External valuations of retail properties are unreliable. Our models indicate considerably lower prices and therefore much higher debt ratios, says real estate specialist of Egbert Nijmeijer of Kempen Capital Management.
Retail property has been hit hard by the coronavirus crisis. Nevertheless, external surveyors were remarkably lenient in their half-yearly valuations. For example, for Eurocommercial Properties and Klépierre, which operate comparable medium-sized shopping centres in Europe, the downward revaluation was limited to just under 3%.
‘We simply do not believe the valuation of retail property portfolios,’ says Egbert Nijmeijer (photo) , manager of the Kempen European Property Fund, in an interview. In order to determine the real estate value independently, the Kempen real estate team estimates the quality of shopping centres, office buildings and other real estate properties worldwide. This provides a unique database of around 25 million data points, says Nijmeijer.
‘Our valuations can deviate significantly from the supposed value. In retail property in particular, we are much more cautious than surveyors.’ Because there are hardly any transactions at the moment, surveyors take initial yields from two or three years ago as their starting point, according to Nijmeijer. ‘That is completely unrealistic. We use initial yields of 5.0% to 6.0% for shopping centre portfolios, which reduces valuations by 30 to 40%.’
Tempting discounts
This also has consequences for the debt ratio. Most retail funds report loan-to-value (LTV) ratios of 40-45%. However, according to Nijmeijer, the actual LTVs are already close to 60%, the current maximum debt ratio in many bank covenants. ‘That is why we saw the bankruptcy filing of the British shopping centre investor Intu and Hammerson’s rights issue approaching well in advance. Unibail-Rodamco’s rights issue does not come as a surprise to us either. In our models, they are already almost violating the bank covenants. I am not assuming that Unibail will write off 30% of its portfolio in the short term, but over a period of ten years that is indeed a realistic scenario.’
According to Nijmeijer, industry peers are in the same situation and will also have to strengthen their balance sheets. ‘Asset sales may help, but they are now difficult to carry out. The management will have to accept substantial discounts on the surveyed value. Then there is a good chance that the entire portfolio will be written down accordingly and that on balance the LTV will not go down.’
On the basis of the net asset values calculated by Kempen, European retail property funds trade at a discount of 44%. Nijmeijer: ‘The discounts are very tempting. But the financial position of a number of retail property funds is so bad that they are value traps.’
Convenience shopping centres
It was not only the coronavirus crisis that got retail property into trouble. With an ageing population, e-commerce, too many square metres of shops and unsustainable rent levels, the sector has been in a ‘perfect storm’ for some time now, Nijmeijer believes. Nevertheless, he believes in the future of retail properties. However, he sees a structural recovery only after redevelopment of existing shops into other functions and substantial rent reductions. ‘Cash flow is down by a quarter this year. In 2022 a recovery may occur. However, rents will no longer return to pre-corona levels and will be permanently 15% lower.’
The Kempen European Property Fund still owns shares in the French shopping centre operator Klépierre. In addition, Unibail-Rodamco, Deutsche Euroshop and Mercialys are on the team’s radar but Nijmeijer is waiting for a better entry moment. He is particularly interested in convenience shopping centres. ‘Garden centres, DIY shops, supermarkets and other shops for daily groceries are doing well and are able to pay rents.’
Smaller, flexible offices
In addition to rental flats and storage space for private individuals, the real estate specialist currently sees most opportunities in the office market. Offices have a weight of approximately 30% in the portfolio and are being overweight by 6.3 % compared to the benchmark. In all European countries, offices have been hit hard by the coronavirus crisis as employees are working from home in numbers and prefer to avoid public transport. This is reflected in the low valuation of European office funds, which, according to Kempen’s internal calculations, are 25% below net asset value.
Even if there is a vaccine next year, employees will probably not be eager to go back to large offices in central locations until 2022. ‘Not everyone will want to be vaccinated and it remains to be seen how effective a corona vaccine will be.’ Companies will respond to this, Nijmeijer thinks, by relocating part of their office space to central areas.
That is why for the time being he prefers smaller offices on the outskirts of large cities. As an example, the fund manager mentions Germany’s Alstria Office, which is located in cities such as Stuttgart, Frankfurt and Hamburg. Nijmeijer also finds the British flexible office landlord Workspace attractive. ‘In these uncertain times, companies want to be flexible. What’s more, Workspace is in the right locations in London outside the city centre areas. With a 40% discount on the intrinsic value, the stock is far too cheap.’
Since the start date of the current investment strategy in 2012, the fund has achieved an average annual return of 11%. The current dividend yield of the fund is 3.5%. ‘Our current long-term return expectation is 6% per annum for our European strategy’, says Nijmeijer.