Lenders look to retail as high yields support more expensive debt

This month, both British Land, the UK real estate investment trust, and Toronto-headquartered manager Canada Pension Plan Investment Board have brought shopping centre assets to market – a sign market participants believe values in the sector have finished falling.

British Land has appointed property consultant CBRE to sell one of the UK’s largest shopping centres, Meadowhall in Sheffield, for £750 million (€862 million), reflecting a circa 7 percent net initial yield, reported the Sunday Times on 17 September. Meanwhile, CPPIB is reported to be exploring the sale of its 50 percent stake in CentreO Oberhausen, a 1.6 million-square-foot regional shopping mall and leisure centre north of Dusseldorf, Germany, according to React News on 20 September.

The proposed sales come as retail sales volumes increased by 0.4 percent in August in the UK, according to the government statistics agency, the Office of National Statistics.

There is also evidence lenders are increasingly confident the retail sector’s poor performance in recent years is beginning to stabilise, both in the UK and across continental Europe.

There have been several notable retail financings this summer. London-based manager Canada Life Asset Management invested in the UK in August, providing a £59.4 million four-year loan, at a loan-to-value of 50 percent, to a pan-European property fund managed by Patrizia. The loan was secured by three UK retail parks. At the time, Nicholas Bent, the lender’s head of real estate finance said Canada Life had been attracted by the “good yield enhancement opportunities” of the deal.

Head-start

Retail had a head-start on other commercial property sectors in terms of property value and yield adjustments. While yields in other sectors have been on an upward trajectory in the past 18 months, due to the impact of inflation and rising interest rates, retail values were falling and yields rising, for several years before that, due to the impact of the covid-19 pandemic and, before that, the growth in e-commerce. Market sources say yields in the retail sector are high enough, and the assets are therefore generating sufficient income, for sponsors to support a higher cost of debt.

In the UK today, yields are around 8 percent for prime shopping centres and 6.75 percent for regional retail warehouses, according to Cushman & Wakefield. By contrast, industrial yields remain as low as 4.55 percent in London.

It is a development observed by Tom Leahy, executive director of data provider MSCI – who leads the company’s commercial real estate research in Europe. Leahy says there has been a stabilisation in the retail sector and this, combined with the fact yields are higher relative to other asset classes, makes parts of the sector now appeal to debt providers.

In MSCI’s latest quarterly performance data, released on 6 September, retail was the best performing sector for the first time since December 2010 in its Europe Quarterly Property Index – recording a positive total return – the sum of capital returns and income returns – of 0.4 percent. Income returns, or rents, exceeded the fall in appraisal values in the index sample.

Leahy explained: “The results show a moderation in the bad news, a flattening out of poor performance where the outward movement in yields is now slowing down.”

He added that high retail yields, which once reflected the fact retail was out of favour, are now compelling – of particular interest to lenders being “needs-based retail and retail parks”.

Uncertainty wanes

Among those financing the sector in Europe is German lender pbb Deutsche Pfandbriefbank, which in June provided a €73.5 million loan secured by 61 retail properties to retail and residential developer and asset manager Trei Real Estate. The loan was designed to enable Trei to expand its retail portfolio in Poland – where prime retail park yields stand at 6.90 percent and at 6.15 percent for prime shopping centres.

Charles Balch, head of real estate finance for international clients, UK, CEE and USA at pbb, told affiliate publication Real Estate Capital Europe: “Part of the reason retail is possibly appealing once again is those retail assets that show strong performance have survived a series of blows over the years. This coupled with rebased rental levels and high yields, given the asset class has been out of favour, makes the asset class more interesting on a comparative basis against the backdrop of today’s interest rates.”

Balch added not “all retail has fared poorly”, explaining: “Factory outlet centres can be compelling if they are well-occupied and well managed. Other retail assets can be of interest where leases have been recently renewed, meaning the underlying income is more predictable.”

The bank is also “cautiously considering” a limited amount of shopping centre financing for the right assets, Balch said, adding this was not something the lender would have done this time last year.

The UK currently offers opportunities to invest in assets anchored by grocery retailers, he said. “That is solid income and, provided the borrower could fill vacancy with an equally strong retailer, this works for lenders. There is enough income overall so that the lender can put in a cash-sweep covenant in to protect the bank’s position.”

Low vacancy

BGO, the US-headquartered real estate investment manager, refinanced a Dutch high street retail portfolio owned by London-based Castlelake with a €115 million facility in September. The six assets are in central locations in the regional towns of Assen, Deventer, Helmond, Spijkenisse, Veenendaal and Venlo.

Robert-Jan Peters, executive director at property consultant CBRE’s debt and structured finance division, who arranged the debt on behalf of Castlelake, said the investment manager had “various attractive options” from lenders. “The uncertainty just isn’t there any longer, as it was this time last year. Any further changes are likely to be marginal and not impact the value of portfolios much.”

Peters agrees the outward shift in yields and rent decreases that took place before the cost of debt began increasing last year are helping investors find finance for assets in the sector. But he also believes borrowers in the Dutch retail market have the added advantage of historically low vacancy rates, which are 6.1 percent nationally, according to CBRE.

This is due to strict planning legislation which controls what type of retail is allowed in a particular location, meaning any oversupply issues have been quickly overcome. He explains: “The Dutch market does not have huge out-of-town schemes or shopping malls, as other markets do. Therefore, it is easy to find finance for neighbourhood retail where there is not much competition for footfall.”

While other retail markets lenders are now looking at still have high vacancy rates – at 13.8 percent on the UK high street, according to the British Retail Consortium, there is a growing sense of confidence that the sector in general has gained a basic level of stability. In today’s market, stability counts.