It is said that patients with underlying health conditions are more susceptible to the novel coronavirus. So the retail real estate industry, weakened by cyclical pressures, the stress of e-commerce and balance sheet woes has found itself flying down a metaphorical hospital corridor in recent weeks. Prognosis: critical.
‘We’re already in a socially-distanced recession,’ says Rob Virdee, analyst with real estate research firm Green Street. ‘Lockdown across most of Europe, with the notable exception of Sweden, has brought economies to a standstill; physical stores are shut. Shoppers can’t spend even if they wanted to.’
Virdee notes that unlike 2009 following the global financial crisis, the negotiating position of retail landlords is noticeably weaker, and tenants, though frail, still have the upper hand. ‘Rent deferrals are now a forgone conclusion and rent concessions are likely forthcoming, although the sheer magnitude is unclear,’ he says. ‘Some landlords are collecting one third of the rent they would normally earn. In 2009, you could find a replacement tenant. That’s not going to happen this time.’
Operational cracks exposed
What is clear is that Covid-19 has exacerbated operational cracks that were already evident to the vigilant. The transaction market has ground to a halt, with institutional sellers – at differing levels of desperation – far outnumbering willing buyers.
‘We know there is going to be distressed pricing, but nobody knows where the bottom is yet. If you are sitting on cash you can deploy, that’s where the outsized returns will come from – just like in 2009. But there are virtually no retail landlords in this situation.’
He adds: ‘Green Street has long been an advocate for keeping LTVs under 30%. We hate to say “I told you so”, but it is nigh-on impossible to time the cycle. Balance sheets, which should be in focus all of the time, are only in the spotlight now.’ The latest Green Street research favours Continental European retail property companies over UK REITs, but there are examples of poor health on both sides.
Struggling UK REIT Intu remains in the firing line after months of bad news. The firm said that the impact of Covid-19 was delaying regulatory approval for the disposal of Intu Puerto Venecia, and thus pushing the receipt of £95 mln in funds to May at the earliest. The firm has asked CBRE to look into selling Merry Hill in Birmingham and Intu Milton Keynes, as well as its 50% stake in the St David’s Centre in Cardiff. Furthermore, at the end of March, it reported receiving only 29% of second-quarterly rents - across the whole portfolio.
Virdee suggests that in such cases, retailer psychology also comes into play. ‘If retailers think that a landlord is going to fail, that they aren’t going to have to nurture a long-term relationship, are they more likely to stop paying?’ he asks. ‘Landlords with firm horizons are in a stronger bargaining position.’
Yet funds are tight across the board. Firms including Unibail-Rodamco-Westfield (URW), Shaftesbury, Hammerson, Deutsche EuroShop, Eurocommercial and Capital & Counties have all announced suspended or reduced dividend payments. Capital expenditure has been similarly frozen. ‘We have to remember that we’re looking at a near-term loss of rental revenues which may never be clawed back,’ Virdee notes. ‘Government legislation across Europe is in flux, it is likely that landlords are going to have to share tenant pain.’
Essential retail a safe haven?
However, retail landlords that own units let to supermarket tenants and other businesses classed as ‘essential retail’ are having a starkly different experience. The UK’s biggest grocery investor, Supermarket Income REIT, has not only announced it would be paying quarterly dividends as usual after receiving 100% of rents – but told PropertyEU that ‘tenants have actually paid their rents earlier than usual, as they are trying to be supportive of their supply lines’.
Set up two years ago, and listed on London’s main market, Supermarket Income’s business model focuses on assets occupied by the country’s top four supermarket chains, with a preference for well-located sites with omnichannel potential. Tesco occupies five of the trust’s assets, with four leased to Sainsbury’s, and one to Morrisons. In just two years, the trust has become the UK’s most significant grocery investor holding £525 mln of assets.
Steve Windsor, who with Ben Green founded Atrato Capital, investment adviser to Supermarket Income REIT, affirms that Supermarket Income is ‘one of the few REITs trading above pre-crisis share prices, along with medical surgery REITs. That means a strong balance sheet, good support from our shareholders and the opportunity to hopefully pick up some assets in future months, especially from struggling property owners.’
Despite the lockdown complicating matters, he believes there are deals to be made. ‘Site visits are hard, bank finance is more complicated, and in this market, most valuers are going to add clauses warning of the material uncertainty in valuations. But we think it’s undoubtedly the moment to buy assets.’
Dealing with online demand
While it is notable that the Supermarket Income business model has always hedged in favour of e-commerce expansion – choosing sites with enough space to act as delivery hubs – Windsor says that he isn’t worried about a significant post-crisis shift to online.
‘The current crisis has shone a light on how little online capacity there is in the UK supermarket industry,’ he notes. ‘People thought that businesses like (online grocery service) Ocado would do incredibly well, but the reality is it was already operating at close to full capacity, and has only been able to focus on servicing existing customers – and even those not terribly efficiently.’
Johnnie Wilkinson, CEO of Dublin-headquartered Greenman Investments, an investor in German food-anchored retail parks and retail warehouses, agrees.
‘Online food retailers’ technical infrastructure and physical response has not matched consumer demand to date,’ he notes. ‘If online food retail sales had worked really well, this could have had a negative impact for us at a market level.’
He adds: ‘It would take a very large investment by a grocer to develop the kind of infrastructure that could meet big spikes in demand in the future. Grocers are more likely to look at reinforcing their position in physical retail and logistics.’
Greenman Open’s €750 mln-strong German portfolio is significantly exposed to grocery retailing. Wilkinson estimates that some 81% of its tenants are essential retailers, while the rest can trade partially, or not at all. In contrast to the UK position, German stores that sell a range of goods are required to remove non-essential stock or block access to certain aisles. ‘Some of the retailers which are partially trading have asked for rent reductions,’ says Wilkinson.
‘We have said we’ll look at it, but asked them to share their turnover data. Even where retailers have been forced to close across Germany, rent obligations haven’t been waived. This gives us the opportunity to be tougher with tenants where appropriate.’
German legislation may also help landlords manage their debt at this time. ‘There is a point, yet to be tested in court, that during the period from April to September, lenders are obliged to show forbearance on interest payments. Our lawyers have not been able to shine a light on that yet – but it may help borrowers,’ Wilkinson notes.
While it’s not quite business as usual, the Greenman chief also hopes to continue making acquisitions. ‘But only 100% food,’ he says. ‘We have ongoing relationships with existing project developers from whom we will continue to buy. We’re hopefully just about to enter into an agreement with one for five projects, delivering between Q1 2021 and Q1 2022. We’re also close to signing a €90 mln deal to acquire another 23 supermarkets.’
For Supermarket Income, the outlook is perhaps even rosier. Supermarkets in the UK haven’t been banned from non-essential product sales and it is here that Windsor sees a further spike in demand in the medium term. And although the initial weeks of hoarding and panic buying are out of the way, the other key trend is what Windsor calls the ‘restaurant replacement phase’.
‘In the UK, some 30% of calories are usually consumed in casual dining,’ he notes. ‘Most of that food is now being bought from supermarkets. We expect supermarket sales to show very strong like-for-likes for some time yet.’