Andrew Jones, chief executive of LondonMetric (LMP), suggested that many large supermarkets were valued at yields of 4-5 per cent on balance sheets, but said that this should already be nearer to 6 per cent. On current valuations he reckons that the big supermarket picture is "economically unfit", adding that as an asset class supermarkets (the properties that they hold) are likely to be a "serial underperformer".
This should set alarm bells ringing among the institutions that have taken part in Tesco's long string of sale and lease back agreements. These were designed to free up capital for Tesco to invest in new ventures and expanding the existing supermarket chain. A typical example involved British Land (BLND) in 2007, where a £650m joint venture raised £570m for Tesco. This particular example was scheduled to run for 20 years. Other similar deals were already in place by this time, notably a £450m joint venture set up with the British Airways pension fund.
Events have moved on since then, and the question now is, what happens when these agreements mature or reach the point where Tesco can exercise a get-out clause?
There are a number of options. On some sites, the tenant may simply renew because the supermarket site is a real cash generator. The second solution would be to install a new tenant if Tesco decided to walk away. It may decide to stay, but at a lower rent, in which case the matter would immediately go out to arbitration. However, there is another option. In this case the tenant decides to stay but wants to occupy only part of the site and at a reduced rent. This would leave the joint venture partner facing the cost of refurbishing the now empty part of the building to accommodate smaller tenants, who would almost certainly be unable and unwilling to pay the same rent. This would leave the joint partner spending more money to achieve a lower rental income. An alternative to all of these would be for the joint venture partner to decline renewing the lease. In this case, the tenant would be due compensation of twice the rateable value of the property.
The good news is that in the case of British Land, where Tesco, which is its single largest tenant, is making up around 7 per cent of contracted rental income, there are no lease breaks or maturing agreements scheduled in the accounts before 2019, and the actual figure is probably nearer to 10 years from now. However, valuations will be affected long before then as valuers start to write down property values as the lease shortens. It's also worth pointing out that British Land was slowly reducing its exposure to the supermarket world a long time before the Tesco saga of misfortunes came to light. Using half year data to the end of September 2014, British Land had reduced its superstores portfolio weighting from 11.7 per cent to 10.1 per cent, and it seems reasonable to assume that this will continue.
Bright spots remain, however, especially for canny operators such as LondonMetric, which recently announced the purchase of the Tesco.com distribution centre in Croydon, south London. This is one of only four so-called 'dark stores' in London that Tesco uses to serve its online distribution network. The rationale embraces a demand by customers for more immediate delivery, notably in the traffic congested areas surrounding central London. What's more, the latest deal - where the initial rent of £6.70 per sq ft with a 5.8-year lease expiry - is relatively low. And a rental review/uplift is due before the end of this year.
What does this say about the relationship between the supermarkets and the joint venture partnerships cemented over the last decade? Clearly, it seems that trends have changed. The sale and lease back arrangements were a steady and relatively safe gravy chain for all parties involved. It could be said that the advance in mobile devices to check prices may be a factor in affecting supermarket footfall. According to retail research agency Columino, retail floor space will contract by 6 per cent in the next five years, and the number of shops will fall by 10 per cent.
