Against this backdrop of unprecedented uncertainty, as tenants of shops, bars, restaurants and offices refuse to pay their rents en masse and almost all commercial property deals fall through, it’s all but impossible to put an accurate price on the current value of commercial real estate.
Virtually no one can escape the economic fallout from Covid-19. Not even the owners of commercial real estate, who benefited so handsomely from the central bank-engineered bailouts and property bubbles of the past decade, are immune.
In the UK, a decision by the government to grant retail tenants a three-month moratorium against eviction — an essential lifeline for many businesses that have seen their incomes dry up or drop dramatically as a direct result of the lockdown — has shifted the locus of immediate financial stress from tenants to property owners and their lenders.
The shuttered bars and restaurants in central London are a case in point. Early last week, they received a collective quarterly rent bill of around £500 million. But most of the bars and restaurants took advantage of the government’s moratorium: Instead of paying their rents, they decided to use the freed-up cash to try to weather the crisis. Now, it’s their landlords who are suddenly short of money and who may, as a result, struggle to pay their staff and meet fixed costs such as quarterly interest payments to lenders.
The same is happening across the retail landscape. Some commercial landlords received less than a third of their expected rent on Wednesday.
They include Intu, the embattled owner of dozens of semi-shuttered malls in the UK, as well as a handful in Spain, which revealed it had collected just 29% of expected first-quarter rent, even after offering a deferral and cutting service charges. That compares to 77% during the same period last year, which was already low.
Even before the virus crisis, the company was already on its last legs having endured wave after wave of retail restructurings, resulting in soaring vacancies and plunging property values. In mid-March, two weeks before the UK government initiated a generalized lockdown of the retail sector, Intu warned it was on the brink of bankruptcy after declaring losses of £2 billion for 2019 and a debt of £4.5 billion. Its shares are now worth just four pennies a piece, having tumbled by 96% over the past year.
Intu is now threatening to take legal action against non-paying tenants, saying it would not “bankroll” retailers that have “just decided they don’t want to pay their rent.” Many other retail landlords are reportedly doing the same, despite the fact that many of their tenants have had to halt the lion’s share, if not all, of their business activity, decimating their earnings for the foreseeable future. Even before this crisis hit, many of these retailers were already struggling in the face of slowing sales, high costs, low profitability and rising competition from online rivals.
Intu is also frantically lobbying the government to grant it access to the £330 billion of state-backed loans and guarantees the government has pledged to roll out in support of businesses affected by the lockdown. If the government caves, Intu may have a fighting chance of renegotiating the huge loans it owes to its lenders before the covenants on some of those loans are broken.
Given the company already failed spectacularly in its bid to raise fresh funds from investors earlier this year, the banks may end up deciding not to throw yet more bad money after bad, even if the government agrees to guarantee up to 80% of any new loans. After all, once the lockdown begins to be lifted, the UK’s bricks-and-mortar sector will be in an even more parlous state than it was before the crisis, as evidenced by department store Debenhams’ announcement Friday that it is filing for bankruptcy, less than a year after being rescued by lenders, which wiped out its stockholders.
There’s no way of knowing how many more retail chains and store will follow in Debenhams’ doomed footsteps. Against this backdrop of unprecedented uncertainty, as tenants of shops, bars, restaurants and offices refuse to pay their rents en masse and almost all commercial property deals fall through, it’s all but impossible to put an accurate price on the current value of commercial real estate.
This is the rationale being used to justify gating most of the UK’s large open-end property mutual funds, trapping over £20 billion of investor funds. The first wave of closures, in mid-March, affected around a dozen mutual funds that offer daily withdrawals to their (predominantly retail) investors, even though the funds’ core investment — offices, industrial property and retail parks — is extremely illiquid, often taking months to offload. Between them, these funds manage some £11 billion of assets, equivalent to around a third of the total assets under management in the UK’s property fund sector.
At the end of March, a fresh wave of gatings hit, as the £3.4 billion BlackRock UK Property, the £2.4 billion Schroder UK Real Estate funds and five institutional funds managed by Royal London and Legal & General, including one with assets of £3.4 billion, announced they were suspending redemptions for the foreseeable future. Unlike the earlier round of closures, these funds have quarterly or monthly redemptions and are typically held by institutional investors with a more long-term investment approach.
“The basic issue is the same: there’s fundamental uncertainty over the net asset value,” said independent property consultant John Forbes.
“That’s compounded if the rent income doesn’t arrive. That potentially makes the valuation more challenging.”
In times of extreme financial stress and uncertainty, it’s not unusual for real estate to be plagued by acute liquidity issues. In June 2016, in the aftermath of the Brexit vote, six commercial real estate (CRE) funds suspended redemptions. But never before have so many real estate funds shut the doors on so many real estate investors.
Those investors are likely to have to wait quite some time before they see any of their money again. Material uncertainty “is still going to be here on June 30. I’m incredibly doubtful that we’ll be through this on September 30. [The funds] can’t resume trading until then,” said Mr Forbes. If the recent experience of the gated (and eventually wound down) Woodford Equity Income fund is any indication, by that time the investors may suddenly find that the value of their investment has significantly shrunk.
* * *