Investment funds reduce exposure to high street property

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Bricks and mortar on the high street has seen a massive shift by UK property funds as they drastically cut their exposure when the Covid-19 pandemic took hold. Lock-down closures and the shift to on-line sales and deliveries have taken their toll on retail rental incomes and rapidly falling asset values.

Property fund managers with direct investments in retail stores have had to renegotiate rents downwards to help tenants survive, while at the same time accelerating their divestment strategy, moving away from the sector, which was already facing long-term decline, even before Covid hit.

According to the FT, there is an estimated £6.4bn of rent arrears in the UK retail sector, and with a ban on commercial property evictions now in place until March next year, much of the arrears is unlikely to be recovered.

According to investment consultants and fund managers FE fundinfo, UK Direct Property has reduced their exposure to retail property during 2021, with average allocation now at 5.9%, down from almost 9% in January 2021.

The £1.2bn AUM M&G Property Portfolio has reduced its exposure from from 38.4% to 29.1% as fund manager Justin Upton explains:

“With retail sales exchanged and currently in solicitors’ hands this is due to reduce even further to around 21% in line with the fund’s strategy.

“We have made strategic sales, which have focused on asset risk such as age/location/sustainability and where we had tenant concerns such as covenant strength, lease length or vacancy.

“These sales have subsequently resulted in our vacancy levels falling to 7.7% as of June 2021 – well below the peer average of 12.9%. Our average lease length has also extended to 7.7 years.”

Similarly, head of UK property at Canada Life Asset Management (CLAM) Michael White said the firm’s retail exposure has fallen through “valuation reduction”, and it has “accelerated the strategy to reduce high street exposure where we are able to do so”.

Arrangements for paying off rental debts have largely been left to tenants and landlords, and in some cases has led to bitter legal disputes.

White explained CLAM has been active in this respect by “negotiating lease re-gears, rent concessions and deferrals on a case-by-case basis”.

He added that while this “has proven to be successful”, there remain “certain parties who still refuse to discuss arrears”.

M&G’s Upton also reported “constant dialogue” with tenants over the last 18 months, negotiating “a variety of payment plans” ranging from deferment packages to rent free packages in exchange for longer terms and lease extensions.

The result of this has been M&G Property Portfolio collecting “more than 90%” of both rental income and service charges for 2020, according to Upton, with the fund delivering an income distribution of 4.7%.

Coronavirus has caused significant disruption for bricks and mortar retail, but the sector also faces the longer-term existential threat posed by the boom in online retail.

As a result, property funds managers have been actively reallocating capital away from bricks and mortar retail to online competitors, with assets like warehouses becoming an increasingly attractive investment.

Fund manager and co-head of institutional UK real estate at Columbia Threadneedle James Coke explained in March: “Within the MSCI UK Property Monthly index, net disinvestment from retail has totalled £3.6bn over the past five years, averaging £60m a month.

“As sales proceeds are redeployed into the industrial sector, its market share – and hence performance contribution – has increased, to the extent it now accounts for 37.3% of the index.”

He said “the migration of retail online”, which been accelerated by the pandemic, has “dramatically impacted many town centres but left a nationwide shortage of logistics space, leading to sustained increases in industrial rents and corresponding compression of yields in that sector as investors have piled-in to an asset class considered a safe haven”.

White said CLAM still favours “the out of town retail format”, but that “essential retail”, such as food and DIY, “remains a viable sector” for the fund.

He goes on: “the migration of retail online”, which been accelerated by the pandemic, has “dramatically impacted many town centres but left a nationwide shortage of logistics space, leading to sustained increases in industrial rents and corresponding compression of yields in that sector as investors have piled-in to an asset class considered a safe haven”.

While high street fashion continues to suffer, with the challenge of of online shopping and a current consumer spend aimed at experiences, such as restaurants and entertainment, fund managers are not giving up on the “out of town retail format” and they still favour “essential retail”, such as food and DIY, which remain “a viable sector” for these funds.

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