When leading property agency Savills predicted a fortnight ago that 40 per cent of developments in the planning stages could be scrapped or put on hold, it did nothing to ease the headache that many developers have been trying to shake off.
There has been a decade of high retailer demand and easy-to-secure funding, but now the global credit crunch has brought it all to an abrupt end. If Savills is right, the retail property industry could be on the brink of its most challenging era for many years.
The property boom came to a halt in 2007, and since the industry has faced a battering from a number of angles. The main blow has come in the form of the global credit crisis, which has hit property development particularly hard because of its dependence on debt to fund schemes. Add to this a wave of punitive Government legislation and increasingly demanding retail clients and the short-term picture becomes bleak – a fact reflected in falling share prices since last year among some of the biggest players.
So how are developers going to get through the downturn intact? The answer depends on who you talk to but, for many, where external funding is essential to get a scheme off the ground, the only option is to put the plans on hold.
According to Savills director of retail development Paul Wright, some of the more marginal schemes will inevitably be put on the back-burner. “Shopping centre space in the pipeline is estimated at between 50 million and 80 million sq ft [4.65 million and 7.45 million sq m] over the next five to seven years,” he says. “We believe in the current climate only the strongest schemes with secure funding will be realised, which means we estimate no more than 60 per cent of those schemes will proceed in their current form.”
Banks have gone from one extreme to another. In a matter of months credit has gone from being easy to come by to an elusive commodity and developers that rely on it to fund new schemes run the risk of being left out in the cold if a bank decides to suddenly withdraw its financing.
Sometimes the facts speak for themselves and the share performance charts of four of the UK’s biggest quoted property developers for the past five years make things clear (see above right). A year ago, things were still on the up after years of steady growth. But each company reached a peak in 2007, since when value has been falling off the share prices at a steep rate.
It is hardly the best time to be considering new developments and Wright says many that are already in their early stages could be shelved to cut costs. Developers have realised it is not in their interest to continue supplying a market which does not have the demand and, by holding off on new-builds in the short term, they can ensure that, once the economy begins to recover, demand will have bounced back.
The Savills Commercial Development Activity report published in March revealed increasing pessimism among developers and contractors about future growth. The report states: “Anecdotal evidence suggests that tougher lending requirements, as well as concerns about the outlook for the wider UK economy, were the reasons why developers expect a further drop in activity.”
“It’s getting a lot harder to borrow money and a lot of developments are being funded by debt,” says Lend Lease head of retail asset and fund management Peter Allwood. “Banks have become increasingly risk averse.”
One scheme that has been paused recently is Quay West, a joint venture between Henderson Global Investors and Invista Real Estate Investment Management in Hull. Construction on the£300 million retail-led scheme was due to start this year, but in March it was put back until 2010 while the developers review their plans. Schemes in Newport in Wales, Dumfries in Scotland and Chester in Cheshire, worth£600 million between them, have also been put on hold.
Other factors have exacerbated an already difficult situation. The main focus for frustration has been the reduced levels of empty property rate relief that came into effect on April 1. An unpopular move, this has created resentment throughout the industry at a time when many feel the Government should be attempting to lighten the load rather than adding to it.
A British Property Federation spokesman explains: “The Government is doing its best to apply the brakes in its own indiscriminate way. With the rising costs for the property industry resulting from the increasing requirements to demonstrate the environmental impacts of development plans and the legal requirement to produce Energy Performance Certificates [EPCs] on sale or lease of property, it would seem that the time is right for Government to give very serious attention to how it can help the property industry battle through the downturn.”
The benefit of facing tougher times is that it forces companies to sharpen up their act. This will certainly be the case for the landlords of shopping centres – particularly older centres that are becoming outdated rapidly. A sink-or-swim environment is likely to emerge but, as many have pointed out, this could be to the benefit of those who are able to up their game and good for the industry as a whole if some tired, older-format schemes are refurbished.
“Developers are competing for a smaller market share,” explains EC Harris head of commercial development Nick Cryer. “There is always a drive to make centres more marketable – the downturn has just accelerated this.”
According to Cryer there are three ways in which developers can entice retailers back to their schemes. Sustainability has become vitally important among retailers keen to improve their green credentials and landlords need to ensure their properties are up to scratch environmentally. This means being fully compliant with Government legislation such as EPCs and other self-imposed industry initiatives and working with retailers to improve the way both parties can help the environment.
Landlords will need to be more innovative in the technology they provide to drive value and reduce cost. And they will need to create schemes that attract tenants from a variety of sectors, including retail, leisure and residential.
This is all good news for retailers. As is another consequence of a tougher market: better lease deals. Where five years ago retailers were queuing up to take space, now landlords are having to be that little bit more accommodating to entice them in.
“The current market uncertainty is there for retailers to exploit,” says SA Law head of commercial property Terence Ritchie. “Obviously some tenants are more valuable than others, but I would expect even one-off sole-trader types to be able to get better deals than they did five years ago. It’s an ideal time to acquire stores on more flexible terms.”
Retailers can insist on better deals and developers should be more willing to provide them. Shorter leases, shorter break terms and turnover rent-based leases are all ways of attracting new tenants that developers will need to entertain. And now is not the time for adversarial lease negotiations, which many feel slow down the whole process unnecessarily.
Five years ago, the market was so buoyant that, according to Allwood, “you could have given a monkey£50 million and it would’ve made money for you. Things are much tougher now. At Bluewater in Kent a couple of years ago we’d say to a retailer: ‘These are the spaces we’ve got, yes or no?’ What we’re finding now is that retailers are saying they still want to come in, but on certain terms.”
Disagreements over abstruse points in a lease take time and cost money just when time and money are the two commodities both parties are unsure of. The key, according to Denton Wilde Sapte senior associate Nick Darby, is to get a deal agreed as soon as possible so a retailer can start trading and a landlord can start earning rent. “I think it’s sad that it is looked at in terms of who’s got the balance of power and who hasn’t. The less of an adversarial position retailers and developers can adopt, the better. There’s no point in either party setting out deals where the consequence is meeting after meeting. It costs everyone more money.”
The global credit crisis has thrown the market into a period of uncertainty and risk. The drying up of loans to retail developers poses a serious threat to the short-term development pipeline, and the pessimism that is rife in the industry reflects this. Landlords face a demanding few years as they struggle to attract tenants and wait for the pendulum to swing back, but when it does, the result could be a more level playing field between supply and demand.