There was a reminder this week, 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 landlord 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 on how lenders are more inclined to work with their borrowers to resolve cases of default, and thereby avoid holding the keys to retail assets during troubled times for the sector.
The topic of how the financing of retail should be handled was mulled over during a panel discussion hosted by the Loan Market Association in London on 24 April. The upshot: a new approach is needed.
The basis of the discussion was that the UK’s most prime shopping destinations continue to perform well, as do many discount stores. What lies in 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, repositioning and redeveloping retail assets to create a sustainable mix of uses will be necessary.
For lenders, which like predictability of income and have been used to financing retail with standard loans on properties benefiting from traditional full repairing and insuring leases, repositioning retail assets is a worrying prospect.
If retail owners want to retain the support of their senior lenders while taking measures to rejuvenate their properties, they will need to accept that refinancing will take place on far more cautious terms. Senior lenders are a conservative bunch. Although they will remain keen to fund malls in the best prime locations, most will argue that they are not paid enough to take the risk of writing loans against assets in transition.
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.
For many investors in retail that are aiming to source new debt for assets in transition, it may be necessary to turn to the non-bank lending sector. The retail market presents a huge opportunity for those real estate debt fund managers with higher return targets than the senior lending banks. As retail properties increasingly come to resemble operating assets, the 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 in order to make lenders – senior and higher-risk alike – comfortable. A common complaint among lenders is that shopping assets need to be repriced to reflect the unpredictable cashflows they are generating.
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 fundamentally changed.
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