June rent day – the next retail pinchpoint
COVID-19 Market Update – 05/06/2020
11 minutes to read
Introduction
This is the ninth of a series of weekly notes analysing the state of the UK retail market in the light of the COVID-19 pandemic. This note explores three key themes:
- Our expectations for June rent day
- The pros, cons and complexities of turnover rents
- Further occupier fall-out
Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.
Key Messages
- Retail collection rates in June will be down on March
- KF projects that 10%-20% of occupiers will pay on time and in full in June
- Polarity between foodstores (ca. 100%) and leisure/F&B operators (ca. 0%)
- A number of “essential” retailers that paid in March will now seek concessions
- Lease re-gears and/or transitional repayments over 2021/2022 for landlords?
- Contingency planning for September should start now
- Shift to turnover-rents rising up the agenda (e.g. New Look)
- On paper, an equitable and flexible solution
- In practice, far more complicated with no “one size fits all” outcome
- Residual mutual mistrust between landlords and tenants a key constraint
- Lack of transparency another key barrier
- Monsoon Accessorize to appoint administrators
- But likely to survive in a rebased form under new ownership
- TRG to close 120 Frankie & Benny’s / Garfunkel’s outlets
- COVID-19 accelerates rationalisation process.
1. Our expectations for June rent day
Quarterly rent day on 24 June is looming large and will prove another major pinchpoint in the retail sector. We predict that retail rent collection rates will be lower than those achieved in March, for the very simple reason that most operators’ cash positions have significantly worsened over the lockdown period.
We project that only between 10% and 20% or retail and leisure/F&B operators will meet their June rent obligations in full and on time. This compares to our estimate of 33% in March, a figure we believe subsequently rose to around 50% over the course of the intervening period. Note that our projection is unweighted, whereas the collection rates reported by landlords will invariably reflect weightings within their respective rent rolls.
In broad terms, the division between “payers” and “non-payers” will be broadly similar to Q1. All the major grocers are likely to pay in full. At the opposite end of the spectrum, very few Leisure / F&B operators are likely to pay anything this quarter. In between, there will numerous shades of grey amongst the “non essential” operators.
Not all “essential” operators will pay their full quarterly contribution and this is likely to be a significant cause of controversy. AS Watson (owner of Superdrug and Savers) has already indicated that it will only pay 25% of rent this quarter. Understandably, there is something of a dividing line between “essential” and “non essential” operators, but in the defense of the former, just because they have stayed open during the lockdown does not necessarily mean they have maintained trade at anything like “normal” levels.
The majority of operators will continue to seek landlord concessions, be they rent reductions, extensions to rent holidays, or shifts to monthly payments. The contentious issue of turnover rents will continue to rise up the agenda – for our thoughts on turnover rents, read the second section of this note.
A shift to monthly payments is one of the softer concessions a landlord can make. While quarterly payments obviously provide greater assurance to landlords, monthly payments do ease cashflow pressure for retailers. Rather than an indefinite / permanent shift to monthly payments, a fixed-term switch is a potential area of (happy?) compromise.
The question as to how any rental arrears are recouped by landlords remains a burning one. There is certainly no “one size fits all” solution. For landlords, there are two potential avenues to explore: seeking to re-gear the lease or securing transitional payments covering the rent owed over a future timeframe. Both proposed courses of action are not without their complications.
In some cases, there may be an option to re-gear leases to incorporate an additional term commensurate with the length of the rent holiday. This is usually a multiplier of the holiday. But there are still complications (and negotiation pinchpoints), not least around who pays for Stamp Duty Land Tax (SDLT) and whether the additional term is at current, higher or indeed, lower rent.
Staggered re-payments of rent arrears may work in some cases. The terms will obviously vary, but few are likely to start until 2021. A 12 month period may work for some, but others may require longer. Some may be prepared to pay interest on the arrears, others may not. Delayed payments are obviously better for a landlord than complete waiver, but there is also inherent risk should that operator fail or launch a CVA, for example. Again, this is another minefield to negotiate and is anything but straightforward.
It is not too soon to look forward to September quarterly rent day and plan accordingly. Although most of the retail market will have at least re-opened by then, it will still be a very long way from recovery. Realistically, September will be as much a pinchpoint as June and those landlords that can need to take a longer term view – not necessarily to bow to every occupier demand, but collectively work on compromise solutions.
2. The pros, cons and complexities of turnover rents
The thorny issue of turnover rents has once again risen up the agenda as quarterly rent day approaches. This week it was revealed that New Look is in negotiation with landlords over a potential move to a sales-based model at the majority of its 500 stores in the UK and Ireland. Other operators such as Mike Ashley’s Frasers Group, Pret A Manger and Theo Paphitis’ retail group are reportedly all having similar discussions with landlords.
On paper, turnover rents seem a no-brainer; in practice, they are anything but. To the uninitiated, they seem a perfectly fair and equitable solution. The occupier de-risks a trading location and pays only a proportion of turnover that an individual store generates, therefore maintaining an equilibrium of affordability. The landlord has a happy tenant who will not default, helping cover any shortfall in performance, but also benefitting from any level of out-performance. If only it were that simple.
For a start, there is no “one size fits all” approach. The model has evolved from the base and turnover, or rack rent with turnover top up approach of a decade or more ago. It has moved to the current scenario where, more commonly, turnover rent may be just that - a rent based on an agreed percentage of net turnover (VAT exclusive), with a low base or on account rent.
Turnover rent percentages vary depending on the type of retailer. There is wide variation between fashion, discount, health & beauty or leisure/F&B operators, for example, but generally higher density sales mean lower turnover percentages, and vice versa. Inclusive turnover rent leases are still not that common and occur mainly in the fashion retail sector, partly down to the leverage key fashion brands have. But they do occur in other sectors and generally at turnover rent percentage levels of 12–15% (including rates and service charge), but can be slightly lower or higher.
But total transparency is still a prerequisite for turnover rents to work and in many cases, this is still lacking. Retailers are understandably protective of their trading data and will always seek to limit its release into the public domain over concerns of miss-use (e.g. falling into the hands of competitors or negatively influencing future deals). But without it, landlords have no transparency.
The fact that retail is increasingly multi-channel muddies the waters even further. Historically, assessing a store’s turnover amounted to simply counting what went through the cash register. In a multi-channel world, the role of a store has evolved and become far broader. What actually goes through the cash register may actually have declined, but that store makes a contribution to a wider multi-channel offensive e.g. a showroom for online orders, a collection point for click & collect orders, a repository for returned purchases (from online and other stores), overall marketing support for the brand.
Quantifying all these factors to derive a meaningful and accurate figure for store contribution (upon which a turnover rent must be based) is a minefield. There is an unwelcome irony in the fact that a transparency-dependent model is rising up the agenda at the same time as transparency itself is rapidly diminishing.
Not all landlords are averse to turnover rents, but most remain skeptical. Few believe that they will benefit from retailer outperformance, noting that retailers only seem to propose switching to turnover rents in times of crisis rather than prosperity. With some justification, others may point to the fact that in the base + top up model, hardly any top ups are actually triggered.
In our opinion, residual mistrust on both sides (landlords and tenants) is still a major constraint on turnover rents becoming commonplace. There needs to be more give and take on both sides. The current valuation and funding models also make turnover leases difficult to value and finance.
At the same time, the retail market needs to evolve if it is to emerge from this crisis intact and the sector needs to embrace greater flexibility. On paper, a switch to turnover rents could be a positive catalyst to necessary change, but the whole model needs fundamental review to establish full transparency, including a Code of Conduct and a formal process of external audit.
3. Further occupier fall-out?
1. Private equity ownership (current or historic). 2. a track record of past failure. 3. weaker operators within the over-supplied / soft consumer demand fashion sector. 4 over-expanded / balance-sheet challenged F&B operators – the four key (but not exclusive) “red flags” that drive our “at risk watch list”.
Monsoon Accessorize ticks two of these boxes (2 and 3). The fashion retailer has lined up FRP Advisory to handle the process and reportedly plans to file a notice of intention to appoint administrators in the coming days.
Monsoon Accessorize operates around 220 stores and employs a workforce of around 3,500. The anticipated administration would come less than a year after Monsoon launched a CVA, which saw it close 40 stores and reduce rents at 135 other locations. As part of the CVA process, owner and founder Peter Simon injected £12m of his own cash into the business. Mr Simon has since reportedly sought a sale of the business, but has yet to find a buyer, although negotiations with a number of potential bidders are understood to be ongoing. Mr Simon himself could yet buy back a portion of the business, should it collapse.
Will the Monsoon Accessorize business survive? In all likelihood, yes. It has historically been a very strong performer, achieving both high margins and strong sales densities. Its product has a distinctive handwriting and for all its recent tribulations, its brand is still relatively strong. It is largely the victim of an over-supplied market, possibly having also lost its way on the product side. It is likely to live on under different ownership (with Simon involved in some capacity) on a slimmed down basis.
Far less surprising was this week’s news that The Restaurant Group (TRG) will undertake further rationalization of its portfolio. A few weeks ago, the group issued a profit warning and said that 61 of its 80 branches of its Tex-Mex dining chain Chiquito would not reopen. It also said it would permanently close its 11 Food and Fuel pubs in London. The decision led to the loss of almost 1,500 jobs.
In a subsequent move, TRG is to permanently close up to a further 120 restaurants, with almost 3,000 job losses. The closures will predominantly focus on the Frankie & Benny’s and Garfunkel’s brands, with Wagamama’s largely unaffected.
In many respects, this “news” is not news at all. Back in September, TRG announced plans to close more than 150 outlets on the back of an £87.7m pre-tax loss for the first half of this year. The plan was to close at least half of its outlets across the two brands as soon as leases allowed, having previously labelled a third of them “structurally unattractive”. The pandemic has clearly accelerated this process.
These closures are inevitably being blamed on COVID-19, but the simple truth is that TRG’s challenges predate the outbreak of the pandemic. The facile media narrative that fewer people were eating out prior to the onset of coronavirus also carries limited sway and is actually factually incorrect. COVID-19 is merely turbocharging an industry shake-out that was taking place in any case.