In receivership: Nicholsons Shopping Center, Maidenhead, England

In June 2016, the UK’s then home secretary Theresa May visited the Nicholsons Shopping Centre in her constituency of Maidenhead, a town 25 miles west of London. The mall had been bought the previous March by private equity-backed property firm Vixcroft and private credit manager Cheyne Capital with the promise of a revamp. The soon-to-be prime minister was checking in on the upgrade.

“We want to see more shops and businesses attracted to the town center so that it can become a vibrant hub for the community,” May said on her visit. The opposite happened. As the UK’s bricks-and-mortar retail crisis hit, several tenants vacated Nicholsons. Last October, it became the first major example of a UK shopping center to be placed into receivership during the current cycle – a consequence of its failure to meet its debt obligations. The scheme was bought for £37 million ($47.6 million; €42.5 million) in 2015, backed by a £26 million loan from Hermes Investment Management, according to reports.

“Retail is challenging in the UK at the moment,” says Morgan Garfield, managing director of Ellandi, a property company specializing in managing shopping centers across the UK and which took on management responsibilities for Nicholsons in 2017. “Across Europe, there is growing online penetration that will reshape the retail landscape. In the UK, Brexit is an additional complexity. The effective devaluation of sterling since the referendum has increased retailer costs and eroded profit margins while uncertainty has undermined the confidence of occupiers and investors.”

Consumer confidence continued to decline in the fourth quarter of 2018, according to data from Deloitte Consumer Tracker, as uncertainty surrounding Brexit reached new highs. Retail footfall registered a year-on-year decline of 2.1 percent in 2018, according to retail analysis firm Springboard.

The fate of Nicholsons – since acquired by Tikehau Capital and Areli Real Estate – highlights the tough decisions facing real estate lenders as the high street and shopping center retail crisis intensifies. As capital values plummet, debt providers are forced to consider the health of their loans to retail properties, as well as their long-term exposure to the sector.

Falls in value

The challenge for lenders is ascertaining how much the collateral to their retail loans is worth. Data provider MSCI recorded a 5.7 percent decline in capital growth across the UK retail sector during 2018. CBRE’s monthly index, meanwhile, showed an average drop of 10.5 percent for shopping centers over the same period. Fund manager Fidelity International’s prediction is a drop of 20-40 percent for prime retail, with secondary stock expected to fall in value by as much as 70 percent.

“There is a debate as to whether valuers are reacting quickly enough to the reality,” says Nick Knight, executive director and valuation specialist at CBRE. “I can understand how people looking at average values in published indices might say it feels worse out there than the numbers show. But I’m disappointed by suggestions that it is valuers’ conflicts of interest that is keeping values high. You only need to look back to the global financial crisis, when values were written down by 40 percent, to see this is not a community that is afraid of taking values down.”

The lack of transactions in the sector means valuers have limited comparable data to draw on. Savills data show 2018 was the worst year for UK shopping center investment volumes since 1997, with a total turnover of £1.3 billion across 34 deals, down 60 percent on the long-term average.

“Valuing retail now involves balancing sentiment and evidence,” says Savills’ head of valuation, Ian Malden. “Investors are placing less emphasis on yield; it is more about the true cashflow and geared returns. Falling rental values and questions over the sustainable income going forward are very relevant. Valuers also need to increasingly consider the value in a repurposing scenario, which adds a new dynamic to the valuation matrix.”
Knight expects more pain: “There is further to go. History tells us that when you reach an inflection point in the market, there can be a time lag.”

Lenders must also decide whether to take enforcement action if loan-to-value covenants are tripped in their facilities. Anecdotal evidence suggests lenders are desperate to avoid situations of default. The financial crisis of 2008 remains fresh in lenders’ minds and many are understood to be reluctant to take measures that would mean admitting property lending has, again, resulted in failures.

“Some lenders have put pressure on borrowers to cure LTV breaches,” says one UK debt advisory specialist, “but lenders are nervous of defaults, because they remember the pain they went through in the crisis.”

While lenders we spoke with did not refer to specific situations they, or their peers in the industry, might be involved in, they argued that most debt providers will be taking a considered view of the properties they are financing, rather than panicking at the fall in values.

Income eroded

The slew of high-profile retailer administrations in the last six months has created a real danger to retail income. Retail property experts also point to the damaging impact of retailers using company voluntary arrangements – deals allowing them to reduce rents as part of a survival plan – which many consider an abused tool in recent months. The traditional upward-only rent review, it seems, is not sacrosanct.

“Tenant failures and falling rents will erode net operating income,” says Garfield. “If, in turn, this has an impact on the ability to service debt, lenders will have to act.”

Sector analysts do not expect pressure on retailers to let up. The Centre for Retail Research expects 22,100 retail closures this year in the UK, up from 18,443 during 2018. Andrew MacDonald, head of real estate finance at asset manager Schroders, is one of those who see the threat to income as the most immediate concern for lenders.

“Banks are pulling back from retail and there is a definite focus on the best examples of retail, which means outlet centers and retail warehouses are an easier sell than high street units or shopping centers”

James Wright
Link Asset Services

“In the financial crisis, it was more a capital value-led issue,” he says. “Lots of loans breached LTV covenants because of yields rising, but income was still robust in lots of those loans. The issue this time for retail is on the income side of the equation. Loans breaching their income coverage ratio covenants is more of an issue than LTV breaches.”

Some, including Trevor Homes, head of senior lending at debt fund manager DRC Capital, are convinced income will hold up across many UK shopping centers, despite the crisis. “Income is holding up at a lot of shopping centers, so although there have been a few administrations, we are not seeing ultra-low occupancy at shopping centers. The serviceability of debt is usually sustainable. The lending was generally done on sensible terms in the first place.”

While lenders are not, at this stage, pulling the plug on their existing borrowers en-masse, sourcing new finance in the retail sector is understood to be difficult. Banks are negative on the asset class in general, despite protestations from some in the industry that parts of the sector, including leases to the major supermarket chains, remain robust.

The long-term liquidity of retail property debt is in the balance, and may cause problems for those sponsors in need of refinancing come the maturity of their current loans. Many of these fall due at the end of this decade, with Savills identifying 2020 as the market’s refinancing spike. Given many assets across the UK are owned by private equity funds that have deadlines to return capital to investors, debt for refinancing is a necessity.

Lenders have also taken a more conservative approach to underwriting during this cycle. Leverage levels typically fall below 60 percent, compared with the 85 percent-plus seen before the crisis.

Debt advisory specialist James Wright, head of the real estate finance business at Link Asset Services, recalls the challenges of sourcing debt for clients in recent situations. “Banks are pulling back from retail and there is a definite focus on the best examples of retail, which means outlet centers and retail warehouses are an easier sell than high street units or shopping centers. It comes down to the covenant strength, lease lengths, the quality of the real estate, but also increasingly the alternative use value.”

Although banks do not tend to signal cooling appetite for a sector, there is an acknowledgement from many that retail is problematic. Where banks retrench, alternative lenders tend to in-fill and sources say the market is playing into the hands of those debt funds with higher risk/return profiles.

Filling in the gap

Some alternative lenders see the fall in retail values as an overcorrection and will lend, if vacant possession value is higher than the loan volume. Others argue alternative sources of capital will not be the cure-all for those in need of retail finance, with some institutional investors, which back many alternative lenders, sharing banks’ qualms about the retail sector.

The factors causing the retail crisis are not going away. A bifurcation in whether retail properties can attract finance is likely to emerge, with properties that have been revamped or repositioned attracting finance, and those which simply do not work in the modern retail environment losing lender support. A major consideration for lenders is what the next generation of UK retail property owners looks like. While better performing assets will remain largely in the hands of institutional ownership, or in the portfolios of listed property companies, there is much debate around who will step in to buy bargain assets that hit the market in the near term.

The vultures are already circling distressed situations. “Many private equity investors, ranging from real estate private equity funds to hedge funds, are eyeing the retail sector, some of whom are looking at the debt as a way in,” says Christopher Daniel, founding partner at Quadrant Estates, which owns retail property across the UK.

“People’s shopping patterns are changing. The internet is not the reason some retailers are suffering – it is because they have a tired offering of the wrong products. The internet just exacerbated the situation”

Trevor Homes
DRC Capital

However, many believe the work-out of the UK’s distressed retail will require investment and long-term thinking, rather than short-term profit.

Buyers are likely to tackle problem retail in joint ventures in order to bring a combination of capital and expertise to the table, says DRC’s Homes: “It might include local authorities, which have the incentive to make these schemes work. When product came out of NAMA [Ireland’s National Asset Management Agency], buyers knew they could do a quick turnaround. Those easy wins are not there at shopping centers – if they were, the existing sponsor would be doing it.”

Shopping for bargains

There is evidence of institutional investors taking the opportunity to buy into the sector. For example, LaSalle Investment Management is reported to be close to buying The Galleries mall in Bristol from Infrared Capital Partners.

“We will definitely take advantage of current pricing, to be very selective on stock,” says Mahdi Mokrane, LaSalle’s head of research and strategy, speaking generally about the possibility of buying assets in a changing retail landscape. “Key considerations for us are location and asset flexibility – dominant urban shopping centers are typically more attractive to us – and capital expenditure, as retail assets need more capex to convert spaces to increase footfall or for alternative uses.”

Just as investors see positive fundamentals in segments of the retail sector, lender appetite will be determined by the individual fundamentals of an asset. “Retail is not dead, but we need to recognize in the UK that we have too many shops,” says Homes. “People’s shopping patterns are changing. The internet is not the reason some retailers are suffering – it is because they have a tired offering of the wrong products. The internet just exacerbated the situation.”

The full extent of the UK’s retail crisis is not yet apparent. What is clear, however, is that lenders are reacting. At this stage, the receivership at Maidenhead’s Nicholsons is not the norm, but as loans come due at struggling shopping assets, more lenders are likely to pull the plug. Further forward, lenders will assess their appetite for the sector; retail, many point out, is not dead, but the wrong kind of retail – the dated stock that does not fit with the times – will not be worth lenders taking the risk.