Intu - Still more pain to come?

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Intu announced its half year results this morning. Like for like rental income has reduced by 7.7% well in excess of the Company’s previous full year guidance of 4% - 6%.

 The portfolio valuation is down by over 7.5% in the first six months of the year.

I have been forecasting, since the full year results announcement in February, that increasing yields together with falling rental income make covenant breaches all but inevitable. The business is apparently in full cash preservation mode (no dividend and redundancies reportedly being considered) and it is hard to see the share price recovering before the property market.

The first half figures from Intu for rental income have always been weaker than the second half but extrapolating to get an estimate of the 2019 full year figures based on the first /second half revenue ratio from last year gives full year revenue of about £605 million and suggests a full year drop in the valuation, even with no further outward yield shift of 14% between December 2018 and December 2019. That is driven by a vacancy rate that has increased from 3.3% to 4.9% which both reduces revenue and increases irrecoverable costs. There will also be increased tax costs because of the (temporary) loss of REIT status.

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The trajectory remains clear, the falls in rental income are, in my mind, set to continue. That negative pressure will continue to reduce investor appetite for retail, so further outward yield shift is likely.

The management has announced a new five-year strategy for a business which will do well to last for another 5 months.

In my view this is now a full turnaround situation, the management is facing covenant breaches and unless it acts faster than it seems to be at the moment, a complete breakup, possibly at fire sale prices, or a deeply discounted rights issue is becoming increasingly likely.

Either way further reductions in shareholder value are almost inevitable.

#Intu #ReceptConsult #cre

Intu - more difficulty?

Earlier this week I had a conference call with a distressed debt purchaser about Intu.

Since my last blog, Intu has a new CEO, a new CFO and has sold a 50% stake in Intu Derby at a yield of 6.6%. That sale only reduced the LTV by about 1%. The Company has also provided guidance that current year rental income is forecast to fall by between 4% and 6% due to vacancies and tenant CVA’s.

Notwithstanding the dividend cancellation, Intu is constrained and will be for some time from investing in value accreting opportunities.

The planned sales in Spain will help but could be swiftly offset by further valuation falls in the UK portfolio. The falling rents, which also bring increased costs in rates and irrecoverable service charges will, in our view, almost certainly lead to further outward movement in yields. The forecast drop in rents and yield shift could easily see the portfolio lose a further 15 -20% in value through to the end of 2020.

The new CEO needs quickly to come up with a plan B to de-gear more aggressively to allow Intu to move forward and restore the REIT distribution, or it risks being on life support for many years to come.



The results from Intu earlier this week looked on the face of it dire, but it is possible that the worst is still to come.

I have taken a quick peek at the numbers disclosed in Intu’s report and here’s the thing..

Net Rental Income is about £450 million, and the vacancy rate is 3.3%

The valuation is based on a Net Initial Yield of (give or take) 5%.

I stressed those numbers a bit to see what happens by moving the vacancy rate out to 6% overall, it is already above that at Merry Hill and St David’s, Cardiff, so it is far from an impossible scenario. Along with that, I moved the net initial yield out by 100 basis points. If large retail centres remain out of fashion with investors and in a market where vacancies were rising, that sort of yield shift would not be unfeasible. (Yields on the Intu portfolio have moved out 62 basis points over the last 12 months).

The result is a 20% fall in values, that would see the Company (so it says) having to borrow a further £43 million to cover covenant breaches. Would Intu’s board of directors do that? The wisdom of borrowing more money in a falling market thus increasing the overall LTV in the business must be questionable. The asset specific borrowings where covenants are most stressed may of course not also be non-recourse which would leave the board with a more limited choice.

It is perhaps time for a plan B, long-term secure income from tenants does not really exist anymore with the rise of defaults and CVA’s. Intu has led the way in branding of its centres, perhaps now is the time to fully embrace the partnerships with retailers and move towards performance and turnover based rents.



Machine Reading of Leases

Stephen and I are currently engaged in a very interesting project to provide a potential client with the ability to intelligently extract information from leases to allow quick and easy access and to populate a planned new property management system.

We believe that this has a wide industry application and could be a truly disruptive use of technology.

Call either Stephen or me for more information.


For the avoidance of doubt (if any)

Legal contracts exist to record the terms of the commercial bargain made between the parties to that agreement.

The job of the draughtsperson should be to make any agreement clear and unambiguous, in other words there should be no doubt.

It is not uncommon however to see the words 'for the avoidance of doubt' used in contract documents.

When I see the phrase used, I immediately think that the draughtsperson has failed in their task.

It is somewhat rarer to see the phrase qualified by the words (if any), as I came across when advising a client last week. In seven words the agreement claimed to be trying to avoid doubt whilst also doubting that there was any doubt!

My clear and unambiguous advice to draughtspersons everywhere is this.....

If in doubt, even if you doubt that you are in doubt, avoid the avoidance of doubt.

Business Update

It's been a while since I updated my blog, which is  a reflection on how busy we have been. There has been a lot going on.

Firstly, we have completed the 75% acquisition of Solaris Developments Limited from Stephen Spooner. The business has been renamed Recept Asset Management and Stephen and Cass have come on board as part of that acquisition. Recept AM retains the management of four large Solar PV sites in the UK and we will be looking to build on that expertise over the coming months. As Stephen said in his last blog, we expect to see more consolidation in the sector which will provide opportunities for us. 

We are also expanding the asset management business into commercial property more generally leveraging our expertise to acquire, sell manage and finance property on behalf of owners and occupiers. The existing business, which already manages significant amounts of client money provides a platform with the appropriate internal controls and compliance.

As well as asset management we will continue to use our consulting platform to advise investors on investment, development, finance and portfolio issues. At any one time, most CEO's have too many opportunities, and from time to time too many problems, to be effectively dealt with in-house;  that is where Recept can, and do, help.

In the last twelve months, we have, for various clients, raised bridging finance, provided independent expert advice, undertaken development management and provided lettings and sales advice. One particular project, on which we are still working, has been to troubleshoot the development and construction of a 5 Star boutique London hotel, which had suffered delays and cost overruns.

On top of all that, we have moved offices, our new premises were secured on excellent terms because we were able to use our commercial acumen to take advantage of a situation where a title defect rendered the premises virtually unlettable in the open market.

As ever, if you need any help, or just have questions, please give us a call.


Tesco & Sainsbury v. Asda & Morrisons

Asda has today announced that it will no longer roll out its petrol station convenience format. Coming close on the heels of the sale of M Local by Morrisons we now have a situation where two of the big four players (Tesco and Sainsbury) have a convenience store business and two don't (Asda and Morrisons).

The decision by each of Asda and Morrisons is driven by a desire to focus on the superstore format. With superstores still accounting for over 75% of grocery sales in the UK, that might seem like a logical decision. But is it the correct one?

The answer to that question is not yet known and although there are good arguments to be made about the cost and scale efficiencies of a superstore portfolio, that counts for little if shoppers go elsewhere; and recently shoppers have been drifting away to other formats and the internet.

What is clear is that there is now open water between the strategies of Tesco & Sainsbury when compared to Asda and Morrisons.




Morrisons- Not digging after all

Last week I wrote about the sale by Morrisons of its C stores to My Local. I suggested that this was a clever way for Morrisons to retain exposure in a capital-light manner by continuing to supply My Local on a 'franchise' basis.

Today, My Local have announced a billion pound five year supply agreement with Nisa, so I couldn't have got that more wrong!

This seems to me to be a missed opportunity for Morrisons, and something of a coup for Nisa in a business where scale is important. Without a supply agreement with My Local, Morrisons options in convenience may just have become even narrower.

That's not to say however that the direct operation v. franchise battle is not still raging; in fact it might just have intensified further.


Convenience Food - There are more ways than one of digging for money

In August I wrote about the potential sale of M Local by Morrisons. That sale has now been confirmed, 10 previously closed stores are reopening, and the business is being rebranded My Local - a great name by the way.

In its results announcement today, Morrisons said that

'Convenience remains an important growth channel, and we will continue to consider capital-light, returns-enhancing opportunities in the future.'

Back in August I also mentioned franchising as being a model that could work well for Morrisons. Using its integrated supply chain to better effect by supplying franchised convenience stores seems to make a lot of sense, and neatly fits the returns-enhancing, capital light opportunity that Morrisons is looking for.

In my view we will see the battle for a greater share of the convenience market fought on two fronts now, by direct opening of stores  by retailers; and by increasing use of franchising by national multiples to take market share from the symbol groups. Simply Food is well used to the franchise model and Tesco (using the One Stop fascia) is aiming to open over 180 franchised stores this financial year.

"There are more ways than one of digging for money."



Tesco Store Valuations

Hidden in the announcement yesterday by Tesco of the sale of Homeplus in Korea was  a statement about the use of proceeds that included Tesco's intention to

'consider value accretive opportunities across the group including the selective purchase of some existing leasehold stores in the UK.'

It will be interesting to see whether such a policy will provide a cap on Tesco superstore yields. Theoretically, that should be the case, but the important question is at what yield level purchases are accretive to Tesco - perhaps a case of watch this space.

Bridging Finance Mandate

In the middle of June, we were mandated by an existing client to raise bridging finance of up to £20 m. The loan was partly to refinance existing indebtedness and partly for general working capital. The time scales were tight with important contractual payments needing to be made at the end of August. With insufficient cash flow to meet interest payments any funding needed to provide for interest to roll-up until maturity.

Having approached a small number of potential lenders, we swiftly selected a preferred partner and worked closely with them to finalise loan terms. We provided the interface between the client and its lawyers as well as providing commercial advice on loan terms. We were able to negotiate a deferred drawing of part of the loan significantly reducing the interest cost.

The loan for an overall term of 20 months was completed and drawn last week, ahead of the client's deadline.

We added significant value to the transaction by reducing interest costs, securing a loan facility that was substantially better for our client than anticipated by its lawyers and by negotiating  to reduce other professional costs.

A full case study is available on request.


What would a sale by Morrisons mean to M Local?

Over the weekend, rumours surfaced that Morrisons have entered into negotiations to sell M Local to Greybull Capital. That is not altogether a surprise and I have been saying to potential investors in our new C store real estate fund that an exit was a possibility.

My view is, that in the hands of the right management, there is the core of a successful business here, with 150 stores and the distribution infrastructure to service them. There is a good brand in M Local and provided a mutually beneficial supply agreement can be negotiated as part of the sale I see no reason that a 'franchised' model cannot work both for the new owners and for Morrisons.

After all, It is not a new model in the sector, with SSP Group plc running many Simply Food stores and Tesco increasingly looking to the franchise model for new One Stop openings.

It makes sense for Morrisons to concentrate its capital spend on the core large store estate and to outsource the not inconsiderable capex needed to grow the convenience business. And growth will be key, with in my view at least a doubling of the store numbers needed to achieve critical mass. With each new C store costing up to £1m to convert and fit-out, that is a significant capital commitment.

Of course it is possible that the sale is merely a prelude to a wind-up, but don't bet on it. My guess is that Greybull have long term plans for the M Local business.


Selective Sunday trading reform fails to maximise benefits.........

and potentially puts new investment in retail at risk.

The government's 'Consultation on devolving Sunday trading rules' has been published this morning.

The paper quotes from a study that suggests that there could be a benefit of £1.4 billion a year from removing the existing restrictions across England and Wales. The consultation does not however suggest a blanket removal, but instead suggests that the power should be devolved to local areas. The actual financial benefit of the proposal is therefore largely unknown.

The first option suggested by the paper is that powers should be devolved 'to local leaders, for example metro mayors, through devolution deals.' 

It is unclear exactly who these leaders are, but current proposals for metro mayors appear to cover only large conurbations. Devolving powers in this way would appear on the face of it to leave the majority of England and Wales without a choice over Sunday opening hours and to be focussing the benefits towards towns and cities and away from rural areas.

The second option suggested is that powers should be devolved to local authorities.

In either option the devolved powers will be capable of being applied to specific zones and 'potentially exclude out of town supermarkets'.

It seems to us that there is a fundamental flaw in the thinking behind either of these options in that no consideration has been given to the effect of local boundaries and the effect that different approaches from different local authorities or leaders might have on transport, travel and road congestion.

For instance, if the Wiltshire local authority were to decide, broadly, not to relax Sunday opening hours but surrounding cities such as Swindon, Bristol, Southampton did then it is likely that significantly more journeys would be made over greater distances on Sundays than is currently the case.

We are not sure that would be beneficial.

As well as the transport issues there are site by site cost and value issues to contend with. If, as the consultation suggests, the benefit

 'is generated from lower prices as a result of increased efficiency from shops being able to make more use of existing stores' 

then it follows that stores that are able to open for longer on a Sunday will be more valuable to retailers. They will therefore theoretically be willing to pay a higher rent leading to a higher capital value. 

However if the restrictions can be added or removed at a local level can a retailer or landlord ever be certain about that enhanced value?

Although we accept that, to quote the consultation paper 'Extending Sunday trading hours would ..... support competition and drive economic growth' we take issue with the words 'across the country' that follow. In fact the proposed restrictions would benefit certain areas of the country and not others and rather than supporting competition would be more likely to skew it.

As it happens, we do not have a strong view as to whether the restrictions should be relaxed, but it does seem to us that, if there is an economic benefit to be gained which the government wishes to realise, then it would make sense to capture that for the whole of England and Wales and not just selected parts.

Buy to Let - A Reit relief?

George Osborne has announced that mortgage relief on buy to let will be restricted to the owner's basic rate of tax from 2017.

One of the effects of the changes could well be a reduction in the levels of gearing and thus an increase in the equity required to purchase a Buy to Let property. The ability to gear Buy to Let properties highly is one of its principal attractions when compared to other ownership structures.

Buy to Let mortgages have been available at 60% - 80% LTV with the best deals at the lower end of the range. If the best pricing were to fall to mortgages in the 50% range then returns from Buy to Let should theoretically at least, be closer to those achievable from a residential REIT.

Add in that a Reit would benefit from diversification and economies of scale, and the playing field starts to look more level.

Buy to Let Mortgage Relief

Rumours abound in the daily papers that George Osborne is set to reduce or remove the ability of buy to let landlords to offset interest costs against income.

If true, that could create a seismic shift in the market for residential property in the UK.

The details will be all important and we will have to wait and see if and how the change is implemented but landlords, banks, institutional investors, tenants and even home owners should be watching carefully, as all could be adversely affected.

Expect a further update from me later in the week.

Sunday Trading Reform - A mess waiting to happen

George Osborne is set to announce a consultation on changes to Sunday trading laws.

Apparently he intends to leave it local authorities to decide policy. That means, for example, that Dartford Council could allow Bluewater Shopping Centre to open for longer hours on Sunday whilst across the Thames, Thurrock Council could refuse to allow extended opening at Lakeside.

I can only imagine the employment difficulties that retailers would face with such a piecemeal policy.

What is easier to understand is that the ability to trade longer on Sunday in certain locations could improve the attractiveness of those locations to retailers which in turn could lead to higher rents and higher capital values.


New Property Fund

Over the next three weeks Stephen and I are road-showing to potential investors to raise equity for our first major real estate fund. Our aim is to raise £90 million of equity, to which we will add £60 million of debt to give a total initial capacity of £150 million.

After an initial investment period of about 18 months we expect to show a cash on cash return of c.7% with a target IRR in excess of 10%.

Investments will be made in a sector where Stephen and I have long experience.

This is an exciting next step in the evolution of Recept and I hope to be able to share more details with you in early September.

Professional Negligence Claim

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It is perhaps inevitable that the downturn has led to an increase in the incidence of negligence claims against valuers. In one high profile case last year the High Court found against Colliers in a claim worth €32 million.

Although not on that scale we took the first steps last week in a claim against a firm of valuers for an amount of nearly £2 million in respect of the valuation of an office building in Birmingham in 2010.

We hope to achieve a sensible financial settlement without resorting to litigation; however we have prepared the ground with lawyers and expert witnesses so that, if necessary, we can commence proceedings. We have taken detailed advice on issues such as the application of the statue of limitation, our duties to mitigate and how to quantify the amount of any loss.

Although we hope to settle by negotiation we have, of necessity, put aside a substantial fighting fund to meet the costs of the litigation. 

For now we are keeping silent about the identity of the valuer, but should we commence proceedings that will undoubtedly become public. Let us hope that this can yet be dealt with amicably, and out of the public eye, and without incurring unnecessary legal and other costs.

Tenancy Fees - Is Ed Miliband right?

Some years ago, before the financial crisis I can remember getting into a somewhat long and complicated debate about the fees charged by rating agencies to provide credit ratings to companies issuing bonds.

It seemed to me at the time to be wrong that the issuing companies paid those fees, rather than the investors who benefited (or not) from the ratings. I accepted that if investors were to pay then it was likely that the costs would in some way be passed back to the issuers, perhaps by way of pricing on the bonds, but the fact that the investors did not pay for the rating left a gap in accountability.

That gap in accountability was dramatically exposed by the financial crisis.

I found my thoughts drifting back to that debate today, when I read about Ed Miliband's latest proposals to address perceived problems in the residential lettings market.

There is of course much that many landlords, including me, will dislike or disagree with in those proposals; and I am sure (if they are ever enacted) that the law of unintended consequences is likely to come into play.

However, I find myself thinking that, in respect of the tenancy fees element of his comments that Mr Miliband is right. Letting agents are instructed by landlords and not by tenants and the agents' responsibility is to the landlords. It is clearly the landlords that gain the benefit from credit checks, inspections and other administration for which fees are commonly charged.

As with the rating agencies, I think that responsibility for fees should rest with the party who benefits from the service provided which, in the residential lettings market, is the landlord. Otherwise an accountability gap exists that could well contribute to problems that we have yet to fully foresee. Additionally as the landlord is not paying there is no 'market' control on the level of the fees. In most cases the tenant will have to just accept the charges, whereas if the landlord were paying he could compare total lettings costs much more easily.

Of course the tenant may ultimately bear the cost by way of an increase in rents, but if all lettings were undertaken on that basis then it would be easy for the tenant to compare different options.

There is no doubt in my mind that were such a control imposed, the additional costs charged by agents would fall dramatically over time leading to a better overall deal for both tenants and for landlords.


Tesco property values - Still not adding up

Tesco has today announced that, as part of its programme of rebuilding trust and transparency, it is providing 'increased disclosure, including additional details on property valuation and ownership'.

So what has Tesco told us?

It has told us that the estimated market value for its fully owned property was £22.9 bn. Note please that this is an estimate not an external valuation notwithstanding that Tesco later says that "This valuation represents an estimated surplus of £2.7 bn over the year-end net book value".

Tesco also tells us that the £22.9 bn represents a reduction of £7.6 bn year on year. By my calculation that is just short of a 25% reduction in value. That reduction is described by Tesco as 'driven mainly by a significant weakening of the UK retail property market....'

I'm fairly confident that the UK retail property market didn't fall by 25% last year nor did the supermarket sector. In respect of the latter, the latest figures (to 30th Sept 2014) from British Land showed its superstore portfolio growing by 3.1% year on year.

Notwithstanding Tesco's claim of improved transparency, it seems to me that something still does not add up.