Health and efficiency
As the nation's focus switches to health and the burning of excess Christmas calories, the thoughts of the UK’s landlord community switch to the financial health of their occupiers. With a challenging 2023 envisaged, many retailers will be unable to continue to pass on the increased costs generated by current inflation.
So, with profits and balance sheets expected to suffer as a result, how should the UK landlord community be assessing the health of its occupiers?
One of the few benefits of lockdown was the increased transparency that it demanded of the UK's landlords and occupiers. With occupiers asking for reductions - or holidays from paying rent, landlords needed to better understand what their occupiers’ business models were, and what they needed to survive, whilst in turn looking ensure best possible return from their own assets. The UK now sees a greater proportion of rents linked to occupier turnover and, as a result, a greater transparency in turnover performance has been achieved.
Whilst understanding turnover performance is key, a large proportion of landlords still employ a basic `effort ratio' - comparing turnover to known occupancy costs (rent, business rates and service charge) – to try and gauge occupier health. Whilst allowing for a basic comparison of performance, such analysis misses two key elements:
Gross margin achieved, which can vary year on year and from occupier to occupier
Cost of business, which is significantly rising year-on-year
Gross margin has the largest impact on occupier performance – the c.70% gross margin achieved by many jewellers for instance gives a significantly larger pool of income to pay for the high-end shop fits demanded by brands versus the c.35% gross margin achieved by those in fast-fashion. But it is in ignoring the cost of business that many landlords could get caught out, particularly in an inflationary environment.
Many physical stores showed strong sales performance in 2022 due to a combination of factors: improving consumer confidence in the safety of spaces post-lockdown, and a resurgence in demand for physical experiences over online and worries over recent strikes impacting online delivery. But chief amongst the contributors to increased sales have been price rises pushed through by retailers as the cost of business rises. McDonald’s hit the headlines in July for increasing the price of a cheeseburger for the first time in 14 years. As such, values may have been increasing but volumes could be static.
A simple `effort ratio' comparison of an occupier’s 2022 sales to largely fixed occupancy costs will see many landlords expecting improved profitability in their occupiers. But such analysis misses trends including:
Increasing employment costs
Both the National Minimum Wage (for those of at least school leaving age) and the National Living Wage (those 23 and over) have continued to rise in the last year. The National Living Wage will rise again in April 2023, from £9.50 per hour to £10.42. With a high proportion of retail staff employed at these pay levels, this rise of +9.7% is a considerable cost for businesses to consider, particularly when added to PAYE and other staff benefits.
Increasing energy costs
Retail Gazette recently reported the steps being taken by major retailers to reduce their energy costs. Whilst some steps, like Curry’s turning down the brightness of displays on its instore TVs, offer a `no cost' solution, many will involve additional spend, which ultimately falls through to occupier profitability. For example, Waitrose’s investment in electric heat pumps will offer longer-term benefits in energy efficiency, but short-term costs will be incurred and do little in to manage John Lewis Partnership’s expected £18m overspend on energy for the year to January.
To achieve a greater understanding of an occupier’s business, landlords should engage in an analysis of their occupier's business model. Filings at Companies House can offer a wealth of data and insight into performance (Next’s quarterly reports always offer a key insight into the performance of one of the UK’s leading omni-channel retailers), the challenges retailers face and the steps the industry should be looking to take. But no solution is fool proof – company accounts report on previous trade rather than looking forward, with many accounts still reporting on periods of lockdown or recovery from lockdown. Accounts can be opaque, with many brands sitting within wider divisions for which specific information is impossible to extract and reporting styles can make like-for-like comparisons awkward. So where does this leave landlords?
Ultimately, lockdown and general trends in landlord/tenant relations show the benefit of increased transparency between both parties. This approach needs to be extended to the analysis of occupier profitability and financial viability. To ensure occupier engagement, landlords must try to gain as much of an understanding of occupier performance, however imperfect the methodology, to ensure occupiers truly engage.
Andrew McVicker