Can the increasing activity of councils in the shopping centre investment market be justified?
As Local Authorities take on challenging shopping centres in a falling market Charlie Barke, Head of Retail Capital Markets at Knight Frank, looks at the positives of an often maligned move.
5 minutes to read
There has been plenty of dialogue on the activity of Local Authorities (LAs) in the commercial property market over the past 12 months. Much has been critical, which is fairly typical when a new source of capital emerges into an established market.
Perhaps the criticism is fuelled because of the perception that the capital invested is sourced from each and every one of us, the UK tax payers.
I must admit, at the outset I was cynical, especially, seeing Local Authorities (LAs) pay reasonable prices for challenging shopping centres in a falling market.
However, having now spent considerable time working on transactions with a number of LAs, in some instances selling to them, in some looking to buy for them, I am now much more comfortable with this emerging trend.
"Our town centres need to fight their corner and who better to re-invigorate community spirit, who better to understand what their town needs and who is more motivated to take the necessary steps than the Local Authority. "
Whilst some have criticised LAs as being naïve and lacking specialist expertise, my recent experience has shown me otherwise. Indeed, I have been continually impressed by their level of understanding, both technical and financial.
I have been impressed by the positive mentality shown and I have been impressed by their determination to take action and do something about what is a growing problem in town centres – our struggling shopping centres.
Aside from the need to “take control” of what is probably the local area’s largest and most important commercial asset, there is a sound financial case behind LAs acquiring shopping centres.
As well as all the usual benefits that a property investment carries, LA owners benefit from making a success of their local centre in many other ways, including:
- Improvement to the environment of their town centre
- Generation of local employment
- Sustaining or possibly growing revenue from commercial rates
- Encouraging 3rd party investment into the wider area
- Taking control of town centre regeneration, including potential key residential sites
- Unlocking marriage value where they are already freeholders.
"I have been impressed by Local Authorities' determination to take action and do something about what is a growing problem in town centres – our struggling shopping centres. "
Also, it should not be overlooked what an incredible opportunity is being presented to these buyers with lending rates of 1% or lower. They can borrow either from the PWLB or other sources with such low rates on offer due to the perceived strength of the borrower.
Even with full amortisation, which I would generally recommend, all-in costs are typically 2-3%, leaving a large margin over interest payments. With 100% LTV on offer and long term deals of 25-50 years available, buyers can fully amortise their loan, retain a significant sinking fund for future capex, employ an asset manager and still generate a healthy annual cash surplus.
There are fears that the shopping centres LAs are investing into are undergoing a terminal decline
Offered anything like these debt terms, there would be a myriad of Private Equity & Prop Co buyers chasing these deals down, even in the current climate.
So why have LAs had a hard time from some quarters for buying their local shopping centres? To me, there seems to be four areas of concern, though to each there is a sound counter-argument.
1. There is a concern that shopping centres are hard to manage and that inexperienced LA teams will be found wanting
To which I argue they should employ an expert asset manager. The cash surplus over interest cover makes employing such an expert eminently affordable, giving the LA better access to national retailers and to the experience of an established team.
2. There is a fear LAs will fail to allow for the capital expenditure that a shopping centre may require
To which I argue that they should build up a sinking fund from part of the annual surplus to ensure unforeseen capex can be covered from within the budget.
3. There has been criticism that some LAs have overpaid for assets
This is an easy criticism to make in a falling market and certainly something you could lay at the door of every institution and REIT over time. Of course, LAs should get the best advice they can and should negotiate price as hard as they can.
However, they do not have the luxury of waiting until the market has ultimately bottomed out. If they do the asset and the town might have dropped to a level of irreversible decline.
LAs need to take action sooner rather than later and, with yields now above long term averages, the risk of marginally over-paying and holding for 20 – 30 years is arguably better than taking no action and leaving the town centre to decline at the hands of an inactive shopping centre owner.
4. There are fears that the shopping centres LAs are investing into are undergoing a terminal decline
Whilst retail is certainly going through a dramatic evolution, leaving shopping centres in the hands of inactive landlords is tantamount to surrender. Our town centres need to fight their corner and who better to re-invigorate community spirit, who better to understand what their town needs and who is more motivated to take the necessary steps than the Local Authority.
There is more to debate and the complexities of the argument can go significantly deeper. However, for me the headlines are this:
A. If the shopping centre is strong then the financial support available to LAs make an acquisition a very attractive investment play.
B. If the shopping centre is weak then the LA may need to take action where others will not, invest time and money into these key commercial assets and get these town centres back on the right track through a proactive approach.
Let us not forget, LAs have been freeholders of many of the UK’s shopping centres for years, with long leases and operational control granted to property companies and pension funds. Now many LAs are simply upscaling their stakes from 10-20% to 100% ownership.