Rebuilding retail: why clever landlords are turning to smart technology
As new experiential drivers of value enter the retail market, landlords must turn to technology to measure and share in that which is generated through the presence of a physical store.
The demise of traditional retail
It is no secret that the retail sector has been in decline for a number of years, largely due to the economics of online retailers and their network of next day logistics being able to outcompete physical stores, who must also account for prime rents, business rates, utility bills and high staffing costs. While the growth of personal consumption on experience-related services, such as going to restaurants, amusement parks and shows, has grown 1.5 times faster than overall personal spending and 4 times faster than expenditures on goods[1], 72% of millennials now prefer to spend money on experiences than material items[2].
Then, as if things weren’t already bad enough, COVID happened and almost all major retail centres went into prolonged shutdown, while governmental stay at home orders have further driven the retail experience online. Statistics released in April 2020 showed an unsurprising 10 year high in year-on-year online retail growth, up 23.8% on April 2019[3]. This represents an additional £5.3bn in UK online spending[4]. While e-commerce giant Amazon have emerged a clear winner during the pandemic, needing to expand its employee base by over 100,000 workers to meet increasing demand[5].
This seismic shift in purchasing patterns has huge knock on effects for the UK high street. According to updated statistics from the Centre for Retail Research[6], more than 20,620 stores in the UK are expected to close by the end of this year — a further increase on top of 16,073 in 2019 — representing 235,704 job losses.
This has placed a renewed urgency on retail occupiers to search for technological solutions to compete with online retailers, while their landlords are now experimenting with more flexible leasing concepts in order to identify a sustainable rent model that will work for both parties. It might not be long before we start to see retail leases being marketed for both the customers that a property can bring to the store and what it can tell about their behaviour when they come in.
Flexible leasing innovation
It is no surprise that against this backdrop of widescale store closures, the most well-known flexible retail space provider, Appear Here, have raised a further $14m to expand their operations outside of trophy cities and into the second tier regions of both the UK and US[7]. While in the industry’s first, long overdue, retail lease upheaval, landlord L&G recently declared their shift towards more flexible, turnover based rents across their £4.5bn retail and leisure portfolio[8]. With a lower security of tenure, these shorter leases will allow for properties to return to market rent. The market would prevail and ultimately the landlords are better having some rent and a thriving market around them than empty shops and dereliction[9].
However, while this may appear revolutionary given the historical, 5 + year, upward only rent review leases facing the majority of UK retailers, in the US, France and Italy where leases are shorter, having part of the rental payment linked to turnover and visitor traffic is more common[10]. It is our belief thatsimply tying a flexible lease to store turnover will itself soon be outdated. For example, some retail industries, such as electronics and bookstores, are more vulnerable to “showrooming” than others, where customers browse goods in store only to later purchase them online. If there is a high risk of showrooming, then it would be wise for a landlord to have a high proportion of fixed rent and a low proportion of turnover rent so as to minimise the income risk faced by the landlord. However, these are the exact physical retailers most at risk from online disintermediation and those who will require more flexible lease terms to survive.
This inability to capture any uplift in online sales resulting from the presence of a physical store is perhaps the biggest challenge facing retail landlords as most retailers will feel that their significant investment in building an online presence is not something in which the landlord should share, especially if their online prices match their in-store price[11].
Start-up, Coniq’s July 2020 release of its Total Customer Engagement Platform claims to overcome this issue, bringing the digital and physical worlds together into one unified tool for retailers. Monitoring the movement of customers in store as well as their subsequent interaction with products through Coniq’s online offer platform unveils data on the successful online conversion of a physical store. Their customer profile and spending data also allows for a system of targeted advertising and bespoke offers[12]. However, this model assumes an old way of retailing, where a single store acts as a distribution channel for self-manufactured or precured products, all of which are available through a dedicated website. When competing with the immediacy and range offered by online retailers such as Amazon, even this tech driven approach is no longer enough.
Using AI to better understand consumers could inject £27bn per year into the UK retail market, while retailers using AI are growing 30% faster than those that are not[13].Forward thinking retailers are turning towards new concepts of brand agnostic, dynamic stores, which use intelligent product selectors to offer a smaller selection of the most desirable products in order to challenge the curated online experience.
Retail landlord, Westfield (URW), recently trialled a real time ‘Trending’ pop-up store in their flagship Stratford site, Europe’s largest shopping centre. The shop was designer-agnostic, using algorithms to stock and sell just 100 garments and accessories based on predictions of what was trending on social media channels and sourced from stores within the shopping centre[14].
Such data driven product selection and optimal pricing strategy has also long been used by Supermarkets. Through offering reward cards and loyalty schemes to regular customers, supermarkets have been able to amass customer purchasing data to inform stock selection, in store deals and individually targeted offers. However, advances in machine vision and in store occupancy monitoring looks set to not only change the process of gathering customer data, but the whole shopping experience all together. For example, AmazonGo stores use occupancy tracking and computer vision software to allow a registered shopper to walk in, pick items off the shelf and leave, with automatic payment settled upon exit.
This frictionless shopping is likely to grow over the coming years as machine learning software becomes more intelligent and efficient[15]. Critically, machine vision technology allows for a retailer to understand the entire in store customer journey, including those data on where a customer may have browsed without purchasing and which area of the shop the majority of customers spend their time. But in a future where no cash is exchanged in store and goods are purchased through online accounts, how can a retail landlord begin to identify where to set a sustainable rent?
Consumer data sharing
It is clear that what constitutes a successful retail store in 2020 is very different from that a decade ago and the consumer data captured by progressive physical retail occupiers is fast becoming an essential tool for future landlords as well. While nearly 80% of UK retail landlords expect the COVID-19 pandemic to lead to permanent changes in the way shop rents are calculated, as much as two thirds of landlords do not have access to the data which would enable them to do so[16]. Perhaps the best place to start is with something retail landlords are used to working with, footfall data.
Start-up Placense helps businesses understand the connection between people’s behaviour and physical locations by turning data from mobile apps into aggregated & anonymous real-time insights. Uncovering metrics such as customer visits, visit duration, visit frequencies, customer journey paths, gender, age groups, income levels, modes of transport, and other related demographic characteristics, Placense can help retail landlords understand the quality of their location and identify the correct tenantto maximise any turnover indexed lease.
Experimenting with emerging, digital first measures of store success will be a necessity for landlords in the future and is a first step towards fulfilling CACI’s vision for a ‘halo’ inclusive rental model[17]. Rather than simply basing rent on store turnover, their new performance lease model suggests retailers adopt a low base rent, with a top up rent calculated on five different variables: store sales, click & collect sales, returns, the marketing value of a store and the online sales uplift generated in a store’s surrounding area. Key to the success of this model is the use of data, with CACI analysing information from the tenant and landlord independently to offer an assessment of store performance.
For a long time, while both sides were doing well and making healthy profits, the lack of transparency between landlords and tenants was not a problem. Indeed, the two sides withheld information from each other to try and gain a competitive advantage. However, to better navigate through both the current retail and real estate risk, a collaborative approach towards data sharing needs to be encouraged to ensure mutually beneficial outcomes. Perhaps CACI’s model of acting as trusted data intermediary is a necessary first step in overcoming the current protectionism that has endured for both retail landlord and occupier.
At the furthest end of the lease innovation spectrum are retail space-as-a-service start up, Sook. Offering high-street booking by the hour at a demand driven rate, Sook’s shops use a combination of digital screens and removable fittings to offer prime space to anybody who wants it, from retail to hospitality, leisure to education. Critically, Sook propose that prime retail space is leased to them for zero base rent, instead offering landlords a revenue sharing model which at 30% occupancy breaks even and at 70% occupancy would see the landlord benefit from twice the market rate. Such a joint venture would likely require the open sharing of data between landlord and tenant as both are set to gain from the enhanced store operations. Whether there is sufficient demand from repeat, hourly occupiers to make this model a success is yet to be seen, but with two imminent central London store launches, Sook’s gutsy approach is certainly one to be monitored closely.
Considerations
As with all things real estate, complex regulations and mis-aligned financial incentives means that any tech driven leasing transformation will not be as simple as installing a couple of in store sensors and drawing up a revenue sharing model.
Firstly, those who lend against retail real estate have a need to accurately forecast rental values in order to match their liabilities. Any shift to turnover rents will create volatility in this rental income, further reducing the attraction of this already struggling asset class.
Secondly, due to high vacancy rates leading to oversupply, current market power sides with the tenant. Why are retailers going to freely enter into a turnover linked based model or data sharing agreement when they don’t have to? Instead they are likely to negotiate more favourable terms with their current landlord, who will be reluctant to decline. This has been demonstrated by the recent use of Company Voluntary Arrangement’s (CVAs) by retailers to dictate their own turnover linked terms. UK fashion brand, New Look, did exactly this, seeking to move over 400 of its stores on to their preferred turnover-based rental model, which after much push back was eventually approved by creditors in September 2020, saving over 11,000 jobs[18].
These problems will compound, and the retail real estate market will soon resemble the Wild West, as investors, landlords and retailers continue to use market opacity to take beneficial positions at each-others expense. There is a clear need for regulatory bodies, such as the RICS, to provide a code of turnover leasing practice to prevent such a scenario.
Rebuilding retail
What we are witnessing is not the death of physical retail, but the digital metamorphosis of an industry that will emerge from the grey, lifeless cocoon of COVID-19 with renewed purpose.
Landlords will have to turn to new lease models as the pandemic will only accelerate the trends witnessed over the past five years, where retail business launches and failures have increased by 29%[19]. Added to this fact the likely rise in the number of entrepreneurs and SME’s, as has occurred in previous recessions, further driving the demand for flexible space across all sectors. As online brands likely build-out their in-person retail presencethey will demand more from their landlords. Not only will they want a much more data-driven understanding of local demographics and foot traffic, they will also expect their physical stores to have technology to help them optimize their product selection and pricing strategy. However, a majority of shoppers recently reported they haven’t encountered even the most talked-about or basic in-store technologies, and more than 35% reported zero exposure to any option[20].
The demand from businesses currently looking to operate with a makeshift physical presence has perhaps never been a bigger opportunity for retail landlords. However, where a strong retail covenant may be linked to the size of a brand’s social media following, identifying those tenants who will maximise rents as a function of in store experience and online sales will not be straight forward.
In the absence of an industry standard that both landlords and retailers are happy to use as a framework going forward, those owners who remain passive when it comes to emerging lease concepts and the required technologies to capture the new ‘digital first’ indictors of store performance, such as mobile footfall analytics, customer engagement monitoring, social media interaction, the impact on online sales and the flexibility to identify and adjust stock towards local sub-market shopping trends, will most likely suffer. While those who are experimental now will be the first to realise that no two stores will carry the same solution and will be one step closer towards reaching the sustainable, flexible, data indexed rental model that looks set to flourish in this new retail landscape.
References
1. https://www.thestorefront.com/mag/pop-up-stores-and-the-experiential-retail-economy/
3. https://www.cushmanwakefield.com/en/united-states/insights/the-great-retail-reinvention
4. https://www.essentialretail.com/news/covid-online-sales-high-april/
6. https://www.retailresearch.org/retail-crisis.html
7. https://www.egi.co.uk/news/appear-here-gears-up-for-expansion-after-bumper-fundraise/
9. https://placetech.net/news/lg-offers-turnover-rents-for-retail-leisure/
11. https://www.propertyfundsworld.com/2020/08/10/288401/caci-unveils-new-retail-lease-model
12. https://www.cushmanwakefield.com/en/united-states/insights/the-great-retail-reinvention
13. https://www.telegraph.co.uk/business/tips-for-the-future/future-of-retail/
14. https://www.sbs.ox.ac.uk/sites/default/files/2020-02/proptech2020.pdf
15. https://www.unissu.com/proptech-resources/ai-and-retail-real-estate-the-impact-on-valuation
17. See 10
19. https://placetech.net/news/lg-offers-turnover-rents-for-retail-leisure/
Images
1. https://blog.dealroom.co/wp-content/uploads/2020/06/Marketplaces-2020-vFINAL.pdf
