Will debt for European retail real estate dry up?

Retail property values in Europe are falling, forcing lenders to question their exposure to the sector. PERE's sister title Real Estate Capital investigates.

In June 2016, then UK home secretary Theresa May visited the Nicholsons Shopping Centre in her constituency of Maidenhead, a town located 25 miles west of London. The centre – a distinctly average UK shopping scheme – had been bought the previous March by private equity-backed property firm Vixcroft and private credit manager Cheyne Capital with the promise of a revamp. The soon-to-be prime minister was checking in on the upgrade.

“We want to see more shops and businesses attracted to the town centre so that it can become a vibrant hub for the community,” proclaimed May on her visit. The opposite was to happen. As the UK’s bricks and mortar retail crisis hit, several tenants were to vacate the Nicholsons. Last October, it became the first major example of a UK shopping center to be placed into receivership this cycle.

In receivership: Nicholsons Shopping Centre

Failure to meet the Nicholsons’ debt obligations led to its receivership. The scheme was bought for £37 million (€42.5 million today) in 2015, backed by a £26 million loan from Hermes Investment Management, according to reports.

Those involved with the Nicholsons were reluctant to speak about the situation for this feature. Morgan Garfield, managing director of Ellandi, a property company that specializes in managing shopping centers across the UK and took on management responsibilities for the Nicholsons in 2017, did however speak about the impact of online shopping on the wider retail real estate market.

“Retail is challenging in the UK at the moment,” Garfield admits. “Across Europe, there is growing online penetration that will reshape the retail landscape. In the UK, Brexit is an additional complexity. The effective devaluation of sterling since the referendum has increased retailer costs and eroded profit margins whilst uncertainty has undermined the confidence of occupiers and investors.”

Consumer confidence continued to decline in the fourth quarter of 2018, according to data from Deloitte Consumer Tracker, as uncertainty surrounding Brexit reached new highs. Retail footfall registered a year-on-year decline of 2.1 percent in 2018, according to retail analysis firm Springboard.

The fate of Nicholsons highlights the tough decisions facing real estate lenders as the high street and shopping center retail crisis intensifies. As capital values plummet, debt providers are forced to consider the health of their loans to shopping properties – as well as their long-term exposure to the sector.

Falls in value

The immediate challenge for lenders is ascertaining how much the collateral to their retail loans is worth. Data provider MSCI recorded a 5.7 percent decline in capital growth across the UK retail sector during 2018. CBRE’s monthly index, meanwhile, showed an average drop of 10.5 percent for shopping centers over 2018. Fund manager Fidelity International’s prediction is a drop of 20-40 percent for prime retail, with secondary stock expected to fall in value by as much as 70 percent.

There is a debate as to whether valuers are reacting quickly enough to the reality,” says Nick Knight, executive director and valuation specialist at CBRE. “I can understand how people looking at average values in published indices might say it feels worse out there than the numbers show. But I’m disappointed by suggestions that it is valuers’ conflicts of interest that is keeping values high. You only need to look back to the global financial crisis, when values were written down by 40 percent, to see this is not a community that is afraid of taking values down.”

The lack of transactions in the sector means valuers have limited comparable data to draw on. Savills data show 2018 was the worst year for UK shopping center investment volumes since 1997, with total turnover of £1.3 billion across 34 deals, down 60 percent on the long-term average.

“Valuing retail now involves balancing sentiment and evidence,” says Savills’ head of valuation, Ian Malden. “Investors are placing less emphasis on yield; it is more about the true cashflow and geared returns. Falling rental values and questions over the sustainable income going forward are very relevant. Valuers also need to increasingly consider the value in a repurposing scenario, which adds a new dynamic to the valuation matrix.”

Knight expects more pain: “There is further to go. History tells us that when you reach an inflection point in the market, there can be a time lag.”


The dilemma for lenders is whether to take enforcement action if loan-to-value covenants are tripped in their facilities. Anecdotal evidence suggests lenders are desperate to avoid situations of default. The financial crisis of 2008 remains fresh in lenders’ minds and many are understood to be reluctant to take measures that would mean admitting property lending has, again, resulted in failures.

“Some lenders have put pressure on borrowers to cure LTV breaches,” comments one UK debt advisory specialist, “but lenders are nervous of defaults, because they remember the pain they went through in the crisis.”

While lenders we spoke to did not refer to specific situations that they, or their peers in the industry, might be involved in, they argued most debt providers will be taking a considered view of the properties they are financing, rather than panicking at the fall in values.

Trevor Homes, head of senior lending at debt fund manager DRC Capital, says he has seen valuations move out 100-200 basis points in the last 12-15 months. He argues: “If you are a senior lender with leverage at 60 percent and values have moved by 100bps, you might be at 70-75 percent LTV now. If they have moved by 200bps, you could be closer to 80-90 percent; that’s most likely an LTV breach. Most facilities will have cure rights and better sponsors will be able to inject some new capital. I’m not hearing of any examples of keys being handed back to banks.”

John Barakat, head of real estate finance at M&G Investments, says a lenders’ course of action is specific not just to the asset and operator, but also to factors such as location. “You have to take a bespoke approach to each situation and determine what’s the appropriate course of action and what has caused the breach; is it a fall in value, is it a vacancy issue, have the tenants gone bankrupt, is the centre no longer fit for purpose? Lenders will analyse the different reasons to determine the best course of action to maximise the asset recovery,” he says.

The slew of high-profile retailer administrations in the last six months has created a real danger to retail income. Retail property experts also point to the damaging impact of retailers using company voluntary arrangements – deals allowing them to reduce rents as part of a survival plan – which many consider an abused tool in recent months. The traditional upward-only rent review, it seems, is not sacrosanct.

“Tenant failures and falling rents will erode net operating income,” says Garfield, “if, in turn, this has an impact on the ability to service debt, lenders will have to act.”

Sector analysts do not expect pressure on retailers to let up. The Centre for Retail Research expects 22,100 retail closures this year, up from 18,443 during 2018. Andrew MacDonald, head of real estate finance at asset manager Schroders, is one of those who see the threat to income as the most immediate concern for lenders. “In the financial crisis, it was more a capital value-led issue. Lots of loans breached LTV covenants because of yields rising, but income was still robust in lots of those loans. The issue this time for retail is on the income side of the equation. Loans breaching their income coverage ratio covenants is more of an issue than LTV breaches.”

Some, including DRC’s Homes, are convinced income will hold up across many UK shopping centers, despite the crisis. “Income is holding up at a lot of shopping centers, so although there have been a few administrations, we are not seeing ultra-low occupancy at shopping centers. The serviceability of debt is usually sustainable. The lending was generally done on sensible terms in the first place.”

In situations where lenders are uncertain of the value of underlying assets, but trust their sponsor, it seems the preferred course of action is to support the borrower – possibly also apply pressure to increase capex – in the hope that income from the scheme will feed loan payments, allowing the lender and borrower to ride out the crisis.


While lenders are not, at this stage, pulling the plug on their existing borrowers en-masse, sourcing new finance in the retail sector is understood to be difficult. Banks are negative on the asset class in general, despite protestations from some in the industry that parts of the sector, including leases to the major supermarket chains, remain robust.

The long-term liquidity of retail property debt is in the balance, causing potential problems for those sponsors in need of refinancing come the maturity of their current loans, many of which come due at the end of this decade, with Savills identifying 2020 as the market’s refinancing spike. Given many assets across the UK are owned by private equity funds that have deadlines to return capital to investors, debt for refinancing is a necessity.

Real estate debt providers have gradually reduced their exposure to retail – as well as all commercial real estate – since the last crisis, although it remains a significant component of many loan books. In 2007, retail accounted for £55 billion, or 27 percent, of the total UK commercial real estate debt pile of £214 billion, according to Cass Business School data, whereas it accounted for £25 billion, or 19.7 percent of the £127 billion 2017 total.

Lenders have also taken a more conservative approach to underwriting during this cycle. Leverage levels typically fall below 60 percent, compared with the 85 percent-plus seen before the crisis.

Debt advisory specialist James Wright, head of the real estate finance business at Link Asset Services, recalls the challenges of sourcing debt for clients in recent situations. “Banks are pulling back from retail,” he says, “and there is a definite focus on the best examples of retail, which means outlet centres and retail warehouses are an easier sell than high street units or shopping centres. It comes down to the covenant strength, lease lengths, the quality of the real estate, but also increasingly the alternative use value.”

Wright describes a recent hunt for finance for a town centre retail parade in an undisclosed UK location. “The WALT (weighted average lease term) wasn’t terrible, but there was a significant tenant with less than two years on its lease. It was a defining case in point for us.”

A bank loan reached first stage credit approval at a circa 3 percent margin, but the deal was to be upended by a policy change at the bank. A sector review led to a ‘stop’ policy on retail exposure for new clients at the bank, meaning Link needed to look for other options.

“We went back out to market,” Wright continues, “and, now a couple of months later, with a shorter lease term and the ongoing negative sentiment engulfing the sector, no other bank would take the loan. We eventually sourced a loan from an alternative lender. The margin went up from about 3 percent to more like 8 percent.”

Ellandi’s Garfield agrees pricing is rising: “Just before the Brexit referendum, we saw loans at 65 percent LTV, priced at 150bps over LIBOR. On a senior basis, you probably couldn’t get that type of loan today, it would be circa 50 percent LTV at 250bps,” he says.
While banks do not tend to signal cooling appetite for a sector, there is an acknowledgement from many that retail is problematic.

Phil Hooper, head of commercial real estate lending at Royal Bank of Scotland, argues retail remains a “hugely important” part of the property market. “While we are aware of the risks, and will at times take a more conservative approach, we continue to support our customers across all sections of the market,” he tells Real Estate Capital.

A clear understanding of what level of rent is sustainable for specific retailers in a given location is crucial, explains Hooper. “In an environment where CVAs have become more commonplace and even profitable retailers are planning store closure programs, it is not enough to simply rely on an existing lease and ignore the sustainability of the contracted rent.”

The size of a catchment population is the key criteria for national retail chains, Hooper says, while the retail offering in secondary locations will be focused on convenience and value shopping. “These segments tend to come with fairly tight profit margins, and as a result occupational costs are limited to a lower proportion of turnover than might be the case in higher margin segments.”

Where banks retrench, alternative lenders tend to in-fill and sources say the market is playing into the hands of those debt funds with higher risk/return profiles. Some alternative lenders see the fall in retail values as an overcorrection and will lend, if vacant possession value is higher than the loan volume. However, others argue alternative sources of capital will not be the cure-all for those in need of retail finance, with some institutional investors, which back many alternative lenders, sharing banks’ qualms about the retail sector.

The factors causing the retail crisis are not going away. A bifurcation in whether retail properties can attract finance is likely to emerge, with properties that have been revamped or repositioned attracting finance, and those which simply do not work in the modern retail environment losing lender support.

A major consideration for lenders is what the next generation of UK retail property owners looks like. While better performing assets will remain largely in the hands of institutional ownership, or in the portfolios of listed property companies, there is much debate around who will step in to buy bargain assets that hit the market in the near term. One debt market observer, speaking in private, poses a pertinent question: “Who’s going to want to own all this stuff?

“A lot of private equity guys went in hoping values would recover; they weren’t expecting further value falls. So, there will be a bunch of owners taking a bath and we are not talking about permanent capital such as REITs or insurers. We are talking about private equity capital that needs to be returned to investors to a deadline.”

Some argue the vultures are already circling distressed situations. “Many private equity investors, ranging from real estate private equity funds to hedge funds, are eyeing the retail sector, some of whom are looking at the debt as a way in,” says Christopher Daniel, founding partner at Quadrant Estates, which owns retail property across the UK.

However, many believe the work-out of the UK’s distressed retail will require investment and long-term thinking, rather than short-term profit. “Local authorities could be the saviors of retail,” one market observer comments.

Buyers are likely to tackle problem retail in joint ventures in order to bring a combination of capital and expertise to the table, suggests DRC’s Homes. “It might include local authorities who have the incentive to make these schemes work. When product came out of NAMA [Ireland’s National Asset Management Agency], buyers knew they could do a quick turnaround. Those easy wins are not there at shopping centers – if they were, the existing sponsor would be doing it.”

There is evidence of institutional investors taking the opportunity to buy into the sector. For example, LaSalle Investment Management is reported to be close to buying The Galleries mall in Bristol from Infrared Capital Partners.

“We will definitely take advantage of current pricing, to be very selective on stock,” says Mahdi Mokrane, LaSalle’s head of research and strategy, speaking generally about the possibility of buying assets in a changing retail landscape. “Key considerations for us are location and asset flexibility – dominant urban shopping centers are typically more attractive to us – and capital expenditure, as retail assets need more capex to convert spaces to increase footfall or for alternative uses.”

Mokrane adds his belief that debt liquidity will not be an issue for sponsors with track records in implementing business plans.

Just as investors see positive fundamentals in segments of the retail sector, lender appetite will be determined by the individual fundamentals of an asset. “Retail is not dead, but we need to recognize in the UK that we have too many shops,” says Homes. “People’s shopping patterns are changing. The internet is not the reason some retailers are suffering – it is because they have a tired offering of the wrong products. The internet just exacerbated the situation.”

There are around 850 shopping centers in the UK, says Homes, including around 50 prime malls such as Kent’s Bluewater and Birmingham’s Merry Hill, plus around 200 neighborhood convenience centers, which are also holding up. “It’s the rest – the squeezed middle – that could potentially struggle,” he says. “The solution for a lot of those in the squeezed middle may not be exclusively retail. Empty space may need to be redeveloped into uses that complement the retail. It will involve working closely with local authorities to find a solution.”

The full extent of the UK’s retail crisis is not yet apparent. What is clear, however, is that lenders are reacting. At this stage, the receivership at Maidenhead’s Nicholsons is not the norm, but as loans come due at struggling shopping assets, more lenders are likely to pull the plug. Further forward, lenders will assess their appetite for the sector; retail, many point out, is not dead, but the wrong kind of retail – the dated stock which does not fit with the times – will not be worth lenders taking the risk.



Shockwaves from the UK’s retail crisis are beginning to be felt across continental Europe. “Generally, the mood in Europe is not as gloomy as it is in the UK, but we are starting to see weaker assets hit hardest on the tenancy side,” says Philippe La Pierre, head of Continental Europe at LaSalle Investment Management. “Tenants are selecting more prudently where they are going to expand or maybe reduce shops.

“The advantage on the continent is that industry players have seen what is going on in the UK in the past year or 18 months and have been able to react earlier, such as … better understanding the concept of omnichannel, catering for customers to shop online but return items in a bricks-and-mortar store, for example, in order to improve the shopping experience.”

European retail property markets will have differing experiences of the retail crisis, due to maturity, shopping cultures and, crucially, the density of stock. Europe has less traditional retail stock, proportionally, than the UK: 4.6 square feet per capita, compared with 2.3 square feet per capita in Germany, according to the International Council of Shopping Centres and Cushman & Wakefield. Lender attitudes to European retail vary, although alternative lenders seem willing to finance the sector, selectively.

M&G’s John Barakat says his firm is still backing retail across several countries. “Internet penetration has not been that high across Europe as in the UK. This doesn’t mean that retailers in Europe are not exposed to disruption by online shopping, but there is a time lag between these two markets,” he says.

Property cycles

While there is increased lender caution in more established markets, landmark retail lending deals continued to be closed in countries less advanced through their property cycles. Last January, for example, Oaktree-backed Griffin Real Estate sourced a €635 million loan to finance the €1 billion acquisition of 28 retail properties in Poland.

Nebil Senman, manager partner at the firm, recalls receiving “a couple of offers” of finance for a deal providing significant exposure to the Polish property sector. The mega-deal was eventually financed by HSBC at around 200bps, at a 63 percent LTV. Senman notes a tightening of lending terms, however: “Two years ago, it was easier to secure financing at 60 percent LTV on retail than it is today at 55 percent, while margins were probably around 20bps lower.”

In Spain, listed property firm Lar España last July secured a €98.5 million loan from four domestic banks for the construction of a new mall in Seville, despite lenders having withdrawn from backing large retail developments in the country after the last crisis.
While margins in the UK are increasingly reflecting retail’s risk premium, core assets in Spain are being financed at reduced margins, due to a lack of product and high competition. “Two years ago, we had levels of 175bps for core retail and now we are at 150bps,” says Julián Bravo, head of the Iberian division at ING Real Estate Finance. “Loan pricing for secondary assets remains unchanged at 200-225bps.”

The bank is open to financing Spanish retail, he explains: “It’s true that e-commerce is here to stay, but in Spain the stock for shopping centres is not as high as in the UK or the US. Also, the assets are not as obsolete, and they are closer to city centres.”

Shopping cultures in some parts of Europe also remain focused on bricks and mortar. In Sweden, for instance, Amazon launched only last year. Aksel Lundquist, fund manager at Stockholm-based alternative lender Brunswick Real Estate, is sanguine about the online threat: “Physical stores remain popular in certain locations, especially as online retailers are struggling with next day delivery in a large country with low population density such as Sweden.”



German banks have reduced retail financing as a proportion of overall lending, figures show. In 2015, retail accounted for almost 33 percent of new commercial real estate lending, dropping to 25 percent in 2017, according to the German Debt Project report, compiled by Bavaria’s University of Regensburg. The volume of new retail lending peaked at almost €32 billion in 2015, dropping significantly to almost €25 billion in 2017, according to last year’s report.

“There is a structural change already happening in the German retail business and investors and banks are reacting with caution,” says Sabine Barthauer, member of the board for real estate at one of Germany’s major Pfandbrief banks, Deutsche Hypo.

“There were fewer transactions in 2018 and investors are looking closely at who their operator is and the occupier mix in schemes. Values have been hit and this is the same for high streets across Europe.”

The situation is affecting how Deutsche Hypo approaches lending deals, Barthauer explains. Deals are being structured conservatively, usually below 50 percent LTV, to sponsors the bank has established relationships with. Amid a competitive financing market, it is difficult to raise lending margins, she adds. Sponsors are also shying away from long-term financing, favouring six and seven-year loans, rather than 10-12 years as seen in the past.

“I think retail will remain an interesting segment, but only where there are really experienced operators making use of both bricks and clicks,” Barthauer adds.
“The structure of the asset class will change, with high streets and shopping centers focusing on uses which will entice people who want a day out, such as restaurants.”

Additional reporting by Daniel Cunningham.