High time for lower rents
Now that the property bubble has burst, commercial rents must come down, with or without the abolition of upward only rent review clauses
12 October 2009
As the retail slump intensifies and with property prices after collapsing, landlords are going to have to take a major haircut. Unless and until they agree to significant rent reductions things are going to keep getting worse.
By the end of this decade there will be approximately 3.3 million square metres of non-high street retail floor space in this country. According to figures compiled by estate agents CBRE Richard Ellis, there was 1.9 million square metres of shopping centre floor space and 1.3 million square metres of retail park floor space in Ireland at the end of last year.
This compares with less than 400,000 square feet of shopping centre floor space and less than 100,000 square metres of retail park space at the end of 1999. Even as recently as the end of 2004, less than five years ago, there was only 550,000 square metres of shopping centre floor space and just over 300,000 square metres of retail park space.
In other words, the supply of non-high street retail floor space has increased more than six-fold over the past nine years and has almost quadrupled over the past five years. And the tide of new retail floor space just keep on flowing. CBRE reckons that, despite the downturn, a further 95,000 square metres of new retail floor space will come on stream this year with a further 120,000 square metres set to hit the market in 2010.
Casualties of the downturn
While the retail sector was buoyant the market could just about absorb this huge increase in retail floor space. Unfortunately retail sales have been one of the most high-profile casualties of the economic downturn. The most recent figures from the CSO reveal that, excluding car sales, the value of retail sales was down by almost 12% in the 12 months to July and has fallen by almost 15% from its February 2008 peak.
This combination of a huge increase in the supply of new retail floor space and collapsing retail sales has inevitably led to calls for rent reductions. This of course flies in the face of that staple feature of the Irish retail property scene, upward-only rent reviews.
While the government has already announced that it will introduce legislation to ban upward-only rent reviews, this only applies to new leases. Any tenant with an old lease is still stuck with upward-only rent reviews.
Further complicating matters is the fact that the government seems to be split on the issue of upward-only rent reviews. While Justice Minister Dermot Ahern is in favour of such a move, Finance Minister Brian Lenihan, perhaps mindful of the implications for NAMA, is less keen.
Meanwhile out there in the real world economic reality is beginning to outrun legal theory. In practice more and more landlords are being forced to concede lower rents. A recent survey carried out by Ibec’s Retail Excellence Ireland found that 86% of the retailers surveyed had requested a rent reduction from their landlord and that 13% of them had received a reduction with landlords "considering" requests for rent reductions from another 33% of tenants.
Shopping centre debt trap
What was most interesting about the REI survey was the response of different types of retail landlords to requests for rent reductions from their tenants. While a quarter of high street and retail park landlords conceded reductions only 7% of shopping centre landlords have done so. By the same token, while only 17% of high street landlords and 23% of retail park landlords had categorically rejected requests for rent reductions, a massive 42% of shopping centre landlords had done so.
This is almost certainly a reflection of the fact that, with so many new shopping centres having been built since the beginning of the decade, most shopping centre landlords are far more heavily indebted than their high street or retail park counterparts.
As a result many of these new shopping centres are almost certainly headed for NAMA as the banks offload their property-related loans to the government’s new ‘bad bank.’ Will NAMA be more receptive to requests for rent reductions from shopping centre tenants?
The reality is that it will almost certainly have no choice. Over the past year several retail chains including O’Brien’s Irish Sandwich Bars, Golden Discs and Zaavi have either gone bust or been forced to seek protection from their creditors. Many more are likely to follow. The word on the street is that at least two high-profile Irish retail names are in serious financial difficulties and will be forced to restructure their debts in the coming months.
Lower rents are the only real choice
Faced with a choice of lower rents or empty shopping centres I rather suspect that NAMA will choose lower rents.
That is effectively what the market is already saying. CBRE estimates that Grafton Street rents fell by approximately 15% in the first half of 2009 while yields for even the best-quality retail properties have skyrocketed from just 2.5% to 6.5%. That translates into a fall in values of 60%.
That’s much more than the 40% by which institutional property investors such as Irish Life and Irish Property Unit Trust wrote down their asset values in 2008. It also exceeds the 50% by which Finance Minister Brian Lenihan claimed the Irish property market had fallen, when he spoke in last month’s Dáil debate on the NAMA legislation.
And guess what, a 60% fall in retail property values, is almost certainly what is needed to restore the retail sector to health. With the benefit of hindsight there is no doubt but that Irish retail rents and capital values had completely lost touch with reality by 2007. REI reckons that retail rents had risen to an average of 13% of sales compared to a European average of about 8%.
When you factor in further falls in sales and the glut of new floor space that has come on the market in recent years it is clear that rents have further, much further, to fall. While that may be bad news for landlords and their institutional shareholders it will be good news for retailers and their customers.