

High Street R = ((1+Growth in online retail sales) / (1+household spending growth)-1)*100

Just as with an R > 1 for the transmission of an infection, the higher the High Street R, the lower high street rental value growth is likely to be. Further, the longer this continues, the faster the decline in rental values.

To illustrate:

  • Assuming online spending accounts for 20% of all household spending, in other words for every £100 of household spending, £20 is spent online.
  • If household spending grows by 2%, then total spending will rise to £102.00.
  • If online spending grows by 10%, a High Street R of 7.8, then online spending rises to £22.00 and the proportion of online sales will rise from 20% to 21.6%.
  • Sales on the high street remain flat at £80.00.

If we continue this sequence for twelve years, then online spending would account for almost half of household spending and high street spending growth would be falling by nearly 5% per annum.

The effect on high street cap rates

A deteriorating outlook for high street rental growth would be expected to feed through to cap rates.

If we use an adjusted Gordon Growth Model, then the high street cap rate is composed of:

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