Closing down sale?: the changing face of shopping mall transactions

Once a flagship asset of the investment market, it seems that shopping centres have gone from being the anchor to the quirkily shaped first-floor unit next to the toilets that no one wants. Unduly harsh, perhaps, but in less than 10 years many shopping centres have dropped significantly in value.  According to a recent report by Lambert Smith Hampton, “Half of shopping centres should be demolished or repurposed.” Some have lost more than 90% of their value. The report also estimated that 37% of shopping centres should be dramatically repurposed and 9% of them demolished. Sadly, this will have come as no surprise to readers, and the reasons for this seismic market shift have been well covered in these pages. But what does all this structural change mean for shopping centre transactions? We don’t mean the super-prime or super-regional schemes, but the backbone of retail funds for decades: the shopping centres in market towns, in smaller cities and in suburban locations up and down the country. The approach to sales and purchases of these schemes has shifted dramatically. Repurposing is a lot harder than it sounds The challenges facing shopping centres were there before the coronavirus pandemic, and talk of repurposing has been around for many years. Take Southampton, where we work. Canute’s Pavilion, a 1980s shopping outlet with 72 units, was demolished in 2008 to make way for a waterfront residential development. The East Street shopping centre was demolished in 2013 and replaced by a build-to-rent scheme. Finally, the Bargate Centre, opened in 1990, was closed in 2013 and demolished five years later. Construction is now under way on its replacement, a residential-led scheme. Fundamentally, shopping centres were not designed with repurposing in mind. Where repurposing is most viable, for instance adding a leisure quarter or adding on or converting space into residential, this has already happened. There are plenty of incredible repurposing success stories. Repurposing the remaining stock is difficult for a host of reasons, ranging from town planning considerations and sustainability to changing occupier tastes and the availability of labour, materials and finance for development. A complete knock-down and rebuild is unlikely to be sustainable and is often not viable. Instead, investors and town planners are having to accept a more flexible definition of the high street that is not just about retail and leisure, but also lower-yielding community uses. It should no longer be assumed that a potential shopping centre buyer is going to continue running the asset more or less in the same way. That brings a different focus to asset management initiatives and transactional due diligence. A newish breed of buyer: the local authority Councils have been buying shopping centres for years and the trend has increased, despite a reining in of Public Works Loan Board finance available for investment transactions. This shift is a welcome one for many investors who would otherwise struggle to find buyers in the market. Local authorities have different priorities, and they don’t need to focus purely on financial return. Of course, councils need to acquire a viable asset and must secure best value for their constituents, but they may also be able to give a higher priority to regeneration and amenity.  This trend towards the local authority buyer demands more awareness and consideration of the drivers and constraints faced by local authorities. Future acquisitions may become more challenging: access to PWLB funding depends on low gilt rates, which is clearly not the case at the moment. Arrears matter more than before For years, if arrears were mentioned in heads of terms, it was perfunctory. Now they are front and centre. Exacerbated by the pandemic, arrears are suddenly a significant debt.  As a result of Covid-related legislation, over the past few months buyers and sellers of retail properties have had to grapple with different classes of arrears. Protected or unprotected? Has anything been referred to arbitration? Is the tenant a viable business that struggled to pay rent during the lockdowns or are the arrears a write-off? What Covid rent concessions were given outside of the terms of the lease, and do they bind successors? How substantial arrears are to be treated on a sale becomes important, but low deal values (in relative terms) leave little room for nuance. Does the buyer really want to (a) invest a lot of time in collecting arrears for the seller, and (b) limit itself in future negotiations with tenants by being unable to compromise historic arrears?  Should the seller give up on the right to collect significant arrears from tenants who can afford to pay them? The amount of arrears, their viability and who ultimately gets to keep collected arrears can all feed into the price. As Covid arrears legislation tapers off, we should return to a position where sellers and buyers can more easily get a clear picture of what is owed and what is recoverable, but this increased transactional attention on arrears is likely to remain for some time.  Service charge accounts subject to a higher level of scrutiny Previously, the issue of service charge accounts almost never troubled heads of terms, and the intricate provisions required to deal with service charges were very much left to lawyers to sort out in the sale contract. The loss of BHS, House of Fraser and Debenhams have left big holes in shopping centres, and these holes can be challenging to fill. Owners and agents have had to be creative to find ways of filling the gaps, but in a lot of cases that space still remains empty. With extensive voids and other tenants struggling to pay, service charges are often running at a significant deficit. The buyer’s due diligence team will want to see what savings can be made in the service charge and how that void can be managed.  Alternatively, it may seek a contribution from the seller, which can be time-consuming to agree and finalise, with a reconciliation taking place several months after completion when true income and outgoings are known.  Alternatively, the parties may decide that it is easier to factor the service charge position into the sale price. Does long income still matter? With half an eye on potential redevelopment, buyers have become less concerned with the long security of income and are now more interested in the immediate income stream and whether the current tenants enjoy security of tenure. Even if redevelopment is not on the cards, a lease that is contracted out of the security of tenure provisions of the Landlord and Tenant Act 1954 means that, if and when the market improves, the landlord has the option to take the unit back out to the market. Flexibility has become a key consideration. Can the shopping centres keep their doors open? Of course, these are simply trends and not all shopping centres are the same. Nobody expects bricks-and-mortar retail to disappear completely, but the challenges facing the asset class have mounted up considerably over the past few years.  Despite these challenges, the shopping centre still has a place in many towns and cities, and in the portfolios of a diverse range of landowners. With the dramatic fall in capital values we have seen over recent years, we may soon be seeing signs of, if not green shoots, then at least enough life below the surface of the shopping centre floor for green-fingered asset managers to nurture. Tim Burbidge and Jon Hobbs are partners in the real estate business group at Womble Bond Dickinson Photo © Dinendra Haria/LNP/Shutterstock