High street’s woes hit private landlords

Tim Ward has spent more than 30 years building a modest portfolio of retail properties on high streets around the UK.

Chellbrook, the company he founded with his father, has roughly 50 tenancies worth £15m — mostly in smaller premises, hosting cafés and hairdressers as well as shops.

But the coronavirus crisis has emerged as a profound threat for Ward and other private commercial property investors, who range from local entrepreneurs and self-employed professionals, such as solicitors, doctors and accountants, to wealthy millionaires on national newspaper rich lists.

The pandemic has pushed many tenants to the brink and forced painful discussions about who will take the hit as incomes in retail plummet, leaving behind a swelling pile of rent arrears. The crisis has accelerated the online retail revolution, leaving shopkeepers fearing that footfall may never return to pre-Covid 19 levels.

“We’ve made it clear to [tenants] — we access no grant money, we live off the rent,” says Ward, who is based in Surbiton, on the outskirts of London. “We don’t want any empty shops, that’s the last thing we want. But it’s fragile. If there are any missteps now, if business rates [support] or the furlough scheme are removed too early, we could see chaos.”

There are similar stories from high streets the length and breadth of Britain, especially in poorer towns, where shopkeepers were often already struggling with unemployment and competition from out-of-town retail parks.

FT Money explores the pressure points on landlords in the sector, the options for those facing a financial crunch and the prospects of a recovery in the market. While stores in England and Wales celebrated reopening this week, with shopper numbers in many areas rebounding by more than expected, the direction of travel is clear. 

Retail under fire

Even before the pandemic, more people were shopping online and fewer in stores. Diane Wehrle, insights director at consultancy Springboard, says retail “footfall” UK-wide had already declined by an average of 1.3 per cent a year between 2011 and 2019, and by more in some areas. 

She now expects it to ratchet down to 10-15 per cent below pre-pandemic levels, reflecting not only the shift to online shopping but the growing prevalence of working from home, which will limit the tendency to “pop out” during lunch hours or after work.

Because shops’ running costs are relatively fixed, even a small decline in sales can quickly turn profits into losses. The Local Data Company estimates that a net 6,000 shops closed in the first half of 2020 alone. That figure excludes units deemed to be “temporarily” shut because of lockdowns but whose closures are likely to become permanent — such as over 400 stores occupied by Arcadia brands like Topshop and Burton, and over 100 occupied by department store group Debenhams.

Many of the UK’s estimated 300,000 stores are owned by big real estate investment trusts or pension funds. For them, vacancies and rent arrears are troublesome — but they do at least have the legal and administrative resources to do something. 

They are a much bigger challenge for individual landlords and smaller companies.

In north-east England, the travails of a small investment company show how once-promising investments have turned sour. Acquiring a commercial property occupying a prominent high street site and let to a high-profile, creditworthy tenant seemed like a good idea in 2001.

“It was our first venture in retail. We were attracted by the repairing lease and at the time rents were marching onwards and upwards,” says one of the investment managers at the company, set up to support charities.

But times have changed, and what was a reliable income generator has turned into “a real headache”. Rents on their particular high street have fallen by up to three-quarters. The property is currently on the market — for one-third what the company paid for it — after its tenant went into administration last year.

“Because the building is now unoccupied, our insurance cover is limited and there are ongoing legal and agency costs. We are fortunate that it is a listed building or else we would be liable for empty rates too,” the investment manager said.

Landlords and tenants

Retailers, caught in the eye of the Covid storm, are generally sympathetic to the plight of their landlords. “Most are rational and decent people and they are in it for the long term,” says James Daunt, chief executive of Waterstones. The books chain has almost 300 stores, around half of which are owned by individuals or smaller private property companies.

But tenants are also pushing to realign their costs with lower levels of sales. Big chains with solid finances, such as WHSmith or Next, routinely report securing rent cuts of up to half when they renew leases. 

Some larger retailers have “used the crisis” to push through changes to their lease structures, moving to monthly payments rather than paying for a quarter in advance, according to Anthony Ratcliffe, partner at London-based commercial property investment company Ratcliffes. 

“We’ve acceded to that in the short term but will be pushing robustly for a return after the pandemic,” he says, adding that while “bigger tenants played hardball, smaller tenants tended to behave much better”.

One director of a small commercial real estate business with five properties said Savers — a discount health and beauty store ultimately owned by Li Ka-shing, one of Asia’s richest tycoons — unilaterally imposed a big rent cut for the June quarter in 2020, and withheld rent for subsequent quarters to those landlords that did not consent to the June cut. Savers stores, along with those of larger stablemate Superdrug, were permitted to continue trading during lockdowns.

Both Ratcliffe and Ward stress that most tenants have been amenable in rent discussions, but both single out Edinburgh Woollen Mill, the clothes shop which was controversially acquired from administration by members of its existing management team this year, for being tough in negotiations.

EWM declined to comment on the status of talks with landlords, but rejected the suggestion it had behaved unreasonably in the circumstances.

Savers said it had experienced “an unprecedented decline in footfall during the lockdown periods”, adding that it continue to work with landlords.

“We have longstanding partnerships with many of our landlords and we are grateful to those that have supported us during this period.”

The Sipp stimulus

Two-fifths of investors in Ratcliffes’ funds are pension investors, spanning many professions. “One investor is a poet, one a disc jockey, one or two would qualify for the Sunday Times rich list,” says Ratcliffe. 

Many commercial properties owned by individuals were acquired after “A-day” in 2006, a package of pension reforms that allowed such assets to be sheltered within a tax-advantaged self invested pension plan.

“Around 15 years ago, we went through a phase where some people were just sticking their hands up at auctions and buying branches of Barclays on sale-and-leasebacks,” says Peter Elsom of Elsom Spettigue, a firm of surveyors in Suffolk. “Now they’re finding that banks and stores are closing and these buildings are difficult to re-let”.

In the days when most chains were still expanding their physical space, rent arrears or vacancies due to lease expiries or insolvencies were usually only temporary. But they have gradually become longer as vacancy rates have risen, especially in less well-off parts of the UK. Landlords with portfolios of commercial-only properties concentrated on the high street are most vulnerable, brokers say.

Sam Curtis, partner at broker John Charcol, says borrowers who had properties combining commercial and residential units — a relatively common ownership format on the high street, with a shop at ground level and flats above — had often been able to avoid the worst effects of the pandemic on retail.

“Those with semi-commercial have still taken quite a hit, but generally speaking the rental income from the residential unit will cover the mortgage payment — not by much but enough to keep the property going,” he says. 

But without the same access to government assistance that high street businesses have enjoyed, small-scale commercial property investors face a tough outlook. 

After a year in which banks and specialist lenders have heavily curtailed lending because of Covid-19 restrictions and fears over the outlook, many are beginning to return to the market. 

But they are reducing the amount of risk they will take on the mortgage with a loan-to-value ratio typically capped at 50 per cent depending on the client and tenant. Pre-Covid, loans at 60 per cent LTV “or 65 per cent LTV at a push” would have been considered, Curtis says. 

For those landlords who see bargains in the current market for commercial properties and plan to expand their portfolio, the chief obstacle is banks’ common requirement for a tenant to have been in place for at least 12 months and be able to show evidence of unbroken rental history over that period. 

“That wipes out a lot of businesses. Obviously if you get a blue-chip company — a Co-op or a Tesco with a 20-year lease — it’s going to fly through with any lender, but your standard commercial high street non-brand name shops are going to struggle,” Curtis says. 

In the worst-case scenario — where a tenant goes into administration or liquidation — the landlord is often left to pick up “dilapidations” — the costs of restoring a property to a lettable condition — while a new occupier will often expect a contribution to fit-out costs or an initial rent-free period. 

In 2008, the government introduced empty rates, which oblige a landlord to assume the business rates liability from the departing tenant after three months, instantly turning a revenue generator into a cost centre.

“It must be a nightmare for smaller landlords, especially those in more deprived areas,” says Daunt. The need to avoid empty rates and cover other costs means many “often end up bringing in a charity shop, or a short-term tenant, or someone who they know is probably going to go bust”.

Worst-case scenarios

Landlords or their tenants can resort to formal insolvency processes to reach a resolution. Company voluntary arrangements can be used to restructure unsecured obligations, including future rent payments, and have been widely used by chain retailers in the past few years.

Once the moratorium on evictions is lifted at the end of June, property owners could also start eviction or winding up proceedings against a tenant in default. But both of these involve legal costs, there is likely to be a logjam in the courts once the pandemic ends — and even if a landlord is successful they will still be left with an empty shop.

Turnover-based rents may appeal to the tenant, but Daunt says they are complex and risky for smaller landlords. “Retail is very seasonal but mortgage payments are definitely not,” he notes.

So-called “regearing”, where tenant and landlord agree a longer lease but at a lower annual rent, is emerging as another popular solution. Sometimes regearing proposals include making up a proportion of any arrears built up during the pandemic.

In the longer term there are hopes that increased levels of working from home, coupled with the demise of many chain retailers will lead to a renaissance of local shopping streets populated by independent stores. 

Some retail experts also believe there will be a revival of market towns, which before the pandemic had been hit by the rise of large regional malls with thousands of free parking spaces.

Elsom contrasts the declining retail fortunes of Suffolk’s county town of Ipswich — population 137,000 — with the relatively buoyant market in Woodbridge that has a population 8,000 — just a few miles away. He says: “Not all high streets are the same, and not all are dying.”

Additional reporting by James Pickford