Oversized store portfolios have been an issue for retailers for years, and the repurposing of retail assets was one of the strongest trends to come out of our Emerging Trends in Real Estate 2020 report. COVID-19 has accelerated this trend as retailers are once again looking to use restructuring tools, including those set out in the new Corporate Insolvency and Governance Act, to exit their leases.
As retailers reduce their footprint, landlords are left with empty units with irrecoverable business rates and service charges, as well as an increasing number of tenants on lower based turnover rents. Some are even starting to experience difficulties refinancing and instead landlords or their lenders will look to sell their assets. The issue here is finding a buyer - which is where many local councils are looking to step in.
Although somewhat unlikely property speculators, councils are seeking new sources of revenues, and have a significant interest in transforming their local areas and keeping high streets alive. The industry’s difficult decade means prices have fallen and the need to invest and regenerate in town centres to stop degradation and blight has grown. A National Audit Office report found councils spent £6.6bn on retail and office assets between 2014 and 2019, a 14-fold increase on the previous three years. Is this trend set to continue post COVID-19, and is this an appropriate risk for public investments?
The current HM Treasury review of Prudential Borrowing is unlikely to restrict this type of in-borough regeneration activity, where in some cases councils may even be the buyers of last resort. Councils may be seeking a rare source of long term investment return from these assets, but the question remains: what will they do with them?
Given COVID-19 impacts and the accelerating change in the retail landscape, we expect that more potential investments will become available during H2 2020 as banks are beginning to think about enforcing their security over troubled assets. In some cases, distressed shopping centres might be acquired via a “loan-to-own” strategy: buying into the debt in order to enforce, albeit this may be an overly aggressive approach for local councils.
Councils spent £6.6bn on retail and office assets between 2014 and 2019.
Rental income may be earned from commercial property purchases once they have been repositioned. But in the short term, councils lose the business rate income they would have otherwise received, and will also face significant upfront costs to convert or update the building. There is generally a three- to five-year transition period and each project needs to factor in a realistic timescale and costs involved into the purchase price.
While this work goes on, councils can look to uses such as ice rinks or pop-up stores to bring in some income - although this will be likely relatively minor.
In the longer term, councils should think carefully about how to reposition these properties. If they retain some retail units, their choices will help shape the future of the industry, and teams leading these projects will need to predict what consumers want from their high street and retail parks in decades to come.
So what does a longer-term strategy look like? We are working with clients who are thinking about repurposing all or part of these retail assets for different uses. In a world post-COVID-19, with shorter-term turnover leases on the rise, landlords will benefit from increased optionality to move tenants, shrink retail allocation and repurpose units.
Investors are often aiming to redevelop at least 50% of available space to allow enhanced concentration of tenants. Many of these assets will have ample parking, supporting other uses including regional office hubs as commuting habits change. This may align nicely with the Office of Government Property’s new Regional Spokes strategy and follows a growing trend for commuter hubs across private sector occupiers.
Potential future reforms to the planning system could also allow simpler conversion to residential use, and the maturing of PRS could drive further footfall to these hubs. Careful consideration needs to be given to how a ‘best in class’ conversion can be undertaken to positively add to place.
Local councils are increasingly looking at ‘place based recovery’ and are well positioned to take on these projects at the right price - and if other uses can’t be found, they can fall back on being the occupier of last resort. We may soon see shopping centres and retail properties turning into large scale public hubs with unused space converted into libraries, housing, health centres and even council offices.
Data analytics can help to make this process more robust by building a profile of the demographics and spending characteristics of the local residents. This can boost confidence that the project, whatever it may be, is the right one for that area and its residents.
Investors are often aiming to redevelop at least 50% of available space to allow enhanced concentration of tenants.
Councils have the motivation to regenerate communities, the appetite for risk and the funds required to embark on these projects, but they sometimes lack the expertise needed to manage large property deals. Most of the buildings they buy will need repositioning, switching to a mix of leisure, serviced office, residential and retail. Councils need to be very alive to the risk that this presents and undertake detailed appraisals at pace given the likely sources of opportunities and their importance to the local community.
While some councils are investing alone in retail property, others are turning to public-private joint ventures to help them navigate this, embarking on the journey alongside a private developer or investor who can bring the knowledge needed to make the development a success.
Some councils are investing alone in retail property, others are turning to public-private joint ventures to help them navigate this, embarking on the journey alongside a private developer or investor.
These are clearly ambitious plans, but we are hearing from both developers and investors who are interested in partnering with councils to co-fund and help deliver creative regeneration schemes.
Whether residential, leisure or retail, it’s important to get this repositioning right; joint ventures can help to bring in the right expertise for this and enable councils to hit the right note in shaping the future of the high street.