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Sell signals come in many forms. Conventional wisdom in the City of London, for example, holds that a flashy new headquarters is a reason to avoid a title. This is one way of looking at Kering’s decision to spend 1.3 billion euros on a building in Milan’s iconic Via Montenapoleone.
To be honest, purchasing properties in key locations is not a new trend in the luxury sector. Brands want to secure their footprint in the face of scarcity and competition. Doing something special with the building and store can also give them an “experiential” edge to wow their customers. LVMH is buying properties in New York, Paris and Milan. Prada also bought its New York building. This increases pressure on rivals to plant their flags.
However, purchasing real estate is not the smartest use of luxury cash flows. At first glance, Kering’s deal doesn’t seem that bad. The group obtains 11,800 square meters, of which over 5,000 of commercial spaces. At Milan’s current market rates, the rent could theoretically cost perhaps €50 million per year. Assuming a typical yield of 3.8%, this more or less justifies the price of the building.
But that’s far lower than the double-digit return on capital Kering delivered in 2023, according to S&P Capital IQ. And it’s unlikely that anything approaching current rents will be built from long-term tenants like the high-end (and LVMH-owned) Cova cafe.
Seen in this light, the push to secure prime real estate is essentially a round of begging thy neighbor for luxury companies. According to Bernstein, capital expenditure intensity is increasing, from 6% of sales in 2019 to nearly 9%. Return dilution is manageable for giants like LVMH. But it’s more painful for smaller brands, which may explain why Kering’s real estate strategy also includes seeking co-investors to limit the total capital involved.
The Milan building is by no means Kering’s only new project. In the last two years you have purchased properties in Paris and New York, the perfume house Creed, the sunglasses manufacturer Maui Jim and a stake in Valentino, for a total investment of around 10 billion euros. This is a big boost for a group that generates 4.5 billion euros in cash flow a year.
It also means Kering has a lot on its plate. That’s no comfort given the disappointing performance of its key brand Gucci, which recently warned about profits. Given that Gucci accounts for about half of Kering’s operating profit, the stock’s performance depends on its turnaround. Glitzy distractions, real estate or otherwise, should be avoided.
camilla.palladino@ft.com