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Corporate & Commercial real estate & Corporate recovery, restructuring & insolvency
Jeff Roberts & Dan McCarron feature in Estates Gazette considering whether landlords should take equity in retail tenants, as a way to address the retail crisis.
3 minute read
21 August 2019
The tension on the high street has been well documented. The existing model under which landlords, rating authorities and tenants operate needs to adapt to avoid catastrophes for all parties. Landlords and rating agencies taking equity in retailers might be one answer.
Rightly, landlords need to maximise rent return on their property portfolio investment; local authorities with ever-increasing demands on their everdiminishing budgets need to recover maximum rates; and the squeezed tenant not only has to survive this pincer movement, but has to compete with more consumers buying online than ever before. Retail Economics earlier this year reported a 403% growth in online sales over the past
decade, and that shows no sign of decline.
We have seen this downward spiral pushing tenants into company voluntary arrangements (CVAs) to smooth their rent roll across their portfolios, leaving landlords to absorb the cost.
To reverse that cycle and create a more virtuous circle the constituent parts of landlord, local authority, and tenant need to work together so that they all have a vested interest in the tenants’ success.
Turnover rents and turnover rates are attractive in theory, but there are many hurdles that need to be overcome, which have only increased with the rise of online shopping.
Does the innovative step of landlords taking equity in their tenants overcome these hurdles – and is it the right thing for landlords to do?
Do landlords have the requisite knowledge?
The first question we must ask is: whether landlords are equipped to take equity in their tenants? It has been said that landlords taking a stake in a retailer is not wise, as retailing is not their area of expertise and retailers offering this are typically doing so unwillingly or under duress. However, in our experience, landlords have great expertise in the business of their tenants, particularly those in the retail sector.
It has, for some time, been common practice for landlords of retail shopping centres to require daily turnover information generated out of each shop and to apply analytical analysis to ensure the right mix of tenants, optimising asset management value. Landlords’ knowledge is only set to increase given the rise of new technologies monitoring customer’s shopping habits, particularly beacon technology, which sends alerts to
smartphones based on location proximity. This could, arguably, leave landlords better placed to identify the latest shopping trends and habits than their tenants. Landlords, therefore, may be able to offer the tenants more than a much-needed capital injection.
While it is true that the suggestion of landlords taking equity is only being made as a potential solution to struggling retailers, landlords need to ask themselves the question whether it is better to support a struggling retailer or face empty premises and business rates with no rental income.
Multiple sites, multiple landlords
A single landlord taking equity in a single retailer on a single site might be relatively easy to structure. Translated into multiple landlords of a single tenant operating over multiple sites, that creates huge complexity.
Would that multiple-site tenant have to create a special purpose vehicle (SPV) subsidiary for every site out of which it operates? Perhaps a multi-site tenant seeking equity arrangements with landlords would model its business around creating those SPVs with an apportionment of central and local overhead per site and modelling profit generation in such a way that is fair taking into account online sales.
One possible answer on to how to deal with online sales might be to allocate online profit and loss across the SPV cohort so that the profits and losses of online sales are shared across the portfolio. Similarly, goods returns would need to be allocated properly so that a customer buying online but returning to a local store would not disadvantage those participating in the upside of that store on that site. We have looked at some financial modelling and this is certainly doable.
These same principles can be applied to rating authorities. There could be a low base rent and low base rates to ensure landlords’ and local authorities’ cash flow, rather than having to wait for dividends nine months after year end.
The suggestion is, therefore, whether with single site, single landlord or with multi-site, multi-landlord, there is a way forward provided the parties are prepared to put in the hard yards to make it work.
What would happen, however, if a landlord or rating authority has shares in a company that is struggling and fails to pay its rents/rates? What will the lease say about forfeiture in those circumstances and will the landlord want to forfeit?
Would a landlord want to go from unsecured creditor with a rent deposit to a shareholder coming behind all of the secured and unsecured creditors on the insolvency of the retailer? This could be solved with granting the equity stake landlord and rating authority with convertible preference shares. The advantage of convertible preference shares is that while the tenant’s business is doing well, the landlord would be ahead of the queue on receiving dividends, with the roll up in the accumulation if the tenant had a dip in distributable profits in one year or another. This would provide at least some a cushion if the tenant eventually fails.
A developing trend
Landlords are beginning to make equity investments into retail tenants, albeit in a limited way. The creativity of the sector – its retailers, landlords and advisers – will undoubtedly see this approach increasing with innovative equity models evolving. While it is likely to be driven by landlords and tenants, progressive local authorities should look to the role they can play to participate in this virtuous circle too.
Landlords, tenants and local authorities need to work together to keep high streets as a vital part of the community in order not to be left with the landlords’ worst nightmare – empty premises on which they are liable for business rates.
This article was originally published in Estates Gazette on 21 August 2019.
21 August 2019
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