Is Leisure investment emerging from Retail’s shadow?
Leisure has historically been inextricably linked to Retail, at best its cohort, at worst its poor relation. We analyse why this bond may ultimately be loosening and what Leisure has to gain by achieving independent recognition and establishing a separate investment identity.
10 minutes to read
Read the full 2021 Leisure Report: responding to an experiential crisis
There has always been ambiguity about Leisure as an investment asset class. Officially it has been classified amongst the highly mixed bag of “Specialist Sectors”, which tend to only graduate from being “too complicated to understand” when they become something of a gold rush c.f. healthcare, student accommodation, life sciences. To date, this has not happened with Leisure, which has always maintained an association with Retail. Rightly or wrongly, for better or for worse, it is a bond that has often done Leisure few favours. But in a post COVID-19 world, does Leisure still deserve to be tarred with the same brush as Retail? And what sets it apart from an investment perspective?
Retail parallels – still relevant or redundant?
To state the obvious: COVID-19 has hardly been conducive to property investment markets. Highly susceptible to government restrictions, Retail has suffered more than most other real estate asset classes. That said, significant investment trends did emerge in 2020 and have since gained considerable momentum.
Retail investment markets have polarised hugely since the onset of COVID. In essence, there has been a broad dividing line between those sub-sectors deemed “essential” and exempt from lockdown (though still subject to debilitating social-distancing measures) and those classified as “non-essential” and therefore subject to enforced closure over the three respective periods of lockdown. In broad terms, this has favoured foodstores and some aspects of retail warehousing, but weighed heavily on the high street and shopping centres.
If anything, COVID-19 reinforced the ongoing resilience of foodstores. In fact, it is ironic that it took a global pandemic to prove the investment case to many investors who were previously sceptical. Despite COVID-19, foodstore investment volumes totalled £1.8bn in 2020, above the 10 year average of £1.54bn and the highest annual figure since 2013. If anything, investor demand has intensified further in 2021 and pricing has become keener – yields moved in by ca. 50 basis points (bps) in the first half of the year to 3.50%. But a select few foodstore deals, particularly in Greater London with a re-development / re-purposing angle, have since closed around (even sub) the 3.00% mark.
An equally positive, albeit slightly more nuanced, story on the retail warehousing side. Some aspects of retail warehousing (e.g. value operators, health & beauty) were designated as “essential” from the outset; others (e.g. DIY, garden centres) benefitted from subsequent reclassification to “essential” status and were thus able to operate on an uninterrupted basis from the second half of last year. Others (e.g. furniture, carpets, electricals, fashion) were classified as “non-essential” throughout.
Investor demand for retail warehousing has aligned accordingly. Volumes in 2020 were fairly muted at £1.73bn, just below the figure for 2019 (£1.76bn) but well below historic 10 year annual averages (£2.56bn). But the market has since rallied considerably, with volumes comfortably surpassing the £1bn mark in H1 2021 alone. There has been a resurgence in demand for re-based, discount-led / bulky retail parks and solus units, with far less appetite for “non-essential” retail dominated fashion parks. Prime yields for retail warehousing have already hardened by ca. 75 basis points (bps) in 2021 year to date (YTD) and were around 5.75% at the end of H1 2021.
A less positive picture in-town. In Shopping Centres, pricing for relevant schemes (prime ‘experiential’ and local convenience) is starting to stabilise. On other schemes, valuation write-downs continue to open the door for re-purposers. High street volumes of £0.54bn in 2020 were less than half the 10 year historic average of £1.23bn, but there was some degree of recovery in H1 2021 (£0.43bn). Demand for high street units remains patchy, but it definitely strongest for assets let to secure tenants who, above all, are rent-paying.
Where does Leisure sit relative to this status quo of its Retail bedfellows? If applying traditional investment criteria, the honest answer is “not well”, possibly even at the bottom of the pyramid.
The Leisure market was at the very sharpest end of government restrictions, more cruelly impacted even than “non-essential” retail. Leisure was subject to longer periods of lockdown than the rest of the high street and also bore the brunt of more stringent social-distancing measures. Investors, certainly those with a short-term view, are unlikely to favour a sector that has effectively been closed for business for the best part of a year.
Nor does Leisure readily tick the “rent-paying” tenants box. Few hospitality or leisure operators paid any rent from March 2020 when the pandemic initially struck. 18 months on, some still have not resumed payment, despite having a few months’ trading under their belt. The ticking time bomb of rent arrears – estimated at £6.4bn – hangs as heavily over the Leisure sector as it does its Retail counterpart.
Taken at face value, the investment case for Leisure may not be strong if historic metrics and perceptions are applied. But if there are any positives to emerge from COVID-19, one is that investment models and processes are likely to change, by default as much as by design. Blanket assumptions will give way to more informed, forensic, asset-based appraisals. Perceptions on risk will also be re-evaluated. From this new mindset, a more compelling case for Leisure investment should emerge, certainly for those assets that warrant it.
Leisure: performance and pricing
The diversity and breadth of the Leisure market is both its major selling point and also its Achilles heel, particularly in terms of transparency. The parameters as to which sub-sectors the Leisure market includes are very blurred, making any related metrics highly ambiguous. For example, the inclusion or exclusion of hotels (and pubs, to a slightly lesser degree) can substantially distort the numbers one way or another.
For this reason, it is notoriously difficult to gauge Leisure property market performance. Morgan Stanley Capital International (MSCI), (formerly IPD) do have figures for Leisure, although these refer wholly to Leisure Parks. Although “pure” Leisure assets, they are not necessarily reflective of the whole Leisure market. In simple terms, Leisure Parks operate in splendid isolation from the high street. In contrast, large portions of the Leisure market operate as part of an integrated whole, either as part of a high street or a shopping centre. Anything but splendid isolation. And data which MSCI collates on these Leisure assets is likely to be rolled up as Unit Shops or under Shopping Centres and cannot therefore be disentangled for separate analysis.
MSCI's figures for Leisure Park performance in 2020 understandably make for sobering reading. Total returns were -14.0% on the back of a -18.2% decline in capital values (income returns were +5.0%). Rents were down -6.0%. With the exception of income returns, these figures compare unfavourably with All Property metrics (total return -2.4%, capital value growth -6.5%, rental growth -3.2%). But, of course, All Property figures were skewed by a stellar performance from Industrial.
But Leisure did marginally out-perform All Retail last year (total return -14.2%, capital value growth -18.5%, rental growth -10.1%). Also, over the longest available timeframe (since the inception of the IPD index in 1981), Leisure has considerably out-performed virtually every other mainstream property asset class, delivering an annual average total return of +11.2% (All Property +8.6%, All Retail +8.0%), capital value growth of +4.3% (All Property +2.4%, All Retail +2.1%) and rental growth of +4.2% (All Property +2.8%, All Retail +3.2%).
Similar caveats on investment transactions data, which typically include hotels, pubs and some mixed-use schemes, of which Leisure is just one element. Figures from Property Data show that total Leisure volumes totalled £2,645m in 2020, across 214 transactions. This was around -62% down on historic annual averages of ca. £7bn. Hotels typically account for ca. 60-80% of total Leisure volumes in any given year and 2020 adhered to this trend (71%). Stripping out Hotels, other Leisure volumes were just £428m in 2020 across 61 deals. The irony was that despite COVID-19, non-Hotel Leisure volumes were actually 4% higher in 2020 than they were the previous year (£412m), although significantly below 10 year averages of ca. £1.3bn.
Yields for Prime Leisure Parks are currently around 7.00% (with Good Secondary Leisure Parks at 8.00%+ and Secondary / Tertiary Leisure Parks at 10.00%+). Prime yields have moved out by +175bps since March 2020 and by +225bps since their 4.75% peak in early 2018. As with Retail, this easing of price has inevitably opened up potential counter-cyclical buying opportunities, for the right stock.
Leisure: the independent investment case
As the effects of COVID-19 subside, investment markets are likely to polarise. For many investors, predictability of income will always be king. Hence, ongoing huge demand for Logistics and renewed interest in foodstores and solus retail warehousing assets. For these investors, Leisure still sits stubbornly in “the too complicated to understand” box.
The more savvy investor will increasingly recognise the limitations of merely lumping Leisure and Retail together. Although they often sit side-by-side as multi-let assets, the investment criteria are not necessarily the same. True, there are common denominators in the ‘Structural Failings’ of both the Retail and Leisure markets - the difference is that these tend to be deeper-seated in the former than the latter and will take far longer to resolve. Leisure is a far less mature market than Retail and issues such as over-supply (in some markets) and unsustainable rents are less pronounced and therefore more easily rectified.
Online is perceived to be a less of threat to the Leisure market. While the likes of Deliveroo, Just Eat and Uber Eats have surged in popularity over the course of the pandemic, this is seen as a growth opportunity for the Hospitality sector rather than a source of disruption or destabilisation. The key difference is that the delivery market is largely serviced from an existing restaurant site, so any online sales are viewed as incremental. The huge irony being that this is often the case in Retail too, particularly in online grocery, but negative perceptions of “online killing the high street” are not easily shaken. In property investment decisions, perceptions may be wrong, but at the same time, perception is everything.
“Experiential” is a vastly over-used buzzword in Retail. Vacuous as it may be as word, it is still a box that needs to be ticked for many investors. Leisure, by its very definition, is “experiential” and it is little surprise that an increasing number of shopping centres are turning to Leisure uses as part of wider re-positioning strategies. Leisure is a dynamic and constantly evolving sector, with a steady throughput of exciting new brands and concepts. With both in-town and out-of-town destinations crying out for newness, freshness and constant evolution, Leisure has the occupier base to supply it.
On the more fundamental side, the Leisure sector continues to offer long institutional leases, often with fixed rental increases and / or index-linked rents. And recent easing of yields has inevitably left some of the better stock mispriced and as such, a counter-cyclical buying opportunity. That ship may have already sailed in Foodstores and Retail Warehousing, but not yet in Leisure.
The case for Leisure investment markets to be appraised independently from their Retail counterparts is a strong one. Independent assessment does not mean operational divorce – on the contrary, Retail and Leisure will continue to operate as allies rather than adversaries in our town centres and retail parks. Over the course of the pandemic, retail destinations only returned to anything like full footfall when Hospitality and Leisure opened up some weeks after “non-essential” retail. No doubt this is also reciprocated, with Leisure also leveraging considerable trade off Retail footfall.
A case for independent investment appraisal maybe, but still with huge mutual synergy with Retail. But the investment mindset need not be binary. Surely the savviest investor of all can invest in both the best and most sustainable Retail and Leisure assets, judging both on their relative strengths and merits?