For Unibail, supporting tenants will stop short of buying retailers. Fellow retail giant Simon Property has bought retailers including Aeropostale, and it was reported to be in talks to buy department store company JCPenney alongside Brookfield. “I’m not a fan of that model,” Tonckens said. “As a landlord, I’m partnering with retailers. The moment I acquire a retailer, and run it for my P&L [profits and loss], I wouldn’t be surprised if a retailer turned around and said, who are you? Are you a competitor, or are you a landlord? At the right price I’m sure money can be made, but you’re starting to see some skepticism in the market about whether this is something being done from a position of strength, or of weakness, because you have to protect the income. The jury is out, but [Brookfield Asset Management CEO] Bruce Flatt, [Brookfield Property CEO] Brian Kingston and [Simon Property CEO] David Simon are incredibly smart, so I’m sure they’ll find a way to make money from it.” Tonckens said Unibail has been thinking ahead about how to use stores where tenants are likely to go bust or to vacate space. For example, a Debenhams department store in London has been converted into a pop-up store for famous department store Harrods, as well as click-and-collect space for all of the retailers in the mall.
The pandemic has accelerated trends that were already playing out in retail, rather than heralding fundamental changes, Tonckens said — what might have taken three or four years to play out will now happen in a year or so. So the process of transforming assets that have been pure retail schemes into mixed-use assets will have to be brought forward. A big part of this will revolve around department stores, which are struggling on both sides of the Atlantic, and leaving big chunks of unoccupied space in malls. It is becoming increasingly clear these spaces won’t be taken up by new retailers, so alternative uses need to be found. These conversions take time and money, but can be very good for returns if you get them right. “Department stores in the UK and U.S. have been on the bubble for some time, and we expect this crisis to pop a few more of these bubbles. But if you think about the U.S. approach to department stores in particular, these stores pay very little or no rent for large spaces. They used to be a reason for people to come to the mall, but their drawing power has clearly gone away; if that wasn’t the case, they wouldn’t be in financial trouble. And they don’t pay rent. “So now you have an opportunity to rethink the principle — you can convert these boxes into mixed-use, so that could be offices, hotel. There’s a lot of talk about resi but not many people want to live on top of a shopping centre. But there is a need for people to congregate in places like offices. It costs money to convert, but there is also a significant return to be made, because if you’re getting paid very little rent and then you mark to market what an office occupier would pay, or a hotel, it is many multiples higher, and that allows you to shrink the space dedicated to retail.” In some cases converting department stores to residential will be feasible: that is Unibail’s plan at the Westfield Montgomery mall in Montgomery County, Maryland. A former Sears store is being converted to residential, and the company is working with the city to formulate a zoning plan that will allow for a new school to be built. In general, the days of the big-box, covered mall that is led by retail appear to be over. The company has taken more than $4B of assets out of its development pipeline in the last year so it can go back to the drawing board and reconfigure schemes. That includes major projects in Croydon, south London and Milan, Italy, where retail-led schemes of 2M SF or more were envisaged.
“We were lucky rather than inspired on Croydon,” Tonckens said. “If you think about the way that retail is in the UK today, another Westfield London-sized box is not going to generate the returns that would warrant putting up that kind of capital. So we are working with the city to reconfigure it. There will be retail, but it will be much more mixed-use. We were lucky that we hadn’t fully signed the contracts to start building it yet. “In future, yes we will be a regeneration specialist. Historically real estate has been seen as a static element, but it is living and breathing and responds to its environment. There is money to be made in creating places that respond to an environment. And so you develop that skill set.” Stephenson said this strategy has a positive capital market implication for retail. Investors might be interested in the discrete office element or hotel element of a larger mixed-use scheme, which can be sold off in a phased way to either fund further development or bring in outside capital. Tonckens said that in markets like the U.S. and UK, private equity firms are likely to be the only buyers of marginally profitable retail assets that need major redevelopment, and will only come in to the market when prices are at rock bottom. But he said it is possible to get deals across the line at reasonable prices with more institutional investors for good assets. Unibail recently completed a deal to sell 55% of a €2B portfolio of French malls to a group of French insurance companies. The deal was commenced before the coronavirus but completed in May — it just took some creativity.
“We did want to transact as partners, so we did make some marginal arrangements to help give comfort to the investors that the original IRRs [internal rates of return] that they had underwritten would be achievable,” Toncklens said. “So we have given a €45M rental guarantee over a five-year period. So if the money is lost in year one, that’s it, it’s gone, but given we own 45% of the JV, the impact to us is €24M. So not a significant amount of money. That amounted to 2% of overall price, but it gives comfort. The 2% was not as important of putting down a marker and showing we could get a deal done in this market.” Tonckens added that for conventional retail assets, debt is hard to find, making it more difficult to get deals done at anything other than those rock-bottom prices. But when it comes to buying assets for conversion from retail, lenders are there. “If you have a good plan you’re going to be able to get money for it. You will get money to tear down a mall and put something else up. It’s a construction loan, but there is money for that. There is a need for the product, be that resi, logistics or office, there is going to be money for that.” The company is selling a mall in Long Island, New York, that will be converted into logistics. “We don’t have the expertise in logistics, so we are selling it, but it is going to become logistics. We’re selling at a price that is very appealing to us.” The pandemic was a shock to retail’s system, just when it was looking for a period of stability. But it has the chance to hasten changes that would have been happening anyway, bringing forward a purge that was very much required, if retail real estate is to have a brighter future.