Most commercial landlords are bracing for a further hit to their income, but this week it will become apparent exactly which tenants are under most strain as third quarter rents fall due. The picture looks most stark for those leasing space to retail and leisure companies, who after enduring almost three months of store closures, are facing severe pressure on their cashflows.
Last week the moratorium on commercial lease forfeitures, which prevents landlords from repossessing properties if tenants fail to pay rent, was extended by the government until the end of September. For landlords, which have to balance rental income with their own operating costs and debt obligations, the scales seem likely to tip increasingly towards declining profits, thinning interest cover and loan-to-value ratios edging nearer covenants as valuations reflect the darkening outlook.
Trafford Centre-owner Intu (INTU), which said it expected to collect 37 per cent less rent this year than in 2019, this week revealed that it has appointed KPMG to formulate a contingency plan for administration. The shopping centre owner is still grappling with lenders over a standstill agreement, which would allow it to pause repayments potentially until the end of 2021. The deadline for the discussions is 26 June, but failure to reach an agreement could result in the closure of some centres for a period.
Some companies have already made clear their intentions to withhold quarterly rent payments. Greggs (GRG) has informed landlords that it intends to switch to monthly payments from June, while Primark is seeking to renegotiate lease terms after failing to pay its March rent bill on time. While the latter said it intended to pay some rent on 24 June, it was seeking “an equitable outcome” for the 12-week period when it was not trading.
Travelodge has gone one step further. After withholding rent due in March, the budget hotel chain launched a company voluntary arrangement, which creditors voted through last week. Under the terms of the controversial arrangement, Travelodge will pay reduced rent until the end of 2021, but unusually, no hotels will be closed.
Stephen Springham, Knight Frank's head of retail research, predicts that just 10 to 20 per cent of retailers will meet their rent obligations in full and on time in June. Supermarkets are expected to pay all of the rent due, while prospects for those leasing space to those within the food and beverage sector is far more dire, he said. “If anyone gets any rent out of those guys they have done very well,” said Mr Springham.
However, while there will likely still be some shortfall, the prognosis for rent collection throughout the third quarter could be better than it was after the March collection date, said Colliers International head of investment property management, Mark Jarrett, when retailers and leisure groups had no visibility over how long they would be shut. “This time it’s a completely different story since the retailers are mostly open and trading and the same goes for leisure, they know that they’re going to open pretty soon,” said Mr Jarrett.
Debt danger looms
The pandemic has accelerated the existing structural challenges facing retailers and leisure groups, which has resulted in declining rental values for space across the high street and in shopping centres and retail parks. Pessimism around retail and leisure rental prospects has been reflected in hefty devaluations in UK-listed landlords’ portfolios.
NewRiver Reit (NRR) last week revealed that it had suffered a 12 per cent like-for-like fall in the value of its portfolio during the year to March, around a third of which was due to Covid-19. That resulted in the group, which lets space to retailers including discount retailer B&M (BME) and Sainsbury’s (SBRY), reporting a pre-tax loss of £122m, a sharp rise on the £36m loss recorded the prior year.
The group collected 52 per cent of second quarter rent in cash and has repayment programmes for rent representing around 23 per cent of the amount due at the end of March. Chief executive Allan Lockhart said he expected a similar performance at the June quarterly payment date, but that the prime focus was on strengthening the balance sheet.
That is unsurprising - the loan-to-value ratio had jumped to 47 per cent by the end of March, from 37 per cent the prior year. That may be below the tightest LTV based covenant of 60 per cent - although above management guidance of 40 per cent - but the magnitude of the fall in asset valuations makes it difficult to justify the payment of dividends.
Unsurprisingly, most commercial landlords - NewRiver included - have eschewed recommending dividends in the wake of the pandemic as they prioritise conserving cash. “We need a few months to work our way through, to see how the market is reacting to the post-Covid lockdown environment,” said Mr Lockhart of the possibility of a return to dividends.
Yet the pandemic has spooked investors that had been willing to acquire retail assets, part of the reason NewRiver was a net acquirer of properties last year. “We would have been neutral if we hadn’t lost some of the sales that we were processing, the buyers pulled out when Covid erupted,” said Mr Lockhart.
He is targeting disposals of between £80m and £100m this financial year and has £30m in deals completed or under offer since the end of March, arguing that smaller lot sizes will make it easier to shift properties.
Admittedly, finding a buyer for large retail assets is a much tougher ask. Hammerson’s (HMSO) plans to dispose of seven retail parks for £400m was thwarted after private equity buyer Orion walked away from the deal in May. It seems unlikely the group will secure as high a price tag if it does manage to find a buyer in a post-Covid-19 market.
The valuation conundrum
Would-be sellers need to reset their expectations of the type of price that they could achieve, argued Mr Springham. “The investment market is pretty thin for retail at the moment,” he added.
There is an inherent difficulty for valuers accurately assigning a price to retail assets in the current market, he said. “It's very hard for them at the moment to value these assets, a lot of what they’re valuing is retrospective and obviously the market moves very quickly.”
Most global markets do not expect any sustained recovery in retail transactions until 2021, according to Savills, and even then, more than half of those surveyed anticipated deal volumes would remain flat or continue to decrease.
Landlords are likely going to need to be even more flexible with lease terms as pressure on rental values continues. “I think the lease relationship might change, it might have more of a turnover component to it,” Landsec (LAND) chief financial officer Martin Greenslade told us at the time of the group’s full-year results in May. Around a quarter of leases are currently linked to a tenant’s turnover.
However, an increased shift towards turnover-based rents could exacerbate difficulties around valuing retail assets. Valuations are wedded to quite a “rigid model”, said Mr Springham. “So it’s not really developed to deal with uncertainty of turnover rents,” he added.
While interest in changing the use of retail assets to residential or healthcare has also increased, it is not as easy as it might seem. It only really works within the M25, where space is at a greater premium, said Mr Springham. “It doesn’t stack up on valuation-side, retail values need to come down further,” he said.
|TIDM||Name||Offer (p)||EPS (p)||Dividend per share (p) (adj)||Forecast dividend per share (p)||2y Forecast dividend per share (p)||Dividend cover||Net gearing (%)|
|BLND||British Land Co PLC||399.9||32.7||16||10.2||23||2||49.4|
|CAL||Capital & Regional PLC||102.65||37||21||13.5||18.7||1.8||105|
|CAPC||Capital & Counties Properties PLC||161.5||1.1||1.5||1.3||2||0.7||16.3|
|INTU||Intu Properties PLC||4.72||2.5||0||0||0||na||238.9|
|LAND||Land Securities Group PLC||594||55.9||23.2||22.5||38.6||2.4||45.6|
|NRR||NewRiver REIT PLC||69.1||16.7||16.2||6.5||13.2||1||103.8|
|RGL||Regional REIT Ltd||75||7.8||8.2||5.8||7.5||0.9||65.9|
|SIR||Secure Income REIT PLC||277.5||15.3||16.8||12.5||18.2||0.9||51.2|
|SUPR||Supermarket Income Reit PLC||109.5||5||5.6||5.8||6||0.9||58.1|
|TOWN||Town Centre Securities PLC||104||12||11.7||5||3.9||1||96.6|