Last month, high-street department store House of Fraser announced plans to close 31 of its 59 shops in the UK and Ireland as part of a company voluntary arrangement (CVA). While the fact that the UK high street is struggling will come as news to no one, the impact of this trend on the landlords who own buildings on the high street is less widely discussed.
When businesses are struggling, one option is to try to agree a CVA with their creditors. This could involve repaying debts at a reduced level, or over a longer time period than initially agreed, or both. The CVA sets out the likely financial implications for creditors of either agreeing to the deal or of turning it down. Given the latter can result in the creditor getting back even less money (as the business is forced into bankruptcy, say), the CVA may look like the best way to salvage something from the situation. To go ahead, a CVA must be approved by a majority of shareholders, and by creditors who are owed at least 75% of the debt.
Ducking obligations
Of most significance to landlords is the fact that a CVA can impose rent reductions on them, or in some cases allow retailers to back out of leases altogether even if the landlord does not vote for it. For example, in 2014 childrenswear shop Mamas & Papas cut rents on 35 of its 64 shops as part of a CVA. While this can provide struggling companies with much-needed breathing space, some argue that the mechanism is being misused.
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First, there is the concern that some retailers may use CVAs to duck out of lease obligations for underperforming shops. "Where the operating performance of a business is fine but its ownership structure has excessive debt, or management simply wants to improve its operating profits by reducing rents, we do not believe that the CVA process is fair or appropriate," Mark Greenslade of real estate investment trust (Reit) Land Securities told The Guardian. Second, CVAs have been criticised as being especially unfair to landlords. Other creditors voting on the CVA are not directly hit by rent reductions, and while landlords have the legal right to re-let the premises to tenants who are willing to pay more, this is currently a struggle. Fewer than a third of the shops left behind by bankrupt BHS have been let to someone else, notes Jonathan Eley in the Financial Times.
In an attempt to fight back against this perceived misuse of CVAs, landlords who own buildings occupied by House of Fraser shops have banded together to try to negotiate a better deal from the high-street retailer's CVA proposal.
The impact on investors
If you're an investor in any Reits, then make sure you're aware of the extent of their exposure to the UK high street. The row over CVAs is not going to go away and it's unlikely to be resolved in a way that makes life any easier for landlords. For example, clothing chain Next is arguing for "CVA clauses" to be put into its future lease deals, so that if a struggling rival nearby has its rents reduced, it will too.
Moreover, CVAs are just a symptom of the wider challenges facing bricks-and-mortar shops. Most retailers who have used CVAs since 2008 have gone bust anyway so landlords have taken the hit in the end. As online shopping continues to steal custom from the high street, the outlook for rents will only deteriorate.
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