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The Only Investor To Buy A Shopping Centre This Year Explains Why It Took The Plunge

There has essentially only been one proper shopping centre deal in the UK this year. One.

A couple of small development opportunities changed hands in Q1. But Cale Street’s purchase of a 50% stake in Intu Derby for £186M in April is basically the only game in town for the moribund sector.

Investors have steered clear because of the uncertainty over rental income created by the regular flow of tenant administrations and company voluntary agreements. Just this week, restaurant chain Jamie’s Italian went into administration, closing 20 stores, and M&S indicated it could close up to 150 stores over the next few years. If you don’t know what the income for a centre is going to be, it is very hard to work out what you should pay for it.

Intu Derby

So what made Cale Street invest where others fear to tread? Cale Street founding partner Wilson Lee explained the firm’s thinking at Bisnow's London Capital Markets Review event. It came down to careful underwriting, creative deal structuring, lack of competition and an acceptance that investors in retail are going to have to change their lazy ways, he said.

Cale Street is an independent investment firm that principally invests on behalf of the Kuwait Investment Authority, the fund that manages the Gulf state’s oil wealth. As such, it considers itself a “rifle shot” investor that looks to do a small number of large deals. It can provide funds across the capital stack, from joint-venture equity, to preferred equity, mezzanine debt or senior debt.

Its deal with Intu saw it take a 50% stake in a 1.3M SF centre with net rental income of £25M in a deal that represented a net initial yield of 6.6%.

“It’s a 1M SF, dominant centre, not a well-known town and not a flashy centre but it is very well occupied, with some good tenants, the tenants are happy and occupancy costs are low,” Lee said. “For instance the recent CVA of Debenhams — one of our anchor stores is Debenhams — that store was categorised as a class one store, which means the rent stays where it is. And we underwrote that, believe me, we looked at this deal many times and said, why are we buying retail right now, why are we buying a centre with a Debenhams when they are clearly in trouble? So you need to underwrite very carefully, and you need to have the right partner that is going to manage the centre well.”

Lee said because of that uncertainty, there was less competition for the deal, and the yield looked good when compared not just with historical retail values, which could fall further, but compared with other asset classes.

Cale Street's Wilson Lee

“There will be more tenant defaults and centres shutting down so you have to be cautious, but I don’t believe it's a complete no-fly zone, and right now a lot of people are staying away from it, which means there are more opportunities,” he said. “Right now in commercial real estate most asset classes are trading at an all-time high, and retail is one of the ones that isn’t, so you can get a little bit more yield, and for the right asset you can make it work.”

There is also the fact that Intu is, to use the innuendo beloved in property, a motivated seller. Last year Brookfield pulled out of a takeover deal for the company at a price of 210p a share, and today the company’s shares trade at 97p. It needs to sell assets to reduce debt levels.

The structure of the deal is interesting, and is something that other listed companies may look at in order to sell assets.

“This structured equity transaction includes a prioritisation waterfall for distributions to the joint venture partners,” Intu said at the time of the deal. Decoded, that means the income Cale Street receives is protected: Even if it drops, Cale Street gets a guaranteed income payment before Intu.

“We like to think of ourselves as a creative investor which can provide solutions for great sponsors,” Lee said. “Every REIT that owns shopping centres is having balance sheet issues right now, with the share prices right  down, there are ways that we can be creative to help that.”

Lee said the investment is an assertion that retail, and well-operated regional shopping centres, are not dead. They have just been badly run.

“Retail is going through a lot of changes, but certainly in the UK, landlords and lenders have been complacent for years,” he said. “They’ve had 25-year leases with upwards-only rent reviews forever. Both institutional investors and lenders have been happy to just sit on the asset and clip the coupon and just let things run their course.”

Bisnow's Mike Phillips, Blackstone's Samir Amichi, Cale Street's Wilson Lee, KKR's Seb D’Avanzo, EQT's Rob Rackind, Hines' Alex Knapp

“That’s unique to this country, that’s not how the rest of the world operates in retail anyway. You need to be in partnership with retailers and manage your asset actively. You’ve always had to do that, now you have to do that even more. The norm now for any good tenant will be a 10-year lease with a five-year break, which means you have the opportunity to reposition your centre and tenants whenever it’s not working. But that means as a landlord you have an obligation to create a space that works for retailer and shoppers.”

That means changing the focus of centres. But outside of London, where the heart of communities has often been ripped out by the demise of high streets, well-run centres can serve a social purpose.

“In London there are great high streets all over the city and you can shop anywhere but in a lot of towns across the country you don’t have that, and so a large enclosed shopping centre becomes the town centre and the gathering place where you go to do anything you need to do, be it the post office, the health club or the creche for the kids,” Lee said.

“If you're going to own a large shopping centre, you need to think about what you’re going to create in the future, not what you’ve done in the past. I don’t believe in the demise of retail: Retailers are struggling because of the cost of goods, the cost of labour, but it just means you need to convert retail to other uses. People still want to gather, touch things, eat, go to a movie. There are plenty of shopping centres that can and will be bulldozed, but shopping centres aren’t dead.”

It remains to be seen whether other investors will share Cale Street’s philosophy. For a start, not every investor has the ability to undertake innovative structured transactions like this. And interest might not be there for the kind of smaller centres that are beginning to default on loans. But it is heartening that there are some investors willing to invest in the sector.