German retailers ‘dictate conditions’

German retailers are upping the ante – and landlords are no longer calling all the shots – in a shift that has firmly put the power back in the hands of retailers.

‘Occupiers - particularly clothing retailers - have become very aggressive when it comes to rental negotiations and taking on new space,’ Sandra Ludwig, head of retail investment Germany at JLL, told REFIRE. ‘It used to be the case that landlords dictated conditions for retail space in good locations but this is no longer the case. Bigger tenants, such as Zara, are increasingly requesting rental discounts of 20% or they won’t take the space – and they normally get their way. This has been driven by declining revenues on the part of some mid-market retailers.’

Food retail is the ‘sweet spot’

It may not be glamorous but food retail is increasingly the ‘sweet spot’ for many investors. One investor who has been extremely active in the sector is Patrizia Immobilien. Earlier this month, it acquired an off-market portfolio totaling 140 sqm, or 66 properties, on behalf of an individual mandate of a foreign institutional investor from an unnamed UK-based fund for €205m. Around 85% of the properties’ rental income is generated by well-known German food discounters such as Netto and Real.

‘Since 2012-2013, we have wanted to build up a major food-anchored retail portfolio in Germany,’ Daniel Herrmann, head of fund management retail at Patrizia, told REFIRE. ‘At the time, we had around €500m invested in all kinds of retail assets, now we have more than €2b in food retail which is about 50% of our current total retail exposure.’

Patrizia is targeting grocery-anchored retail schemes for a number of reasons, according to Herrmann. ‘Large food retail tenants in Germany are blue chip organizations with a strong trading performance, so the group considers the quality of rental income to be very high. In addition, we believe that e-commerce won’t have a big impact on food retail in Germany, unlike other types of retail,’ Herrmann said. ‘Customers like going to supermarkets in Germany. Just 1% of food shopping is done online in Germany, compared to 3% to 4% in the UK. We expect that will increase over time as well in Germany but not by a large amount.'

Jens Nagelsmeier, head of retail transaction management at fund manager HIH Real Estate in Hamburg, agrees: ‘Online food shopping is a very small market in Germany, at around 1% to 2% of the food market. This is because we have so many supermarkets in Germany, including all the discounters, so it’s very convenient. The online segment will grow, perhaps, by a percent or two but I think it will remain a small market.’

Other investors are also upping their exposure to retail. Earlier this month, Redos acquired the ‘Bordeaux’ portfolio comprising 10 DIY stores from Invesco and AEW for around €240m.

Also, in September, Patrizia acquired an off-market €400m German retail portfolio comprising 85 properties, marking one of the biggest retail deals of the year. The portfolio was acquired for an individual mandate of a large unnamed German insurance company and was sold by a joint venture between Swedish national pension fund AP3 and PGIM Real Estate, the real estate arm of insurer Prudential Financial. The portfolio comprises 236,000 sqm of lettable space mainly in Southern and Western Germany, with a regional focus on Bavaria, Hessen and Rhineland-Palatinate. Tenants include German food retailers Edeka, REWE, Lidl and Aldi. These acquisitions have boosted Patrizia’s retail assets under management to more than 600 properties with a value of over €4b, more than half of which are food retail assets.

Food retail on the up

Patrizia’s focus on food retail underpins a broader trend in the market to snap up supermarket-anchored retail parks, according to Ludwig. ‘Demand is very strong,’ she said.

It’s easy to see why. There are 123.7m sqm of retail space in Germany, which equates to 1.51m per person, thereby placing Germany fourth in Europe. Of this total, food retail accounts for 35.6m sqm. In addition, retail turnover has increased by around 13.1% since 2010, reaching €483b in 2016, with the share of online retail at 10.9%, according to a study, ‘Food Retail in Germany – Market Structure Data 2016’, carried out by TLG Immobilien this summer.

In food retail, the increase in turnover was even higher, at 16.6%, whereas the share of online retail in the turnover of the food segment was significantly lower at just 1.5%. German households spent €215b on food, drink and tobacco in 2016, up 19.6% from €180b in 2015, according to the study.

As a result, the food retail segment has become very sought-after and yields have compressed as a result, Hermann said: ‘Last year, prime retail parks were selling for 19x the annual rent. This year, we surpassed the 20x mark. That means it’s becoming harder to source affordable deals.’

For its existing funds, Patrizia typically acquires retail properties in the €15m to €45m range but due to the lack of product and rising competition they’re becoming hard to find. ‘It might sound weird but, for us, it is sometimes easier to source the larger portfolio deals for our separate mandates as we can bring large amounts of capital into action and move quickly, even in non-standard and special situations,’ Herrmann explained.

HIH Real Estate, for its part, manages two retail funds which it launched a year ago: a high street fund and a food-anchored retail park fund. Each has a target size of €300m to €400m.

‘I’ve been in the retail sector for the last 20 years: 20 years ago, it was a niche,’ said Nagelsmeier. ‘International investors came in before the last financial crisis. Investors today like food anchored retail because it offers good returns and long leases of 10 to 15 years. Also, rents are around a third of what they would be in the UK. If you want to build a 2,000 sqm store in Germany you have to meet a lot of criteria, especially planning restrictions, but if you manage it, you’re then very protected once you have the store.’

HIH Real Estate has invested around €330m on behalf of both funds so far and Nagelsmeier expects that figure to reach €350m to €400m by the year end. ‘Of the total, food-anchored retail accounts for about a third. I’d expect to invest a similar amount next year,’ he said.

High street makes a comeback

High street retail, which has often been passed over in recent years for its more glamorous cousin, shopping centres, is also making a comeback, according to Ludwig: ‘High street deals have increased this year, which is a sign that more landlords are looking to sell their high street real estate.’

High street deals accounted for 34% of all retail deals in the first three quarters of this year, more than double 2016’s level of 16%, according to JLL.

Subsequently, shopping centres have taken a back seat, she said. ‘We are seeing less demand for shopping centres, particularly in less strong locations, due to concerns about declining rents. Depending on the location, it has become harder to get them fully-occupied.’

Deal volume unlikely to hit 2016 level

In the first nine months of this year, there were €38.6b of commercial real estate deals in Germany, excluding residential, according to JLL. Of that, retail accounted for €7.34b. This is lower than last year because not much has been brought to market. By way of comparison, there were €12.4b of retail deals across Germany last year. This year, JLL expects the total to be around €10b as there are still some big deals in the market.

And next year looks rosy, according to Nagelsmeier: ‘There is strong demand for good retail and not much supply. In very good locations, it's a core business with very secure income. Food retail has witnessed the strongest growth this year. Next year, prices will probably rise slightly.’