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The U.K. retail crisis
By Tom Astle and Deborah Gregory
The U.K. retail industry has been particularly hit hard by the COVID-19 outbreak. Some retailers have been unable to pay rent and others have been placed in administration during the lockdown. Even before the pandemic, retail insolvencies were on the rise in the U.K. With landlords frequently being asked to compromise claims against their retail and casual dining tenants, via CVA or otherwise, the financial pressure experienced by the retail market is starting to be felt by the commercial real estate sector.
Changes in consumer habits, including the continued growth in online shopping, and other factors such as the increase of business rates, the rise of the minimum wage, and the political uncertainty related to Brexit have all contributed to the challenges faced by traditional retailers in the U.K. in recent years. The COVID-19 pandemic has exacerbated the challenges and is expected to create long lasting changes to the retail industry.
Distressed retailers have turned to formal rescue procedures to restructure their debts and obtain the breathing space needed to adapt to the changing trading environment. Increasingly, retailers are relying on company voluntary arrangements to close their unprofitable stores and secure significant rent reductions.
A CVA is a formal restructuring process that allows a company to make a proposal to its unsecured creditors to reduce and restructure certain unsecured debts. If approved by 75% in value of the creditors who vote, it will bind them all. A landlord presented with a CVA faces the difficult choice of either accepting the retailer’s proposal, which is likely to include a rent reduction, or rejecting it and facing the risk that the retailer ends up in a terminal insolvency process potentially with leases being handed back. Recently, affected landlords have started to challenge CVAs; however, such challenges have had varying degrees of success.
According to the Centre for Retail Research, 16,073 retail stores have closed in the U.K. in 2019, with 6,404 shops closing through administrations, 313 shops closing through CVAs, and a further 9,356 shops closing through cost-cutting programs initiated by retailers. The CRR estimates that as many as 20,000 shops could close in 2020 as a result of COVID-19.
It is difficult to measure the long term impact of the pandemic on the retail sector. The U.K. government has recently issued safety guidance to help retailers prepare for store re-openings. However, even once the lockdown has eased, social distancing measures will affect footfall, and other factors such as the ability for retailers to source goods internationally and customers spending generally will continue to negatively impact the industry.
In a domino effect, landlords and retail property investors are starting to feel the impact of the struggling retail market. Since the beginning of the lockdown, several commercial landlords have had no choice but to negotiate rent cuts or deferrals with their retail tenants. Many real estate investment trusts have seen a sharp drop in the valuation of their retail portfolios, some losing more than 20% in value, and have suspended future dividends.
While bricks-and-mortar shopping is unlikely to disappear completely in the U.K., landlords must move quickly and adapt in order to survive the changing demands of the retail industry. Landlords will have to re-think long term leases and be willing to negotiate and enter into more flexible arrangements. Property funds should review their exposure to retail assets and diversify their portfolios. Empty commercial retail spaces should also be repurposed to ensure profitability.
