CVAs and the curse of the vacant unit
A year on from our last look, and the rate of CVAs (Company Voluntary Arrangements) shows no signs of abating. If anything, the rate of store closures has increased over the last year. Although Scotland may have been less badly hit than other parts of the UK, over a third of units which have been through a CVA process in the last year have subsequently closed (a pattern followed by the recent demise of Mothercare) (Source: Savills).
The CVA mechanism has been much-criticised by landlords as simply a tool to re-engineer contracts which were freely entered into, rather than using these as a last resort. However, the pattern continues albeit, perhaps, with a slight shift of focus.
One major issue in agreeing to a CVA is the assumption that a landlord will be able to re-let a property, reducing the gross amount of the claim. However, in the current climate this is not always the case - resulting in reduced rents, re-letting to non-retail operators and vacancies. This general pattern of declining rental income and heightened risk has resulted in de-valuation of retail portfolios. A factor causing a weakened sentiment towards UK retail property in general, with shares in many UK listed retail landlords falling sharply.
As a result, landlords are perhaps more willing to reach agreements with tenants rather than risking more draconian result of a vacant unit which is seen as the worst possible outcome.
Possibly the most visible re-negotiation has been Primark - telling the Sunday Times that “we have a duty to our shareholders to maintain a competitive cost base”. In return for rent reductions, lease re-gears have reportedly been offered including increased durations and commitments to future investment and store refurbishments. Primark is also still investing in its portfolio of stores, notably with the recent opening of their largest UK store to date – again in Birmingham.
Primark is perhaps the most recent example of a trend which was started by Next just over a year ago, when it announced it would be looking to negotiate rent reductions to offset an apparent benefit which had been achieved on CVAs in neighbouring premises. While this announcement was initially treated with some scepticism, Next has reportedly secured an average rent reduction of 29 per cent.
Although Arcadia might seem to buck this reported trend this is perhaps exceptional as landlords had a higher than usual proportion of the CVA votes, allowing them to improve terms.
H&M seem to be leading the way in combining a number of approaches, with reports that they are not only seeking turnover-based rents but “total occupational deals” where the rents paid to landlords are linked to sales but leave landlords to divide the takings between service charge, rent and business rates. This is seen by some as perhaps too aggressive a stance.
So where does this leave the high street?
There do appear to be some new trends developing as the market re-adjusts to address a growing recognition that higher rents are simply leading to vacant units - not a good result for either a tenant or their landlord.
Some retailers are looking at different models with a rise in landlords willing to look at a turnover rent, a model more common in the USA. The argument being that turnover-based models allow both landlords and retailers to benefit financially as both parties are incentivised to seek improvements if there is a downturn in trade. Equally both parties share in any subsequent success. There is some expectation in the retail business that this sort of a model is more sustainable as it facilitates a more reliable rental yield and resulting in fewer void units. However, many landlords are reluctant due to the associated uncertainty as to future levels of income. Whereas some retailers are also reluctant to share data - a necessary pre-requisite in the turnover model.
While many retailers are looking beyond bricks and mortar, and to inspire consumer loyalty through an increased online presence, landlords can take comfort from recent research (CACI) providing evidence for a positive effect of physical stores on online sales with growing evidence for a “halo effect” across the country - indicating that online sales are not the whole answer.
The underlying message seems clear enough, if landlords want to avoid voids some form of an adjustment is required - be that rent reduction, profit sharing, a more flexible approach to income receipts, or even a combination of all of these remains to be seen. What is clear is that the retail market does seem to be adjusting, albeit the threat of CVAs and the curse of a vacant unit is still upon us.
