The Paradox of Covenant Strength by James Andrews

20th December 2018

The Paradox of Covenant Strength by James Andrews

Has the game changed fundamentally in what constitutes a successful and stable tenant?


Going back to the start of my career and until only the recent past, the traditional thinking was that biggest was best. The more shops the retailer had, the more desirable they were as an investment, offering generally long leases and all the covenants and security of the traditional institutional investor. The concept that the same brand could occupy individual shops under individual limited companies was anathema to investors – it constituted no security – so choose someone who is big.


Consider the same thinking now - in the wake of a continued and dramatic range of corporate failures – many of which were perceived as being ‘stable’. Since 2007 there have been over 450 corporate failures of identifiable multiple brands involving over 33,500 stores number of shops and 325,000 jobs. Would this situation have been quite so dramatic had companies paid more attention to their brand, customer and the service they were offering, plus an ability to deal with ‘the bad apples in the barrel’. Success and shopper appeal no longer equate to growing turnover via increased floor space, thereby saddling the operator with inflexible lease liabilities all funded by debt. The failed private equity backed businesses of the last 5 years are a testament to this model!  


Whilst the fundamental shift in shopping patterns cannot be denied, part of this is the public's reaction to the clone town. Whilst we are living with this legacy now, the accusation has been with us for well past the last 15 years at least. The formula employed by developers and owners has to evolve.


With the supply and demand imbalance now weighted against landlords in some places, the CVA issue is arguably twofold: need and ability. There is little disincentive for retailers to deploy a corporate restructure – CVA or prepack Administration because landlords are finding it more difficult to say no. Gladly in some instances there’s an acknowledgement that brands can be successful on different financial terms and this needs to move through the market, if we are to stave off further corporate failure or manipulation, vacancy and a sad loss of employment prospects. 


In the large store market in particular, landlords have spent millions configuring large stores for a market of less than 20 tenants and today, less than 10. The leverage exerted by such brands to maintain occupancy as quasi anchor tenants is also considerable, given the cost of reconversion back to more unitised space. With significant investment required by landlords to open such stores with little or no reciprocal security offered by a long lease, the ‘investment value’ offered by these brands is worth very little in economic terms. Yes, they continue to provide quasi anchor tenancies but with their products increasingly available online, a once ‘special draw’ and catalyst to further retail adjacency is much watered-down.


Similarly, with the ultimate big ‘covenants’, Anchor stores – are these now performing a more literal function when vacant: a deadweight preventing progress in any direction. Dangerous times and the bigger they are the harder they fall! The ripples caused by the failure of BHS and House of Fraser will haunt many locations for a generation. 


As we have progressed from the nineties through the noughties, the favourite Landlord question of what size product to develop grew and grew from 2,000 to 5,000 to 20,000 square feet. Have we gone full circle? Now the answer seems more like 500 - 2,000 square feet to accommodate niche brands and a mix of local retailers at small, affordable quantum’s of rent - offering more in terms of character to the old school line up. Small businesses, family businesses and regional privately-owned chains arguably have a greater stake than other models. But of course, there is a place for both. The need for the local hairdresser butcher or grocer to turn the lights on every day is arguably greater than whether a percentage of a portfolio is pushed to the brink. 


Maybe a focus on individual store profitability and accountability is where we are headed.


So, what will take the place of the clones? Are we ‘Back to the Future’?


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