Retail Rocks: Insane? I'm totally rational, honest....
Posted by Property Week on 5th Jun 2013
Who in their right mind would buy a shopping centre in a secondary town or the third shopping centre in a bigger city today?
Consumer expenditure has been battered by recession and government funding cuts, retailers are either failing or rationalising their store portfolios and any growth in the retail sector is via the internet not the high street. Anything other than super-regional shopping centres are doomed. Doomed, I tell you!
Yet, there are an increasing number of investors who are brave or foolish enough to be buying and it seems that yields are stabilising or potentially even tightening. Against this backdrop, Ellandi are inviting active market participants to debate the relative merits of the secondary shopping centre investment under the banner – ‘Retail Rocks – stairway to heaven or road to hell?’ This event takes place tomorrow at the Geological Society (Rocks / Geology, get it?)
Shopping centre yields for secondary assets are now 8.5%+. A number of schemes have traded at 10%+. This compares to an average yield for all shopping centre transactions of 6.93% between 1998 and 2011. Simultaneously, cash yields or bond yields have fallen to all-time lows, creating an enormous spread between shopping centres and risk free rates. Shopping centres appear to be cheap on a historic basis. Many assets are now trading at 50% to 65% of their peak values.
This discount to historic pricing and the availability of attractive income yields, within a very low yield global investment arena, is starting to attract interest not only from specialist investors but also yield-hungry global investors, a good example being PIMCO’s recent JV with New River Retail.
Cash-on-cash returns look especially attractive to investors if a modest quantum of senior debt can be used, especially given that the all-in cost of debt is low. Applying 50% leverage at say 4.5%, to an asset yielding 9% gives an investor a theoretical cash-on-cash return, before reinvestment, of 13% p.a. Ellandi’s portfolio earns an average cash-on-cash of 15.2%. There are not many investments that offer such strong cash yields.
But can you finance these assets? Debt remains challenging and is likely to remain so for the foreseeable future, as banks de-leverage and apply new regulatory capital regimes, such as slotting. However, senior debt funding remains available at leverage points of 50% to 55% LTV for reasonable quality shopping centre, with strong occupancy and proven sponsors. However, this credit criteria still leaves many shopping centres that cannot be funded. In time this may well become the major determinant of pricing with debt fundable assets at 8% to 10% yields and un-fundable shopping centres trading to cash buyers at 15%+?
Some will argue that secondary shopping centres only look cheap in a historical context and that we are now in a different paradigm, where higher yields accurately reflect the increased risks. They warn that investors should not ignore the likelihood of on-going retailer failure, falling rents and increasing vacancy rates.
Our portfolio of 7 value and convenience-orientated shopping centres, with 338 retail units, gives us a very good barometer as to real tenant demand and letting activity. It is a tough letting environment, yet, we completed 52 new lettings in the last year and our portfolio only has a 5.7% vacancy rate. It is not the desperate picture you would glean from reading the FT of a dying, decaying, urban wasteland.
There are strong retailers with good businesses and strong customer following who are keen to take new space and to extend existing leases at the right price. The critical consideration is do they or can they make money in a given location. We are proud to have recently become 99p Stores’ biggest landlord. They are a good example of an acquisitive, dynamic business well suited to the current retail environment.
We invest significant time and money in ensuring that our shopping centres offer pleasant environments with high quality amenities, such as free wi-fi and cost effective parking, and integrate well within their wider communities. None of this is rocket science but it assists our tenants and improves the shopper experience. This has ensured that rental income has remained robust and that tenants view our shopping centres positively.
The internet is undoubtedly a ‘game changer’ for retailers. Yet, the retail industry now acknowledges that it is part of a ‘multi-channel’ offering so ‘bricks and clicks’ will be the future. Most internet sales operations still lose money as retailers battle with how to provide cost efficient delivery and logistics. Convenience, low value and low margin goods (much of the retail market) will still need shops. There will be store rationalisation as part of a multi-channel world but it is unlikely to lead to wholesale shop closures or the death of town centres.
I don’t contend that there will be a sudden improvement in consumer confidence or dramatic economic growth in the UK. However, there seems to be consensus that the darkest hour has passed. Similarly, retailers are now in better shape: the weakest have failed and the survivors are operating at far greater efficiency. The strongest retailers are now evolving from cost cutting to reinvesting in their brands. It remains a tough retail environment but widespread systematic retailer bankruptcies are hopefully behind us.
If one accepts that we are moving towards a relatively benign economic environment, underpinned by very loose monetary policy, then the prospect of buying assets that offer relatively stable cash flow at a yield that is 7% wider than 5 year sterling SWAPS and 6.5% wider than the 10 years gilt yield is appealing. This is especially the case for investors that seek income orientated returns.
Obviously, there needs to be careful stock selection and capable asset management, this is a time for working with specialists, but the general thesis of buying high yielding shopping centres in a stabilising economic environment appears highly rational to me. Admittedly, it is not a ‘no brainer’ and there are arguments to be made both for and against this investment thesis. We expect a lively debate at ‘Retail Rocks’.
Source: Property Week