Investment report of Ealing Broadway Shopping Centre
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Date: 4 May 2020 Signature:
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Executive summary
Ealing Broadway Shopping Centre, which is owned by British Land is located in Ealing borough of Great London. Based on Ealing Council’s core strategy, it is designated as a development site to facilitate the regeneration of the Ealing Town Centre. Therefore, the property can be regarded as a major shopping and leisure place for Ealing Town residents. After seven years since British Land’s acquisition, the property has completed a refurbishment to attract several new tenants, and provide a modern shopping environment for visitors. However, due to the retail downturn in recent years, the latest operating performance of the shopping center has declined slightly.
Resulting from the market research, risk and valuation analysis, the investment of Ealing Broadway Shopping Centre is not recommended. The current value of the property is below its possible asking price, indicating that it is overvalued. The investor who seeks for stable return with low risks can consider it after the outbreak.
- Project overview
Ealing Broadway Shopping Centre is located at the center of Ealing borough, which is at the west of London’s West End. Adjacent to The Broadway and High Street, the center was initially built-in 1984 and dominated the retail market in the town center. The Dutch company Wereldhave acquired it in 2011 and sold it to British Land (BL) in 2013. After that, BL refurbished it with the purpose of developing the center into a retail destination with improved retail mix and leisure offers.
The site currently covers 6.02 acres of land, with 505,594 square feet of retail and leisure developments. It only takes a three-minute drive from Ealing Broadway Commuter Rail to the shopping center, leading to secure access to the center from Central London by tube or train. Also, the shopping center is equipped with 600 covered and 36 surface parking spaces, providing convenience for nearby residents to come and enjoy services.
Tenants, including Marks & Spencer, Primark, H&M, and Argos, are currently included in the shopping center to satisfy the different needs of residents. At the same time, restaurants, cafés such as Starbucks and Nuffield Health Gym offer leisure activities to visitors (as shown in Figure 1.1). All of these retailers and brands leased areas to operate shops in the shopping center. Therefore, the primary source of revenue of the site is rental income from letting areas of the shopping center to different retailers and brands.
The site can attract sufficient customers for retailers. According to Completely Property (2020), the footfall level of the center is over 15 million visitors per year, and each customer stays approximately 75 minutes in a day. The average contribution per visit is about 50 pounds. As for demographics around the site, the purchasing power of the population reaches 33.4 billion pounds, and 41% of households have a high income within 5 miles of the shopping center (Milcheva, 2020). Therefore, the sales in the retailers of the shopping center are guaranteed, contributing to a stable rental income of the site.
- Developments of the shopping center
In 2013, BL acquired the freehold of the shopping center from Wereldhave with a deal of 142.5 million pounds. At that time, Ealing Broadway Shopping Centre had over 60 tenants and 300,000 square feet of retail and leisure space (British Land, 2013). In order to improve tenant mix and leisure offer, BL carried out a 14.5 million pounds refurbishment in the shopping center, mainly in 2015 (British Land, 2015). Ealing Council permitted about five planning applications associated with the renovation.
Firstly, part of space in the parking lot, as well as the library and a newly created extension on the ground floor, formed a space for center management office, improving the efficiency of management staff. At the same time, the customer toilet was added on the ground and first floors to offer a more convenient and comfortable shopping experience.
As for the square in the shopping center, improvements were realized to offer a more comfortable and flexible leisure environment for customers. The new facade signs replaced the original canopy structure and were installed on the frontage of the shopping center. BL has also established a new canopy for the square, connected lighting, new paving, seating, displays, bins, climbing walls, and landscaping. Additionally, the new storefront was moved to the northern and southern side of the square, and the statue was removed, offering more spaces for flexible shops such as market stalls and pop-up shops. These improvements contribute to a greater sense of openness and create a more attractive appearance for the shopping center.
In 2017, some of the retail units, plant rooms, and public toilets were converted into restaurants. Also, the exterior of the shop has been transformed to create a more contemporary and attractive appearance.
After the refurbishment, the shopping center attracted new occupiers such as Smiggle, Clas Ohlson due to the promoted environment. Several restaurants, including Wagamama, Wasabi, Turtle Bay, Vineyard, and Chicken Shop, opened in the shopping center to provide a variety of dining options to visitors. Also, Doddle opened outlets in the center for shoppers to collect and send parcels. Moreover, five brands, including Decathlon, WHSmith, Sports Direct, Explore Learning, and Neon Sheep, decided to open shops in the center in 2019, offering more choices for visitors in reading and sports.
The refurbishment and new tenants appealed to an increasing number of visitors and stimulated retail sales of the shopping center. According to British Land (2016), retail sales were increased by 5 percent in the fiscal year 2016. As a result, the site after redevelopment may continue to attract more brands with its outperformance.
- Past performance of the property
BL, the current owner of the property, acquired it at the end of the fiscal year 2013 and received income through renting out spaces to retailers. The annual rent per square foot (SF) of the shopping center experienced a downward trend after the acquisition and is becoming closer to the market level in London (Figure 3.1).
At the same time, the vacancy rate of the property was high in the first two fiscal years of the acquisition because some of the space was not used until after the refurbishment in 2015. After the renovation, new tenants were attracted, which resulted in a sharp drop in the vacancy rate during 2016 and 2017. After that, the effects of store closures and voluntary company agreement (CVA) resulted in a steady increase in the figure (Figure 3.2).
As for the value and yield of the property, the dynamics of market values can be utilized to estimate the growth of them (Figure 3.3 and Figure 3.4).
Therefore, property value and yield from 2014 to 2020 are as follows (Figure 3.5). The apparent increase in property value in the fiscal year 2016 is reasonable due to 15 million refurbishments during 2015. The yield showed an upward trend after a decline between 2014 and 2017.
Based on the calculation logic (see Appendix 1) and relevant data collected from 2013 to 2020, operating expenses ratios from 2014 to 2020 and net operating income (NOI) of the property are shown below (Figure 3.6 and Figure 3.7). The operating expense ratios show significant growth in 2016 and 2017, which may be resulted from the increase in operating costs caused by the rise in occupancy rate after refurbishment.
- Risk analysis
- Property-specific risk
The first risk of the property is related to its concentration on the retail industry. As the most rental income of the shopping center is from retail shops, the dynamics of the retail sector may significantly impact the operation of it. Therefore, rising vacancy rates and falling rents are more likely to occur when the retail industry is in the doldrums.
Additionally, the administrations of retail companies may increase the vacancy rate of the property. Compared with those in central London, tenants in the shopping center sell a relatively small range of goods, leading nearby residents to shop in central London and online due to limited choices. Stores in the shopping center may close because of poor performance, thus reducing revenues from leases. The development of transportation with central London also provides residents with Ealing more convenient access to shopping malls in central London. It will distract the catchment, which used to be concentrated in the Ealing Broadway shopping center.
Moreover, as the shopping center has started to operate in 1984, some facilities may need increasing cost to maintain in the future.
- Local risk
Local risks include regulations announced locally and competitions from nearby peers. Firstly, CVA is becoming a significant factor in cutting rents. Retailers can withdraw lease agreements immediately by CVA to prevent the business from getting into trouble (Sam, 2019). Therefore, landlords have to consider a rent reduction to avoid higher costs arising from vacant spaces.
Competition from peer centers with lower rents and high household income is the third risk source. The rent of Ealing Broadway Shopping center is more elevated than eight peer centers within 7.6 miles of it. However, the median household incomes in nearby regions of five shopping centers are higher than that of Ealing Broadway Shopping Centre, indicating a higher turnover of shops driven by large consumptions (Figure 4.1). As a result, the Ealing Broadway shopping center is less likely to become the first choice or renewal location for merchants when comparing the returns of shops between these shopping centers. It may ultimately lead to the rent of a shopping center close to the overall level of peers (Milcheva, 2020).
- Market risk
The retail sector, which is a significant component of the commercial real estate, is undergoing a transition from offline to online in recent years. The share of online retailing in the UK is expected to grow to 18.5 percent by 2022, after which it will gradually level off (Tom et al., 2018). Milcheva (2020) also indicated that retail sales growth in the outer London area including Ealing will remain at only 1% from 2019. It brings pressure to physical retail, increasing rent and vacancy rate in the form of CVAs and administrations.
At the same time, the emergence of Coronavirus has further strengthened the necessity of online shopping and hence weaken the sense of existence of physical stores.
- Economic risk
The operation of the shopping center is largely affected by economic conditions of London, such as unemployment, increasing labor cost and trading relationship with Europe Union (EU), and liquidity crisis. These factors may increase vacancy rate of the property, reducing its ability to generate income for investors.
Unemployment means a reduction in the level of consumption, resulting in decreasing demand for shopping. As Milcheva (2020) stated that a large amount of outer London boroughs is experiencing job losing, the shopping center may lose tenants.
The negative impact of Brexit on commercial real estate may be reflected in two aspects, namely increasing labor cost and trading relationship with EU. After Brexit, the British construction industry will not be able to benefit from the free movement of EU workers and get low-paid workers, leading to higher labor costs. It may increase the cost of refurbishment and maintenance of the shopping center. As for the trade with EU, when it is adjusted to require tariffs, retail costs will rise. Under this scenario, retailers may consider closing some stores to save money, which hence increase the vacancy rate of the shopping center.
- Forecasted NOI of the shopping center
According to assumptions about components of NOI (see Appendix 2), the forecasted NOI in 2021 can be estimated.
- Valuation of the property
The present value of the property can be obtained through dividing NOI of next year by current capitalization rate. However, NOI may be affected by possible risks in the future, hence the risks need to be considered and simulated to obtain most likely present value of the property.
- Rent growth rate
CVA will be a major risk for the growth of rent. When faced with increasing competition from E-commerce, uncertainty about trade relationship with EU after Brexit, the outbreak of the epidemic and decreasing purchasing power due to unemployment, retailers are more likely to use CVAs for cutting rents. According to Tom et al. (2018), CVA will lead to over 40% reduction in rent for 58% stores and 25% reduction for 21% stores, while the rest of stores decided to pay rents monthly. Also, Primark which is an anchored tenant in the shopping center planned to negotiate with landlords to reduce the rent by 30% (Sahar, 2019). Therefore, the average rent growth rate under worst impact may be -3% in the following years.
- Vacancy rate
Store closures resulted from popularity of E-commerce, higher labor costs after Brexit and government policies towards Coronavirus have direct impacts on vacancy rate of the shopping center. As the property is not in the prime area of London, retailers may choose shops here to fall into administrations. Based on the overall vacancy rate of 5.3% in London at the beginning of 2020 (see Figure 7.1), the highest level of it may be 10% in the future.
- Operating expenses ratio
The operating expenses ratio is influenced by operating expenses and gross rental income. Due to a large number of years of operating, the maintenance cost of the shopping center will increase in the future, and some parts will need to be renovated. At the same time, the increase of British labor cost caused by Brexit will contribute to more management fees. On the other hand, rental income may not increase significantly along with rent growth rate. Therefore, the operating expenses ratio will be around 80% in the worst case.
Therefore, the distribution of current value of the property is as follows on the basis of possible ranges of three variables (Figure 6.2). The maximum and minimum values of the property are 44.95 million pounds and 143.81 million pounds (Figure 6.3).
- Sale of the property
As the current owner of the property, BL has two major motivations of selling the shopping center. Firstly, affected by the downturn in retail industry, the company will choose to sell a part of retail properties. According to Julia (2019), the collapse in the value of BL retail properties caused 440 million pounds losses to the company. This issue may be worse in the future because of the outbreak and economic recession. Therefore, BL may choose to sell properties before higher losses occur. Ealing Broadway Shopping centre is likely to be sold as it is not located in the prime area.
Also, as BL plans to reduce retail assets to 30-35% of total assets within five years, it will sell assets for its long-term strategy (British Land, 2019). Mat (2020) stated that selling retail and buying logistics property were regarded as the core of investor strategy in 2020. As a result, the company with limited capital will choose to sell part of the property in the retail sector and invest in the logistics sector to obtain higher earnings.
The selling price of the property is basically determined based on the property value in 2019 and market trends in 2020. According to Mat et al. (2019), the total trading volume of shopping center in 2019 is expected to be less than 1 billion pounds, which is the lowest level since 1995. In 2020, a further slowdown in market activity triggered by the epidemic led to an increase in volatility in the UK retail real estate market. Great liquidity crisis will increase the marketing time of property, which may lead sellers to lower prices later. According to the market trend between April 2019 and April 2020, prices showed a slight change. At the same time, there is a differential of 5% between sale price and asking price (Milcheva, 2020). Therefore, based on the property value of 155.99 million pounds in April 2019, the asking price of this property is about 164.2 million pounds.
- Comparison with alternative choices
Two projects within the 6.6 miles area of the property entered into transaction in the past few months, namely West One Shopping Centre and Kings Mall. The scale of Kings Mall is similar to that of Ealing Broadway Shopping Centre, while West One Shopping Centre is smaller.
Kings Mall was built 10 years earlier than subject property, and its current price of 170 million pounds includes the cost of future redevelopment (Milcheva, 2020). Its location is closer to Central London, and the surrounding transportation system is well developed. At the same time, its anchor tenants are similar to that of subject property, but current vacancy rate is lower, which indicates a relatively more stable rental income. As a result, it may be a more suitable choice for pension funds investment.
- Summary and investment recommendations
To conclude, the current operating performance of the center shows a downward trend. Although the refurbishment in 2015 attracted several new tenants, the depressed state of the retail industry in recent years has had a negative impact on the shopping center which is in the outer area of London.
Based on forecasting and valuation figures, the shopping center will face more uncertainties and risks, resulting in decreased ROI and property value. On the other hand, due to Coronavirus and Brexit at this stage, the duration of property transaction will be extended, while the selling price of the shopping center will not change significantly in a short term. As a result, the price of the property is higher than its real value currently. As for pension funds, managers seek for investment that can guarantee the employees to receive benefits generated from their salaries after retirement. Therefore, the investment should earn a certain level of return while taking minor risks. As a result, it is not recommended to invest Ealing Broadway Shopping Centre recently, and pension funds’ managers can consider alternative choices or revalue it when the outbreak is over.