This should continue to gradually filter into rental values, the ratings agency says. Fitch has reviewed CVA documents agreed for four major tenants in the restaurant, fashion, and department store sectors, which collectively occupied more than 1,500 stores at the time of their CVAs. The analysis shows that while CVAs can help tenants walk away from specific leases on stores which they consider unviable, this is the preferred option for a relatively small proportion of stores in their rented portfolios compared with those subject to rent reductions.
Landlords can claim back and re-let stores, typically within 6-12 months of CVA approval, rather than accept the reduced rent, explains Fitch, adding, in theory, this redress should prevent CVA tenants from demanding rents materially lower than market levels in stores where they want to keep trading. If so, rent reductions in the CVA documents reviewed, which regularly show discounting of 25%-50% and sometimes 50%-70%, might imply that market rents are falling very sharply across UK retail properties, not just in secondary locations.
In its report, entitled CVAs Are Transmitting UK Retail Stress to Prime Regional Shopping Centres, Fitch wrote:
“This would be a very credit-negative development, but updated valuation reports for the four shopping centres in Fitch-rated UK CMBS do not suggest rental value declines comparable with average CVA discounts, while data from Cushman & Wakefield point to two years of rental stagnation rather than outright falls in the relevant dominant regional shopping centre sector.
“In practice, landlords without a replacement tenant lined up may prefer the certainty of belowmarket CVA rent to the uncertainty of finding a tenant willing to pay market rent. CVA Discounts May Overstate the Pressure on Individual Locations While external valuers are cautious about factoring CVA discounts into broader ERV, rising rental yields imply investors are preparing for income declines even in prime regional shopping centres.”
Intu recently said it expects further rental income declines in its portfolio in 2019 and 2020. So far, CVAs have mainly affected landlords directly through the affected leases, says Fitch, adding CVA outcomes are a leading indicator of pressures in the occupational market as the knock-on effects of retailer debt restructuring on the wider property market start to be felt.
“Our analysis of the four CVAs does not find correlation between CVA discounts and variables that we consider drivers of, or proxies for, changes in rental value, such as local economic output, employment, and average earnings. Instead, CVA outcomes appear to depend chiefly on the identity of the retailer. The analysis suffers from not having visibility on pre-CVA store rent against which a given discount is expressed. Still, a lack of geographic clustering of similar rental reductions suggests that a given discount is determined mainly by how well the CVA company can operate from that particular store, rather than by how alternative tenants might fare.”