Are shopping centre investments still lucrative on a long-term basis?

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Is there still money in shopping centres?News that the UK’s largest shopping centre owner, Liberty International, has seen a massive reduction in profitability and net asset value has brought into question the viability of the shopping centre property sector going forward. For the nine months to September 2008 the company reported a loss of £1.1 billion and a reduction in property values in the region to 12%. However it was the larger than expected reduction in rental growth which has spooked the stock market and seen the shares fall back sharply.

It was reported that like-for-like rental growth was -3.4% during the period and the company saw 78 units (31 tenants in total) going to administration and effectively ceased trading. Even though the company announced that 44 of these units have since found new tenants or are currently under offer many believe it is unlikely that rents have been replaced on a like-for-like basis. As the economy continues to shrink there are sure to be further casualties in the retail market and more of these units will probably see new tenants on substantially lower rental figures.

While shopping centres have been one of the best performing commercial property of recent times there are concerns that the sector may well be holed below the waterline and struggle to bounce back as quickly as others.  It is interesting to see how shopping centres have increased in popularity in the property market and we hereby list a number of pros and cons regarding this particular type of asset.

There are a number of issues to consider which include:-

Substantial income streams

While rental charges will vary from shopping centre to shopping centre some of the larger project literally bringing tens if not hundreds of millions of pounds a year in rental income. While a portion of this will go towards the upkeep of the development and some will be used to pay off debts, these particular assets have proved very lucrative and seen substantial growth in net asset values over the years. We have seen such developments as the Trafford Centre in Manchester, which is owned by Peel Holdings, valued in the region of £1 billion. This was a project created from scratch and developed on what was at the time wasteland and therefore attracted very limited conflict with local businesses and local communities.

Sell on value

Many property companies are happy to take risks at the beginning of large-scale shopping centre projects as they know if the project is even remotely successful there is likely to be a significant uplift in the asset value of the development and income streams should increase from day one. The trick to any shopping centre success is the need to attract big names at the beginning with many project managers happy to offer rent-free periods and certain bonuses for joining the project.

A big headline name will not only attract other big headline names but it will also see a number of smaller retail companies sign up which gives the modern day shopping centre a feel of both new and old, fashionable and traditional. It is vital to get the mix correct as this is what attracts the attention of shoppers and the more target groups you can bring into the centre the more income for all involved. There is also the added bonus of being able to borrow against an asset which has increased in value which can also lead to funding for future projects and has seen some of the smallest UK property companies on the market mushroom into some of the major companies which we see today.

Government funding

As with any development which has the potential to benefit not only the local community, local business and local consumers there are very often advantageous funding terms available from the various local authorities and governments throughout the world. From the point of view of the authorities, a successful large-scale shopping development has the potential to not only increase employment in the area, but also create a significant uplift in council tax income, corporate tax income and visitors to the region. These four elements together offer a very potent mix and can literally change a depressed, downbeat area into a vibrant new business hub and local community.

The economy

As we are seeing today, the economy has both a positive and negative impact on shopping centres around the world in that they are in effect a barometer of both the local and national economies and as such their prospects will vary in line with the economic climate.  As we have seen over the last few months many retail companies have found financial hardship with a number going out of business which has ultimately affected the rental income and asset values of these often massive shopping centre complexes.

Debt

Many property companies are built upon debt whereby their assets have been used as collateral to obtain the necessary funding required for the future. In an economic slowdown not only do we see reduced rental income, which reduces the amount of money available for debt reduction, but we also see many property companies breaking their banking covenants which are often based upon the asset value of their properties. In the good times the income flow can be very strong and asset values should grow on a long-term basis, but once the economy turns so we see these two elements disappear and turn downwards.

Conclusion

If ever there was an industry which was a reflection of the local and national economy than the retail shopping centre development sector is the one. In the good times it looks very easy to make money whereas in the bad times when economies shrink and activity falls, the sector can be literally friendless. What can appear to be very strong positions on paper can literally turn around in just a few short months and when banking covenants are threatened many companies seem unable to escape the final and often ultimate consequence of administration.

In truth there is an awful lot of skill associated with the retail shopping development sector, knowing when to build, and where to build and what to charge. Then we have the overall picture of the local and national economies which can also have a major impact upon the potential profitability and prosperity of any development.

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