Transaction activity and valuation challenges

Recent & historic deals

The outlet centre investment market is still in its relative infancy. To date, the majority of OC development has been funded by developers and operators with minimal institutional involvement.

The main operators, Realm, McArthurGlen and Value Retail who dominate the market, have primarily funded their developments by a combination of cash, debt and equity capital. Due to the small number of outlet centres, there have been relatively few transactions during the last two decades and as a consequence yields have varied between assets. However there has been an increase in investment activity in the last 18 months.

The first significant outlet centre transaction was the partial sale of McArthurGlen’s Cheshire Oaks which achieved a yield of 5.5% in 1998.

Since this sale, yields have varied from 5.5% to 8%. Historic sales have shown yields of 5.5% to 6.5%, evidenced by the sales of Gretna Gateway and the Hatfield Galleria in October 2005, which showed net initial yields of 6.5% and 5.5% respectively. The sale of Springfields in Lincolnshire in January 2007 reflected a net initial yield of 5.5% when UBS Triton Property Fund purchased the interest in the property in conjunction with its asset manager.

Livingston Designer Outlet sold to LaSalle IM in 2014 for c.£52m, which provides an initial yield of 9.00%. Three years later and following considerable asset management, the scheme has recently transacted again, with Blackstone reportedly paying c.£100m, with the yield rumoured to be 6.5%.

More recently, two schemes transacted in December 2016, sold by Hermes to Karlin Capital. The schemes, Freeport Talke and Freeport Fleetwood, accounted for 250,000 sq ft and sold for £31.5m, both reflecting yields of 8.00%.

Further to this, Hermes sold Clarks Village, Freeport Braintree, and Junction 32 Castleford in May 2017 to Landsec for £340m, with yields rumoured to be 6.4%. Atlantic Village, Bideford, Devon was transacted early October 2017 in an off-market deal by Karlin Capital.

Although OC transactional evidence is sporadic, yields have tended to sit between Prime and Secondary shopping centres. However, the most recent deals show an improved yield position, closer to prime and more aligned to Town Centre Dominant shopping centres, for which Savills record a long term average of 6.5%.

Is the sector undervalued?

There are a number of challenges that relate to the valuation of OCs and the assessment of their potential for future performance, which sets them apart from a conventional shopping centre.

First, if the centre is let on 100% turnover rents, then the theoretical approach to the valuation should be a discounted cash flow, so that the prospects (or otherwise) of growth in turnover for each individual tenant is reflected in the cash flows. This requires making an informed assessment of turnover growth as compared with a forecast of rental growth.

The difficulty in assessing each retailer’s potential turnover growth has however, often led the market to revert to the conventional approach of income times yield. It is an interesting question, as to which income figure should be adopted as many turnover rents are based on a minimum rent that is below the ERV (commonly 80%), but with annual growth generated by turnover rents. Conventional valuation may therefore under estimate the performance potential of the investment.

These include the diversity of the source of income across a wide range of tenants and the low obsolescence compared with non-Prime shopping centres. The investment risks relate more to systematic market than asset specific issues which should be reflected in the yields.

Furthermore, in common with many of the most successful shopping centres, the outlet market requires specialist operational management. The lease structure and the use of turnover leases means the assets are particularly suited to the use of asset management initiatives to generate enhanced performance.

Pre-2017 investment yields for OCs had moved closer to that of secondary shopping centres. However, the long held view of stakeholders has been that yields should revert back towards Prime as OCs offer advantages over shopping centres on conventional leases; Blackstone and Landsec’s latest transactions are evidence that this is now occurring.