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Once upon a time in the West End

If any single UK retail market has diverged from the rest since the financial crisis, it is London’s booming West End. Mayfair has been the property market’s gold rush town for more than a decade now, outpacing every other market in terms of rental value growth and becoming such a magnet for a global capital that average initial yields have nearly halved from 5.7% to 3% over the last 15 years.

In the most prime of pitches on London’s Bond Street, where not only is the real estate treated like gold but the retailers are often selling it, prime yields are close to 2% and rents are now more than double where they were prior to the global financial crisis. The West End retail market has delivered total returns of 20% per annum over the last seven years. So far, so magnificent.

The sharp fall in the value of sterling following the EU referendum has brought about a further boom in sales.

The sharp fall in the value of sterling following the EU referendum has, at least temporarily, brought about a further boom in sales. Meanwhile, CBRE reports that nearly 60 international retailers opened their first London store in 2016 – around double the number of new entrants in 2015.

And London is not alone in seeing rapid growth in its prime retail market. The likes of Paris’s Avenue Montaigne, Vienna’s Kohlmarkt and Milan’s via Monte Napoleone display similar characteristics. Robust demand at the luxury end of the market and finite supply on the pitches where those brands feel they must be represented continues to drive the market.

However, occupational costs have risen significantly as rent reviews have kicked in and, as well as the universal themes we will address in more detail in a forthcoming series of articles, there is an imminent and potentially destabilising issue to address in the UK.

The long-delayed revaluation of business rates – the first since the 2008 revaluation was implemented in 2010 – is set to hit the UK capital’s retail and restaurant occupiers particularly hard. The revaluation will kick in from April 2017, with rates increasing, on a phased basis, by as much as 90% for some occupiers on the back of the surge in rental and, therefore, rateable values.

While there is no danger of tumbleweeds blowing down London’s streets, or bars as empty as the saloons of desolate gold rush ghost towns, this major increase in occupational costs is a material threat. Smaller businesses, particularly bars and restaurants, where revenues can only be pushed so far and where rental increases have already eaten into profits, could be put out of business. The Chancellor’s March Budget offered some assistance to the smallest businesses but stopped short of any wider relief measures for London. As a revenue-neutral tax, tempering the increase for some would mean less of a decrease in the burden for others where a cut to business rates is long overdue.

It would be unwise to assume that the super-prime pitches of Oxford Street, Regent Street and Bond Street are immune to the impact of this revaluation. Jones Lang LaSalle has analysed the impact on London’s prime pitches and found that New Bond Street retailers will see an 88% increase in business rates liabilities from April 2017. That equates to an additional £340 per square foot (in terms of Zone A) and total occupancy costs rising by more than 20% in one hit, following years of inexorable rises in rental liabilities.

It has been argued that the weight of international retailer demand for finite space and the value of brand positioning will continue to support rising rents. But the sheer magnitude of the business rates increase calls that into question, as occupancy costs threaten to breach 40% of turnover in some cases. If brand awareness is increasingly digitally-driven, will retailers pay for that presence at any cost? Can smaller, emerging brands afford to operate unprofitable stores?

Diversion of sales away from the traditional European luxury pitches is also a threat.

Diversion of sales away from the traditional European luxury pitches is also a threat. In 2016, the luxury retail consultants Bain & Co reported that the Chinese account for 30% of global luxury sales – more than the Americans and as much as Europeans and the Japanese combined – but only 7% of those sales take place in China. Policies to encourage domestic consumption could change that balance, including airport checks to impose high taxes on goods brought in personally and cutting tariffs on goods brought in through corporate channels for retail sale within China. Following Chanel’s lead, and likely driven by online price transparency, many global brands have abandoned charging a premium on products sold in China in favour of price harmonisation, which is also boosting domestic sales.

Anecdotally, agents are reporting that a significant number of Bond Street leases may be on the market in early 2017. There are a number of leases on large units on Oxford Street being quietly sold, some having been secured through huge premium payments only a few years ago. The days of such premiums being paid on Oxford Street and Regent Street may be numbered.

Phenomenal growth on Bond Street means that headline rents have surpassed Paris’s Avenue des Champs Elysees to become the third most expensive real estate in the world. Only New York’s Upper Fifth Avenue and Hong Kong’s Causeway Bay are pricier. Combined with rates increases, if occupiers begin to find that cost harder to justify, landlords may relinquish a large chunk of the gains made in the last seven years. Values could be eroded quickly, as today’s exceptionally low yields rise to reflect increased risk and an end of booming rental value growth, while landlords would face huge rates liabilities on any vacant space.

As the difference in occupational costs to Bond Street has widened, newer retailers entering the market may look at emerging central London streets, where rents and rates remain far lower, even after the revaluation. It could be argued that the new global money from the Middle East and Asia is less concerned with the street address than old world money.

Offshoot streets such as Conduit Street and Bruton Street have seen strong growth but from a much lower base and remain far more affordable for emerging luxury brands. They will need to carefully assess the balance between brand recognition from higher footfall and the occupational cost of that exposure. Investors looking for nuggets of gold in the central London retail market may be more successful in the emerging locations in Mayfair, using a bottom-up approach to identify growth potential. Those looking to invest in some of the most expensive streets in the world, at today’s pricing, may find only sand and rocks at the bottom of their pans.

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