What’s the first thing Mike Ashley of Sports Direct does when he buys another decrepit retail chain like House of Fraser? Shouts at the landlords to reduce the rent, that’s what.
In that is the basic problem facing the commercial property companies in the retail space. It’s not obvious that the likes of Intu (LSE:INTU), or its sometime would-be purchaser Hammerson, have a good way out of it either.
The problem here is the internet. As the Office for National Statistics points out, the last quarter of 2018 saw online taking 20% of retail sales. Back a year, that was more like 15 or 16%. And back a year, we have 15% of UK retail space empty and looking for a tenant. This isn’t a coincidence, of course – that eating of the market by online means we just need less retail space on those High Streets. What’s left is worth less, too.
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However, there’s a quirk in UK commercial leases. They might be for 25 years – just an example – with three or five-year rent reviews. But it is always true that rent reviews are upwards only. So, if trading conditions slow down, or if Amazon starts eating lunches, rents rarely go down to reflect the market.
It’s even true that, to a certain level, the owners of the centres prefer to leave some units empty rather than rent them out at the new, lower market rents. The asset value of the entire set is usually not at actual rental income, but at what it would get rented at what it’s currently rented at. That is, an empty shop or two doesn’t devalue the development because the usual method is to assume that it will rent out for what all the other, older leases are on. But the moment it is let at new, lower rents then this devalues the future value of all of the other leases in the centre.
Yes, an oddity, but there we are. What this means is that we’ve not got a manner of gently bringing rents down if the market itself starts to change. Instead, what’s necessary to bring existing rents down is the near bankruptcy of the tenant – perhaps actual administration, maybe a company voluntary arrangement (CVA) – so that it is possible to force the landlords into some agreement.
Which is exactly what Mike Ashley is doing. Picking up distressed retail assets then shouting very loudly that rents have got to fall or he’s taking his ball home.
The problem for Intu is that there’s no interesting way out of this. Its assets are worth less than they used to be and the prognosis is less next year than this. The system also conspires to make it happen in lumps, in great juddering leaps, as retailers go bust or CVA their way to rent reductions rather than being a gentle and managed decline.
One to avoid for me.
