Retail insolvency: a property dilemma?
A number of recent cases, including the BHS collapse and the struggles of Ed¬ís Easy Diner, have highlighted the critical nature of property portfolios for retail and leisure businesses facing financial distress.
Given the strain the sector is under, following the Brexit vote and significant policy and market developments, questions are being asked about what happens to a property portfolio once a retailer becomes distressed – and the role of landlords in the process.
A challenging climate
The increase in employment liabilities following the introduction of the national living wage, coupled with the prospect of increased property costs as a result of the business rates review, is casting a shadow over the retail sector, and adding to businesses’ anxieties. Meanwhile, Brexit and its effects have only added to this uncertainty. The fall of Sterling against the Dollar and Euro is having an immediate effect on retailers, making imports more expensive, and, whilst larger retailers may currently be sheltered from these fluctuations through currency hedging this may become harder. Small retailers who have not hedged will be adversely impacted and face the real prospect of the erosion of profit margins. The recent ‘marmite-gate’ between Tesco and Unilever may be just the start of many show downs between suppliers and retailers. The brief and unexplained 6% drop in Sterling’s value against the Dollar on 6 October illustrated just how volatile the currency markets could be.
In addition, despite the Bank of England’s interest rate cut, confidence has been unstable, which will likely have an influence on the propensity to spend. Consumer habits are also changing as shoppers choose more and more frequently to make their purchases online, or in “convenience” outlets and destination stores, impacting retailers with large estates to maintain particularly those on the high street.
As a consequence of all these factors it is likely that we will see the sector experience increasing signs of distress over the coming year, if not within the next few months following the key Christmas trading period.
In this challenging environment property costs are one of the key overheads for businesses, and retailers may need to consider restructuring with the aim of amending their tenancy agreements. There are a number of available options for distressed companies –
• Consensual renegotiation with landlords
• Company Voluntary Arrangement (CVA)
The primary restructuring tool for an underperforming retailer with a large property estate is generally the Company Voluntary Arrangement (CVA). A CVA is used by an insolvent business to pay creditors over a fixed period or to make a one off payment- if creditors agree then the business can continue trading. The landlords of stores that make no or only marginal contribution to a business may therefore find themselves bound by a CVA whereby they accept reduced or no rent, or a return of the property. Landlords will always prefer solutions whereby the business keeps trading and paying. However, because of the CVA’s voting mechanism - requiring the CVA to be approved by creditors owed at least 75% of the debt - landlords can find themselves bound by an arrangement they did not vote for. It is also usually difficult for a landlord to challenge the terms of a CVA because they are required to demonstrate unfair harm or prejudice.
The main alternative to a CVA is often Administration. The outcome for the landlord can, though, be similar to a CVA, with the Administrator seeking a reduced rent whilst looking for a buyer for the business. The landlord is under no obligation to accept a lower rent but may opt for this to avoid the return of a vacant property. An empty unit is not an attractive option in today’s uncertain economic climate, particularly as finding a profitable replacement tenant cannot be guaranteed.
Opportunities going forward
However, savvy landlords may be able to preserve retail operations in struggling sites or secure the long term future of their property through alternative investment.
Business insolvencies, such as BHS, where there is a substantial property portfolio, can provide landlords opportunities to redevelop sites and maximise future rent. For instance, large units, such as former department stores, could be redeveloped into smaller shops or mixed-use real estate with commercial and residential spaces.
While a successful sale of a property will usually depend on the location and viability of the site, in the event of a retailer’s collapse, a landlord may look to dispose of freehold investments which could present opportunities for speculative investors – particularly from the US given current currency values.
Ultimately, though, landlords who take a proactive approach to their retail portfolios before their tenants fall into difficulties will likely come out on top, and avoid being left with non-performing assets. Landlords need to engage with their tenants and understand the trading dynamics they are facing. This will involve assessing the performance of individual units and whenever possible, their contribution to central costs. For example, if a tenant seeks to renegotiate lease terms on an informal basis, then the new arrangement could include a temporary profit sharing mechanism.
Retail landlords should also understand the options that are available before entering any negotiation. This might include seeking alternative occupiers or uses for unused space that might help anchor-tenants address their overheads while pursuing a more dynamic customer offering. We have seen several innovations in this area in recent times, with for example, the flexible subletting of space or the creation of concessions or click-and-collect points in larger stores.
The best advice for landlords is that it is key to understand not just their industry, but also that of their retail tenants. This will, in the end, enable a much more flexible, collaborative and economically robust partnership.
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