Europe’s retailing-focused commercial real estate sector faces a multi-layered COVID-19 crisis, one which may have only a modest impact on credit quality in the short term. However, consequences would be more severe in case a future recovery falters.
Scope Ratings says the slowdown induced by COVID-19 in Europe has put retail tenants and landlords under exceptional pressure. Disruptions to supply chains and the forced closure of significant commercial activity under region-wide lockdowns have drastically reduced revenue, sometimes to zero, for businesses that are still expected to pay rent.
“These are extraordinary times for retail real estate, but it is worth remembering that, ultimately, landlords and tenants are in the same boat,” says Philipp Wass, an analyst at Scope.
Short-term impact
Landlords are under pressure from tenants to help provide some relief to accompany the enormous monetary and fiscal support that central banks and governments have announced to cushion the economic impact of the pandemic, says Wass. Wass cites examples across Europe of large retailers – H&M, HEMA, JD Sports, Primark – which have stopped paying rent or entered rental renegotiations. Intu Properties, which owns 17 shopping centres in the UK and Spain, received just 29% of rents for April.
The proportion of rents linked to tenants’ sales revenues is relatively low – below 10% for companies covered by Scope – so credit quality and tenants’ payment behaviour determine the impact on landlords’ toplines.
“We assume rental income (excluding deferrals) in 2020 will shrink by 20-30% on a comparable basis for the sector,” says Wass. However, the impact will be much smaller on landlords whose tenants include a significant proportion of essential retail businesses such as supermarkets, other food shops and pharmacies.
“The investment-grade real estate firms that we follow have adequate liquidity to absorb shortfalls in revenues in the form of available cash and credit lines – typically more than 1x of gross debt due in the next 12 months – in addition to headroom on banking covenants and relatively high-interest cover,”
“Temporary weakness in cash flows will not trigger downgrades for most companies we cover,” says Wass.
Another consequence of the health crisis is the shutdown of the real estate market. “We expect low or zero transaction volume in Q2, resulting in relatively stable asset values,” says Wass. “Portfolio revaluations will happen only with a lag – the impact on loan-to-value ratios will be in H2 when the property market opens up.”
Medium- to long-term impact
The longer-term consequences for the retailing real-estate sector are considerable even if Europe’s recession is relatively short-lived and the recovery swift – both are far from certain at this stage. “The pandemic will speed up the transformation of Europe’s retail landscape, with an accelerated decline in demand for the retail space as the health crisis gives an extra boost for e-commerce, particularly for non-essential retail and prepared food.”
Yields on the retail property will rise, with little or no growth in property values. Property values are likely to fall faster than cash flow declines, particularly for companies with relatively poorly positioned portfolios, resulting in increased leverage ratios.
“We foresee weakening credit quality across the sector in the medium-term, leaving very few corporates fully untouched,” says Wass.
Industry response to the crisis
Large-scale monetary and fiscal stimulus in Europe – from liquidity support, state guarantees and deferrals of tax payments – and the removal or lowering of countercyclical capital buffers on bank balance sheets will help banks provide extra lending to retailers and real estate owners.
“Real estate corporates are temporarily easing payment terms for retailers, either shifting to monthly payments in arrears from quarterly in advance – and/or offering temporary rent reductions in return for prolonging rental contracts for periods of reduced rent,” says Wass. Landlords are scaling back on discretionary spending – including on non-essential capital expenditure, and dividend payments as Unibail-Rodamco-Westfield have done – and cutting non-staff expenses to reduce service charges and pass savings on to tenants.
“Conserving cash is the priority,” says Wass.
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