Big losses for landlords are raising questions about the future of the retail property industry and the changing relationship between landlords and their retail tenants.
With valuations slashed, profits turned into dire losses and once-safe tenants appearing increasingly risky, the UK’s retail landlords are suffering from arguably the worst conditions on the high street in a generation.
Three of the largest landlords – Landsec, British Land and Intu – have been hit by a surge in company voluntary arrangements (CVAs) over the past 12 months, and retail performance has dragged down other more buoyant parts of their portfolio.
Retailers are now finding themselves with the upper hand in negotiations for the first time in years, as landlords seek to fill space. But experts warn that without landlord investment, urban regeneration could cease. Drapers talks to retailers, landlords and agents about the seismic shift in relationships.
Losses at Bluewater owner Landsec trebled to £123m for the year to 31 March. It blamed margin pressure and weakening consumer demand.
Meanwhile, Intu – owner of the Lakeside, Metrocentre and Merry Hill shopping centres, among others – that it was braced for a “challenging year” and net rental income was expected to slide by 4%-6% as a result of margin pressures, weak demand and consumers’ shift to online shopping.
British Land slashed the value of its retail portfolio by 11.1% for the year to 31 March. CVAs alone cost the landlord £14m in lost revenue for the year.
British Land is owner of London’s Broadgate and the Meadowhall shopping centre in Sheffield. Its figures show that, of around 2,000 stores in its portfolio, 132 had been exposed to CVAs and administrations since 1 April 2017, leading to rent reductions of £16.9m. It anticipated that CVA action would reach its peak in the first quarter of the 2019/20 financial year.
Many property experts say the results are the poorest since the financial crisis of 2008, and there may be worse to come for landlords.
One property source believes landlords are finally facing up to reality: “What you have in the valuations is that the prime end [of retail] has been slightly in denial, and then suddenly the dam has burst. In the community end [lower-value retail space] we’ve seen this damage over the past five years.
“The fashion sector is the hardest hit [of UK retail sectors], and the CVAs are accelerating that, from department stores to well-known high street names.”
Other retail experts believe landlords will continue to experience volatility in the market until an end is put to CVAs, which many view as a “legal loophole”.
One property agent told Drapers: “Without doubt, anybody with a retail portfolio will be writing it down for provisions because there will be CVA after CVA [in the coming year] unless the law changes.
“I think [the law] will have to change, but politicians are side-tracked with other issues, so this is not on the agenda, and the high street will fall to one side as long as there is no government intervention.”
Level playing field
For many retailers, landlords’ woes come after years of being on the receiving end of rent hikes that are only now being fundamentally challenged.
A senior director at one fashion retailer that has undertaken a CVA told Drapers: “From our point of view, we were keen to work with all our landlords, but they tended to have the upper hand over many years, and it’s more of a level playing field now.”
The managing director of one UK multiple told Drapers the system is antiquated: “When one of the big brands, say Google or Apple, pays a king’s ransom for a site, that has set the prevailing rates and rents you have to pay. When you come to renew a lease, it doesn’t matter if you turned a profit on that store or not, your rent is hiked.”
One of the starkest example of a write-down of a portfolio was British Land’s 40.1% cut in the value of its department store holdings, which are now priced at £70m. British Land’s exposure to department stores is low compared with other parts of its portfolio – it values its retail parks at £2.6bn and shopping centres at £2.1bn – but the scale of the devaluation is indicative of the precarious position in which department stores now find themselves, following the administration of House of Fraser last year and Debenhams’ ongoing CVA landlord negotiations.
“This isn’t just British Land, Landsec or Intu – all landlords are affected,” one agent added. “If department stores at British Land are being written down by 40%, all landlords are going to be writing the values down by 40%. The interesting thing is who is in denial and who can afford to show it on their accounts.”
Retailers are already dictating pricing in a way which you haven’t seen for many years
Despite the headlines generated by the cuts in valuations, the reality is that retailers can now dictate their terms in a way unheard of for a decade, said one property agent: “I don’t think there’s any impact on fashion retailers [fromthe property losses]. They are already dictating pricing in a way that you haven’t seen for many years through a general lack of demand.
“In some places where people are trying to do deals, artificially high valuations can stop deals from happening.
“Assets needed to be rebased so people can trade in them. If anything, a number of obstacles and gaps between retailers’ willingness to pay and landlords’ ability to accept should get closer – it should make it easier for retailers to do deals.”
The big question for the future of physical retail, some argue, is what long-term effect poor performance will have on investment in the sector. Will landlords continue to invest in an age of uncertainty?
One retail agent believes that is unlikely at present: “Retail as an asset investment is the least favoured [in property], as you simply can’t trust your tenant because of the CVA scenario. If these shopping centre landlords had the money now, would they invest in shopping centre? One hundred percent would actually invest in non-retail.”
The feeling is shared by Dan Simms, co-head of retail at commercial property agency Colliers International. He notes that, although rents may have risen in many new shopping centres, developments that have come on board across the UK in the last two decades have spurred phenomenal regeneration of many cities: “If you look at Bristol, Leeds, Cardiff and Liverpool, the upgrades to city centres are driven by new retail and leisure. If landlords decide not to do that any more, what happens?
“Before Grosvenor built Liverpool One, the city centre was on its knees. It had no inward investment, and no one lived there. Then Grosvenor built that big anchor centre and look at Liverpool now – it’s totally transformed. If the viability of retail slides much further, people won’t be able to build new space or renovate old space.”
The upgrades to city centres are driven by new retail and leisure. If landlords decide not to do that any more, what happens?
Dan Simms, Colliers International
Simms said many landlords are beginning to take the initiative in terms of making space and lease terms more flexible for retailers in a bid to resolve the current problems they face.
“[Landlords] are looking at shorter-term leases and turnover-linked leases. One of the fundamental problems is that there are retailers who want to take more stores but don’t have the capex [capital expenditure] available or are scared of onerous lease commitments.
“We are moving more to the factory outlet model, which is very successful. It is turnover orientated and retailers aren’t as committed, so it makes the market much more fluid and people don’t have to spend £400,000 on a store they can’t write off.”
The managing director of the high street multiple said: “The old business model doesn’t work. Perhaps we may have to lower the base rent and have more turnover-based rent models. But if you are a landlord you’d be crazy to let go of the old model. What is happening is many retailers are saying: ‘We can’t carry on like this.’”
A flexible rental solution may be an option for the future that could more effectively balance the needs of landlords with property to fill and retailers seeking a home. However, the somewhat adversarial relationship that persists suggests there could be a long way to go before it becomes a mainstream option accepted by both sides.
The Drapers verdict
The retail crisis has been an iceberg heading straight at landlords for some time – the question was always whether they would see the danger coming and act. The difference in this downturn compared with the economic crisis of 2008 is that there are fewer new entrants in the UK market that are keen to take up vacated space.
Landlords need to work harder to understand retailers’ pressures, and the leasing model for retail also needs to be updated. Retailers, for their part, need to understand that the vast improvement in many towns and cities has come at a price, and if landlords divest from their portfolios it will be the retailers who ultimately pay. New thinking is required on both sides if the current malaise is to be overcome.