In the English town of King’s Lynn, the carcass of a shuttered department store lies next to betting shops, discount retailers and a cash-for-gold kiosk.
It’s a typical sight across a country where online shopping has taken root more than just about anywhere else. But the boarded-up facades also betray something else: how some of the biggest and best-paid investors have been saddled with unloved property that’s now taking another hit.
The Vancouver Quarter in King’s Lynn, the kind of mall ubiquitous in the U.K. since the 1960s, is one of dozens acquired by private-equity fund managers on the cheap in the wake of the financial crisis. Oaktree Capital Management LP has spent most of 2017 trying to find a buyer, just as retailers feel the knock-on effect from Britain’s vote to leave the European Union.
Right now, there are about 2 billion pounds ($2.6 billion) of shopping centers owned by private-equity funds that would like to sell, said David Lockhart, chief executive officer of NewRiver REIT Plc, which invests in malls and stores. Prices have fallen for non-prime malls by more than any other type of commercial property since the June 2016 Brexit vote, according to research by broker CBRE Group Inc.
“We are not entirely comfortable with their price expectations, which relate back to a time before the Brexit referendum,” said Lockhart. “The world has changed.”
A roster of investors from Lone Star Funds to Cerberus Capital Management LP bought U.K. malls being dumped by troubled banks, betting values would recover and they could sell at a profit. Even though the Internet had been killing off the traditional High Street for years — and still is — borrowing costs were at a record low and consumer spending remained a key driver of the economy.
Private-equity real-estate funds spent 5.6 billion pounds on U.K. malls since 2010, according to data compiled by broker Savills Plc. It accounted for about a fifth of all mall purchases in the country. In the first quarter of this year, the number of transactions slumped to 2008 levels, data compiled by broker Cushman & Wakefield Inc. show.
The investors typically spend about three to four years buying assets followed by four to five years managing and selling them on. They usually aim for returns of 15 percent to 20 percent and are richly rewarded, charging about 1.5 percent to manage the investments with performance fees of up to 20 percent if they hit targeted returns.
Managers that sold malls in the years running up to the Brexit referendum did well.
Blackstone Group LP’s third European real estate fund, which completed raising money from investors in 2009, achieved returns of 16 percent as of June 30. It bought several malls in a joint venture with Catalyst Capital Group Inc., including the Houndshill Shopping Centre in the northern English seaside town of Blackpool. The funds paid about 85 million pounds in 2011 and eventually sold it for 105 million pounds in 2015, or 24 percent more.
But now, households are curbing spending as the pound weakens and inflation outpaces wage increases. Retail sales are growing at the slowest pace for four years. It’s left money managers either having to bide their time or look at alternatives for sites they can’t sell, such as changing the mix of use to include less retail and more leisure or housing.
“The model of private equity has been to buy it, fix it and sell it to institutions, but that conveyor belt is broken at the moment,” said Mark Robinson, property director at Ellandi LLP, which co-invests and manages U.K. malls on behalf of buyout firms including Lone Star Funds, Angelo Gordon & Co LP and Colony Capital Inc.
U.K. malls like Oaktree’s in King’s Lynn were bought by the funds through portfolios of soured loans sold by banks after the global financial crisis sometimes for as a little as 20 pence in the pound. A spokeswoman for Oaktree, which acquired that particular space five years ago, declined to comment on the firm’s investments.
New York-based Cerberus, the biggest buyer of such debt in Europe, owns at least six regional U.K. malls, according to data compiled by Trevor Wood Associates, which publishes research on the retail industry.
The Gyle Shopping Centre on the western fringe of Edinburgh was the largest property in a 4.5 billion-pound portfolio of non-performing loans bought by Cerberus from Ireland’s National Asset Management Agency Investment Ltd. in 2014. Cerberus offered it for sale in early 2015. Nearly three years later, the property still hasn’t traded. A spokeswoman for Cerberus declined to comment.
Big investors like insurers and pension funds, meanwhile, generally have shied from all but the best U.K. malls and shifted into new areas like rental homes, healthcare and retirement housing.
“The search for stable income has increasingly taken them away from the retail sector because it has become a more volatile environment,” said Robin Martin, a director at Legal & General Group Plc’s investment management business.
Another group, real estate investment trusts, has also balked. Companies including Land Securities Group Plc and Hammerson Plc sold smaller shopping centers and paid high prices to reinvest in malls that dominate a region and can attract footfall.
Hammerson, the U.K.’s largest REIT specializing in retail, is focused on malls where brands can “showcase their full range, where we can offer an experience beyond retail, with catering and leisure,” CEO David Atkins said in an interview. “Centers that don’t offer that and can’t offer that I think could well be challenged going forward.”
As a result, buyout firms are undertaking increasingly radical redevelopments and bearing the cost. Blackstone halted a plan to sell the St. Enoch Centre in downtown Glasgow in 2015 after bids fell short of expectations. The firm is now replacing a store vacated by defunct retailer BHS Ltd. with a cinema and more restaurant space.
Clearbell Capital LLP, an investor headquartered in London, has almost completed a total repositioning of the Gates shopping center in the northeast university city of Durham. When the company bought the mall in 2014, it had 49 stores. It’s replacing about half the units with roughly 250 student apartments, a cinema and a new row of riverside restaurants.
At Stretford Shopping Centre in the urban sprawl around Manchester, Apollo Global Management LLC and M&M Asset Management plan to demolish a section where all the stores are empty to try and reverse a slump in shoppers since 2008, according to a filing with the local municipality. They may build homes instead.
“The real problem is the mid-range centers which are in smaller towns or those that are the second best in a larger city,” said Tom Sharman, head of research and strategy for real estate finance at Royal Bank of Scotland Group Plc. Unless you can sell it to the local government, “then I think you are going to struggle to find a buyer,” he said.