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Retail rents under pressure

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The past decade has seen dramatic changes in the Danish retail landscape. A surge in e-commerce, new consumer patterns along with a shutdown of society due to COVID-19 have seriously impacted the basis for the continued existence of Danish shopping streets, not least in small, stagnating urban districts. In this article, we nevertheless offer three arguments why the outlook is altogether brighter for major Danish growth cities. 

Shop closures

For years on end, the demise of small shops has been a recurring topic in domestic media, with several analysts predicting that e-commerce will render Danish shopping streets desolate in the long term. Indeed, in terms of the overall retail market, the trend is clear: Not only have aggregate retail sales levelled off since 2009, but online sales also soared by 356.3% in 2009–2019 according to FDHI, The Association of Danish Internet Trading.

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As e-commerce today accounts for a bigger share of largely constant retail sales, it invariably follows that physical shops have seen a decline in sales. In addition, as the retail industry is notoriously competitive, operating at exceptionally low margins, it is not surprising that traditional shops have been beleaguered since the financial crisis. If anything, the coronacrisis has only accelerated this trend, with some parts of the retail trade currently appearing to be bearing the brunt of the lockdown of society.

If recent years’ developments continue, you may be misled to believe that all shopping streets across the nation will become desolate. The problem with this conclusion is that it underestimates market adaptability. Although it is fair to expect an increasing number of shop closures and discontinued activity along the shopping streets of small, low-growth urban districts, we believe that the shopping streets of major domestic high-growth cities will do just fine. In the following, we outline three arguments to support our claim.

1. The demographic factor

Like the rest of the world, Denmark is characterised by substantial migration into cities these years. This urbanisation trend is often described on a general municipal level. However, in this context it is more interesting to look at migration patterns within individual municipal boundaries, where we see strong population growth in urban districts. Take the City of Aarhus, for instance: In this municipality, the population has increased by 43,333 inhabitants in 2010–2020, with just shy of 87% of this population growth taking place in Aarhus proper. This trend is seen not only in large university cities, but across all major Danish towns and cities. As further examples, we may add that the individual municipalities of Esbjerg, Viborg and Slagelse have seen an influx of 369, 3,611 and 1,598, respectively, in 2010–2020, but the cities of Esbjerg, Viborg and Slagelse have seen an influx of 578, 5,122 and 2,097, respectively.

As Danes increasingly tend to settle in proximity of main shopping streets, it follows that such areas, all other things being equal, have a large customer base. Only few shopping streets in Denmark have seen a material increase in the number of retail units over the past decade. In the same period, the ranks of prospective customers have increased. In other words, even if the average shopper allocates a smaller share of his or her individual retail spend to physical shops, a decline in total retail spend will be partly alleviated.

As a natural corollary of this argument, the minimum size required of a town or city and its catchment area to support a shopping street will increase. Multiple small or medium-sized urban districts that used to border on this size requirement will be in dire straits. As population growth in large urban districts is driven predominantly by migration from less densely populated districts, the increase in the potential customer base of large cities will invariably cause so-called cannibalisation of smaller urban districts. This trend seems set to continue also longer term.

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2. Novel concepts, novel ideas
 
Some goods and articles trade better online than others. The sale of relatively standardised items such as clothes, home electronics, books, etc. has therefore largely moved online. Those days are over when it was sufficient to open a traditional shop, selling standardised goods and offering second-rate services. The physical shops are required to offer something special that e-commerce cannot muster.
 
As a result, we foresee an increase in the offering of experience-oriented shopping with an emphasis on quality and services. We expect most traditional shops to also have an online sales platform. As far as retailers are concerned, physical shops will increasingly function as showrooms where customers may experience an item before buying it online. We therefore believe that an increasing number of physical shops will be perceived as an investment intended to drive online sales.
 
Along with the anticipated increase in experience-oriented shopping comes an increase in the number of restaurants, cafés, bars, bakery shops, etc. This trend has already been underway for several years. Novel concepts and ideas will continue to surface. Because of the strong competitive pressure, market players will be forced to come up with new ideas and be innovative, and the retail landscape of tomorrow will no doubt offer experiences beyond our imagination.
 
Since the 1960s, a constant clamour of voices has predicted mass unemployment on account of computers and artificial intelligence. A large portion of the population today have jobs that were simply inconceivable just 30 years ago. As this example suggests, caution is generally advised when it comes to underestimating the market’s ability to adjust. The adjustment does not happen overnight. However, when old structures break down and crumble, new opportunities arise. This very much applies to the Danish retail landscape, too.
 
3. Rent levels must come down
 
Rent levels are another area where market forces will eventually manifest themselves. In the aftermath of the financial crisis, we witnessed rent hikes in many of the foremost shopping streets in Denmark. In particular Copenhagen and Aarhus saw a surge in the rents commanded in the most important shopping streets and high-street locations. Several shop units were let on long lease agreements with a provision for annual rent indexation by 2-4%. With an average year-on-year inflation rate below the 1%-mark, actual rental costs have seen a steep increase.
 
This trend continued until around 2017–2018, when the pressure from e-commerce and the resulting decline in the sales figures of traditional shops triggered a substantial increase in vacancies. The relatively high vacancy rate level in several of the country’s most prominent shopping streets is therefore a problem that hails back to pre-COVID-19 days. In many instances, landlords have been slow to adjust their expectations to the new normal. This also applies to the banking sector, often granting loans based on prospects of continued rent increases.
 
Despite obvious geographical differences, we believe that the general rent level needs to come down if we are to eliminate vacancies. In our market experience, a rent reduction may often be required if tenants are to run a profitable business.
 
In this respect, Aarhus serves as a good example as the city has been grappling with relatively high vacancy rates in recent years. Ironically, the coronacrisis kick-started letting activity in the city as the socioeconomic situation helped to pave the way for a long-awaited willingness among landlords to lower asking rents. According to our monthly count in the Aarhus high street, today’s number of shop vacancies is lower than before COVID-19.
 

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In purely theoretical terms, there is also evidence to support a rent reduction: Unlike e.g. a pint of milk, the price of which is almost exclusively determined by its production cost, the rental price of premises in Danish shopping streets is to a large extent determined by economic (scarcity) rent. The economic rent relates to the part of the rent that exceeds the amount required to retain the current use of the property. In this instance, the economic rent is created by an inherent exclusivity factor, e.g. a prime Copenhagen high-street location at Strøget.

The high economic rent in the Copenhagen high street may simply be explained by the additional turnover the tenants expect to achieve in such a location relative to the turnover expected in an inferior location. This is why the rent in the Copenhagen high street exceeds the rent in the Aarhus high street, with the latter in turn exceeding the rent commanded in the high street of a relatively small town like Horsens. As turnover expectations based on a central high-street location decrease, the economic rent is bound to decrease, too. In other words, the long-term general rent level is determined by turnover. Obviously, this argument is only valid as long as the rent covers the alternative cost of owning the premises. If this is no longer the case, the premises will no longer be offered to let, which is exactly what we expect to see in many of the small urban districts where the rent is already closing in on the alternative cost.

Overall, based on the continued urbanisation trend, the adaptability of traditional shops along with prospects of landlords becoming more open to negotiations, we believe it fair to conclude that there is hope in particular for the main shopping streets and high-street locations of major Danish cities, always provided they are able to tap into current trends and offer spot-on concepts, experiences and services.