Business analysts are fond of distinguishing between 'cyclical' and 'structural' decline. This is particularly apt in a discussion of high-street shop investments. Except for a short-lived recovery spurt in 2009, shop values have been falling continuously since 2007, according to the IPD UK Retail Property Auction (RPA) index. Is this bear market cyclical - the result of the long squeeze on real incomes, which will reverse when economic growth returns? Or is it a structural consequence of technological change, which will continue as e-commerce and out-of-town retailing take further market share away from traditional high streets? The answer, clearly, is both - yet the relative importance of the two trends matters more than ever now that the economy is showing signs of recovery.
Investors Chronicle turned bullish on the regional property market in a cover feature in March (Tired of London?). That call has turned out to be broadly correct. The regional component of the benchmark IPD index for institutional investors started showing positive capital gains in May, and the growth has since consolidated in tandem with better macroeconomic news.
But it's not yet clear that improving sentiment among City investors is filtering down as far as the market for high-street shops, which is dominated by wealthy private investors and small property companies buying at auction. True, £356m worth of assets exchanged hands at commercial property auctions in the three months to July - 10 per cent more than the previous year. But the latest update from the RPA index reckons values fell 2.4 per cent during the second quarter - an acceleration of the previous downward trend.
One way to understand this apparent contradiction is to assume that a pick-up in risk appetite is drawing lower-grade stock to the market, boosting volumes but depressing prices. "Three years ago we couldn't sell the higher-risk stuff," points out George Walker, a partner at Allsop, the largest auction house. The risk associated with these properties is their insecure income profile - typically because of impending lease expiries, unsustainably high rents or unprofitable tenants. At bargain prices, they are beginning to attract opportunistic property companies, often using debt. Crucially, banks seem to be regaining their appetite for the sector: cash buyers accounted for 73 per cent of purchasers at Allsop's February auction, but only 61 per cent in July.
This troubled sector has most scope to recover - but it is also most exposed to structural decline. Chain stores have discovered they can cover the country with a more concentrated store network, bolstered by the internet. Richard Auterac, chairman of Acuitus, another big auctioneer, cites second-tier towns such as Hanley, Wolverhampton and Bolton as those most at risk. "There are still lots of national retailers on short leases paying high rents. Investors just aren't sure they'll get the rent when the leases expire," he says.
Of course, this risk is already reflected in deeply-discounted prices. The problem is that private investors are ill-equipped to deal with a vacancy. If many shops need to be converted to alternative uses, as the Grimsey report argues, it will require both capital and knowledge of the planning system. Meanwhile, there will be hefty business rates to pay.
This is why private investors have for the past three years focused almost exclusively on top-end assets - shops let on long leases to big brands. Allsop sold a small Tesco in Lincoln for £752,500 in July - "classic private investor territory", says Mr Walker. In 2010 the supermarket committed to pay £44,000 a year for at least 10 years, giving a yield of 5.5 per cent on the purchase price after costs. Bidding for such assets has been competitive throughout the bear market, reflecting their relative scarcity as well as intense demand for reliable income investments. Any wider worries about the future of retailing have been trampled in the stampede for yield.
This is understandable, but perhaps short-sighted. As an economic recovery gradually shifts the attention of investors from capital preservation to growth, Mr Grimsey's reflections may seem more relevant. Eventually, rising interest rates are likely to undermine the appeal of assets that merely offer a secure income stream. Factors such as lease length and tenant quality - which have been all-important through the bear market - may start to play second fiddle to location.
A shop in a thriving town should prove a good long-term investment, whoever the current tenant. A shop in a declining town could easily absorb cash like a sponge. High-street investments used to be bets on retailers. In today's more footloose retailing environment, they have become a bet on towns themselves, encompassing everything from local demographics through public investment and jobs to social change. That suggests shops let on temporary leases to independent retailers in improving locations may be too cheap. It also suggests that direct property investments, more than ever, are a locals' game.
