Whilst shopping centres and all things retail feature heavily in today’s news with discounted sales, defaults on loans, and administrations, there are some basics that should never be overlooked by asset managers, occupiers, administrators and lenders navigating these retail assets. Here are some of the key processes and physical considerations to keep abreast of through choppy waters.
Proactive management of liabilities and maintenance
Owners and those responsible for the management of retail assets, particularly shopping centres, need to be proactive in dealing with the retail occupier exodus. At Hollis, enquiries from occupiers to advise them on lease breaks and tenant exit options have become a daily occurrence and our research is showing a weekly tenfold increase in occupier related dilapidations advice, service charge disputes and space rationalisation work.
Landlords have been hamstrung with limited tools to deal with non-payment of rents and the hands-on distraction of chasing up late rent. However, owners and their asset managers are now starting to plan for the future, including proactively grasping the potential liabilities which rest with occupiers, and in turn the capital expenditure cost and works required (to reposition, refurbish or perhaps sell these assets).
The reconfiguration of retail spaces, particularly those where occupiers have installed escalators, bespoke fit-outs and alterations, will require significant reinstatement and forward consideration of the type of works required to put the asset back into a re-lettable condition. Whilst negotiations around new lease terms are often conducted by both parties with the best intentions, the preparation of dilapidations is often unfortunately left until the last minute. But in today’s physical retail world, the tide has turned; and we aren’t quite sure when or how it will return.
The management of assets during the term can often be dealt with using the tools in a lease, which are often overlooked. Most retail leases contain clauses obliging tenants to maintain the exteriors, redecorate and keep the roofs and façades (and perhaps empty residential units above) of our precious high streets well maintained and in good repair. These leases also often contain an obligation allowing a landlord to (politely, of course!) let the occupier know about these issues and request that they do the works, or allow the landlord to (and costs recoverable without much debate, even for administrators). Taking this kind of proactive, careful and hands-on approach to asset management and maintaining an engaged dialogue with your tenants can really yield results when done right. Sadly, however, this kind of asset management and dialogue is a rare sight nowadays.
It’s not just owners and asset managers who need to be proactive and engaged. Occupiers seeking to exit multiple locations will need to be prepared and assess their potential liabilities – which, for retail assets, can range from a few pounds up to £40 per sq ft or more. Dilapidations claims on retail assets don’t often disappear because reinstating tenant alterations, with the removal of ceilings, flooring etc., to a basic shell rarely negates any liabilities. Documenting these works and their cost is also necessary to comply with accounting standards in the UK: too much provision may draw a query from Her Majesty’s Revenue and Customs, whilst too little may leave not much left in the pot at lease end or for the administrator.
Refurbish or repurpose?
Refurbishing individual retail units to a whitebox specification to attract potential tenants is one option nowadays; designer ready stores appeal particularly to independent or pop up occupiers and certain provisions like neutral tiling add value. Additionally, fully glazed shopfronts do not necessarily appeal to all tenants, so knowing the façade as part of a general review of the demise is advisable to check if it requires replacement.
Larger conversion and change of use projects can pay dividends but will typically require more detailed planning and analysis before contractors are on site, so that’s an important thing to bear in mind when considering desired timescales. For example, we are currently advising a client on the feasibility of converting a department store into a cinema where some of the in-depth considerations include acoustics, adequate toilet provision, fire escapes – all of which need improvement in relation to the site’s previous use.
The take-up of more local serviced office space and conversion of retail assets to office space does of course have the potential to pick up in the short term: businesses and their employees may want to utilise more local amenities to work from instead of the commuting into cities. We can see this happening in London’s suburbs of Richmond and Clapham Junction, for example, where Hollis have been part of the team advising a buyer at acquisition on former department stores being redeveloped into offices with smaller retail offerings at ground floor level.
Effective asset management should be all about getting as much done as possible during the transition period and then – if the property is to be retained as retail – minimising void periods by having a fit for purpose retail destination that will be quickly let.
The risks of mothballing and cutting maintenance costs
Before making the decision to exit, occupiers should look closely at their lease and outgoings to see whether there are any areas of the tenancy they could be saving on or negotiating with their landlord. As the market is still uncertain, communication is key and landlords should remain open to looking at certain areas to help tenants stay – service charges reductions or monthly rents, for example.
Planned maintenance and looking after mechanical and electrical systems will also be an essential step in ensuring the retail asset is, and remains, in good working order. Whether that’s assessing the condition of items ranging from air-conditioning units to roofing components or evaluating the costs of larger works such as removing escalators and floors – both should be considered as early on as possible. A detailed M&E survey will allow you to get the full picture of the condition and lifetime of your mechanical and electrical services, whilst a planned maintenance report will identify, cost and schedule routine and preventative maintenance going forward. These reports and maintenance works have over the years been neglected as asset managers sought to cap service charge works to keep occupiers happy, and in turn many retail assets and particularly shopping centres have in some instances had little if any proactive works behind the scenes. This in turn can lead to a ticking timebomb for any new owner or administrator picking up the pieces who hasn’t acquired a comprehensive vendors report or planned maintenance report which has been regularly updated.
Occupiers should also make sure they scrutinise their on-going costs such as insurance: check that any fit-out works haven’t been included for by your landlords (which is an element often covered in your own business insurance). Landlords need to ensure that insurance premiums are accurate and based on elemental pricing instead of average pricing, so that you can confidently justify the premium if argued against in a dispute.
A buyer’s opportunity?
Whilst the pricing of retail hasn’t bottomed out, there are likely to be retail opportunities for redevelopment and acceleration of this with the UK government’s controversial changes to the planning system, allowing unused buildings to be demolished and rebuilt under new permitted development rights. This may in itself create hungry buyers and trigger the sale of more retail assets, but the developers themselves also need to be aware that these new changes do not negate the need for careful rights to light assessments and permissions necessary under the Party Wall Etc Act 1996.
Risks of buying and continuing to operate shopping centres do however raise bigger red flags for any buyer. A potential buyer or administrator needs more of a forensic approach to understand the necessary works to the fabric, M&E systems, fire structures and lifespan of elements throughout as the costs to keep some sinking ships afloat may need extra cash on top of the rent a lot of cash then even the rent. A wise seller would also prepare for a sale by having all their records and maintenance up to date and prepared as part of a comprehensive vendors report, which would be assignable to a buyer and, of course, more attractive with limited angles for price chips.
The era of sitting back to watch capital value grow in a rising market is definitely over for retail, but that shouldn’t stop those retail buyers, owners and asset managers who know how to work assets hard from making hay – even when the sun isn’t shining.