There was a reminder in late April, as if one were needed, of the quandary in which lenders to retail property find themselves.
Following a loan-to-value covenant breach, Aviva – the provider of a £177 million (€205 million) facility to four UK shopping centres owned by RDI REIT – agreed not to accelerate its security before October while a consensual sale of the properties or a restructuring of the debt is pursued. In our spring edition, we reported how lenders are more inclined to work with borrowers to resolve cases of default, and thereby avoid holding the keys to retail assets during troubled times for the sector.
How the financing of retail should be handled was discussed during a panel hosted by the Loan Market Association in London on 24 April. The upshot: a new approach is needed.
Stuck in the middle
The UK’s best shopping destinations continue to perform well, as do many discount stores. What lies between – including most of the country’s town centre retail – has lost its identity and the interest of shoppers. From the landlord’s point of view, filling empty space is a must, even if that means attracting a quirky range of tenants on turnover leases of varying lengths. In the longer term, however, they will need to reposition and redevelop retail assets to create a sustainable mix of use.
For lenders, repositioning retail assets is a worrying prospect. They like predictability of income and have been used to financing the sector with standard loans on properties benefiting from full repairing and insuring leases.
If owners want to keep the support of their senior lenders while rejuvenating their properties, they will have to accept refinancing will be on far more cautious terms. Senior lenders are a conservative bunch; they may be keen to fund malls in the best locations, but most will argue they are not paid enough for the risk of writing loans against assets in transition.
“For lenders, repositioning retail assets is a worrying prospect”
Some senior lenders have indicated a willingness to stick with their retail-owning sponsors and gain a better understanding of their business plans and the assets’ cashflows. Unless they are prepared to step away from vast swathes of the UK’s retail market, they will need to. Yet they will remain risk-averse: leverage in future retail loans is likely to be well below the 50 percent LTV mark, with pricing hiked significantly.
Investors in retail that want to source debt for assets in transition may have to turn to non-bank lenders. This presents a huge opportunity for real estate debt fund managers with higher return targets than the senior lending banks. As retail properties increasingly resemble operating assets, risk-embracing debt providers are best-placed to structure loans that reflect the new reality.
Sponsors may also need to realise lower valuations of their retail portfolios to make lenders – senior and higher risk alike – comfortable. A common complaint among lenders is that retail assets need to be repriced to reflect the unpredictable cashflows they generate.
The real estate finance industry has a habit of adjusting to market conditions, and liquidity of debt finance to the retail sector is unlikely to dry up. However, for new retail loans to be signed, lenders and borrowers alike need to recognise that the game has changed.