It may be tempting to read landlords’ success in squeezing more money out of Arcadia owners Philip and Tina Green as a sign that property groups are gaining more bargaining power over company voluntary arrangements (CVAs). It follows Sports Direct’s (SPD) decision earlier this month to launch a legal challenge to the financial restructuring plan put in place by Debenhams (DEB), in which it was the largest shareholder.
However, investors should not take too much succour from the Arcadia example – landlords held a higher than usual proportion of CVA votes. The improved terms were a small victory for retail landlords already facing declining rental income and sharp devaluations on their portfolios. Last year the British Property Federation called for a government review into CVAs, arguing that the process was being “mis-used” by some retailers, citing unfair discrimination between some creditors and a lack of transparency.
The threat of CVAs is one factor that has caused shares in many UK-listed retail landlords to trade at a steep discount to their net asset values (NAVs).
After failing to convince some major landlords of its restructuring plans – forcing a week-long postponement of the CVA vote – retail giant Arcadia was forced to improve its terms in order to secure the necessary 75 per cent of acceptances for its seven CVAs. The fashion giant’s owners agreed to contribute an additional £30m to reduce rent cuts to between 25 and 50 per cent, from the 30 and 70 per cent previously on the table, across a third of the group’s 566 UK and Irish stores over the next three years.
Landlords banded together and appointed investment bank PJT to negotiate better restructuring terms. In the event, landlords including Hammerson (HMSO), Land Securities (LAND) and British Land (BL.) voted in favour of the CVAs, although Intu (INTU) – which owns 35 Arcadia stores, equivalent to 4 per cent of the retail property specialist’s annual rent roll – stuck to its guns and voted against the proposals. Intu said in a statement: “We firmly believe that the terms of the Arcadia CVA are unfair to our full-rent-paying tenants and not in the interests of any of our other stakeholders.”
US landlords led by Vornado – which owns two of Topshop’s prime stores – filed a legal challenge to the Greens’ decision to push Arcadia US into administration in a New York bankruptcy court. Arcadia declined to comment on the legal challenge.
The number of retailers opting for CVAs increased by more than half to 38 in 2018, compared with the prior year, according to research by Deloitte.
Under most CVAs, landlords would only be entitled to the amount of rent defaulted on by the tenant, said Philip Abbott, a partner at law firm Fieldfisher. “The issue for landlords has been when you’re calculating what amount is owed to [them]… you’re not projecting to the end of the lease and the unlimited liabilities to the landlord,” said Mr Abbott.
Most CVA supervisors assume that a landlord will be able to re-let a property so that the gross amount of a claim is reduced. What’s more, in contrast to the Arcadia CVA, landlords’ votes are usually far outweighed by other creditors.
Town Centre Securities’ (TOWN) chairman and chief executive Edward Ziff said, while it had eight CVAs in 2018, the Leeds-based property investor – which owns the Merrion Centre – had been “hit with a flood” of them this year and expected the situation to get worse. “We are increasingly worried because there are very few businesses that will survive for a long period of time once they go through a CVA,” he said.
Given the more precarious backdrop for retailers, lease lengths are on average shorter and the company is disposing of units when the market is willing to pay more than what management thinks it may be worth down the line, Mr Ziff said.
For some landlords, re-letting to non-retail tenants is a more viable option. “The number of retailers out there that are willing to take on new units is a fraction of its former size, even two years ago,” said Mr Ziff.
Into bargain territory?
Weakening sentiment towards UK retail property has weighed on portfolio valuations, as the heightened risk attached to owning these assets has led valuers to assume potential buyers will demand higher initial yields. In 2018 Intu’s net initial yield rose 62 basis points to 4.98 per cent. However, determining when we will have reached the bottom in valuation terms may be more difficult than previously because, in contrast to the 2008 sell-off, the decline in NAV is due to structural, as well as economic, challenges.
A greater level of property disposals would make it easier to determine the true market value of retail assets and the rent that can be charged on them. “If someone breaks rank and sells at a marked-down level, we will see a rebasing of valuation yields,” said Miranda Cockburn, a real estate analyst at Panmure Gordon.
However, there is unsurprisingly a lack of liquidity in the retail real estate market. Some landlords will want to hold off selling in a depressed market. At the time of Land Security’s full-year results, chief financial officer Martin Greenslade said the group is likely to exit the retail park market altogether over time. “But this probably isn’t the right market to be selling much in the way of retail,” he added.
Mr Abbott said that his firm had not seen a great deal of bargain hunters circling the sector yet. “If you are going to invest in retail at the moment, unless it really is prime, then you have probably got some investment to make to turn it around,” he said.
That could change. Declining property valuations have pushed up loan-to-value (LTV) ratios for some landlords, prompting them to dispose of certain assets. The sector average LTV ratio stands at 40 per cent, according to analysts at Panmure Gordon. However, Intu’s debt-to-asset level had risen from 45.9 per cent to 53.1 per cent by the end of last year. As well as entering joint ventures and halting the final dividend payment, the group made £171m in disposals last year and said it had “flexibility” to dispose of up to two-thirds of its wholly-owned portfolio.
Hammerson – which last year walked away from a takeover bid for Intu – has also been disposing of a swathe of assets. This year, the landlord – whose LTV ratio stood at 43 per cent on a proportionally consolidated basis last year – is targeting £900m in sales, on top of £570m made in 2018. However, the latter was made at an average disposal price of 7 per cent below December 2017 book value.
“The trouble is you can end up selling what you can rather than what you want to,” said Ms Cockburn.
NewRiver Reit (NRR) is also taking a cautious approach to keeping a lid on its LTV ratio, which stood at 37 per cent at the end of March. “If we want to acquire a new asset, we have to fund that through disposals,” said chief executive Allan Lockhart.
A joint venture with asset manager Pimco was also announced in May, in the hope of raising NewRiver’s purchasing firepower. That joint venture purchased a portfolio of four retail parks for an aggregate £60.5m, reflecting a net initial yield of 9.8 per cent, from Zurich. Mr Lockhart said the agreement was aimed at boosting the company’s return on capital expenditure.
