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The Next Problem For Retail Real Estate: Banks Don’t Want To Lend To It

Stretford, Greater Manchester

The stream of bad news from physical retailers in 2018 is having a knock-on effect for the retail real estate sector, which now has a new problem to deal with: Lenders are increasingly unwilling to lend to retail.

According to Nicole Lux, who compiles the seminal Cass Commercial Real Estate Lending Report each year, the sharp rise in retailers looking to close stores or cut rents is having a pronounced chilling effect on lenders.

“Lenders already commented in the last Cass Lending survey that they are not willing to lend to regional or secondary shopping centres or high street retail property in a regional city. Especially, a shopping centre where there is already more than 15% vacant retail spaces is quickly going to deteriorate further in value,” Lux said.

Lux told Bisnow that only 15 to 20 of the 80 lenders Cass surveyed are willing to lend to regional or secondary shopping centres or high street retail, and in some cases this would be simply refinancing their existing loans rather than writing new business.

The total amount of lending to retail has been falling since the financial crisis, falling from £55B in 2007 to £25B in 2017, a reduction of £3B a year. That is falling faster than other sectors, leaving retail as a smaller piece of the debt pie — the proportion of overall U.K. real estate debt secured against retail assets fell from 26% in 2007 to 19% in 2017.


About one-third is held by U.K. clearing banks and maturing within the next five years.

“German banks have traditionally liked this asset class, but are mostly expected to hold super prime,” Lux said. “However, the House of Fraser store in Oxford Street shutting down and reducing rents is an example of something that would typically have been considered super prime. I think the shock is that it is also affecting prime retail names. Food retail was considered safe, but even the credit quality of Sainsbury is at best BBB, other retailers are BBB to BB and rents are suffering in their large store formats.”

Lux explained that the rationale for banks' withdrawal from the sector was about regulatory factors as well as the general problems on the high street.

“Aside from dealing with insolvency and potential loan payment issues, the biggest impact will come from the deterioration of credit of these big retail names and reductions on leases, which will lead to a ratings decline under weaker slotting of these loans which means an increase in risk capital from 70% to 250%. This will make the loan more costly for the bank.”

Slotting is the regulatory system introduced after the financial crisis which means banks have to categorise their loans according to how risky they are. Because the credit quality of retailers is getting worse, retail property loans get a lower score, and banks have to put more capital aside to insure against potential future losses, making lending to retail less profitable — according to Lux’s calculations, almost four times less profitable.

The group hardest hit by this will be the mainly U.S. private equity funds who snapped up £3B of secondary retail assets from banks and fund managers between 2012 and 2016. The majority of those assets remain unsold, with few buyers in the market, and now refinancing is becoming increasingly challenging.

“Of course for some investors, these will be investment opportunities, but turnaround strategies are highly risky and investors should question their fund managers’ capabilities before investing," Lux said.