UK supermarkets looking at massive property write-downs

While the news from Tesco of late has been terrible to say the least, there is speculation there is more bad news on the way for the UK supermarket sector. Prominent financial experts believe that Tesco is on the verge of writing-down the value its property portfolio by at least £1 billion with some suggesting this could actually double in the short to medium-term. This comes hot on the heels of the £1 billion write-off by the Morrison and Sainsbury supermarket chains.

The fact is that UK consumers are now happy to shop more locally and appear to be shunning large out-of-town stores which have been very successful over recent times. As a consequence the value of individual stores has suffered of late which could have a knock-on effect in other areas of the UK corporate property market.

Property investors looking at the numbers

Historically the U.K.’s largest supermarket chains have invested heavily in property although recently they have been releasing capital in the shape of sale and lease back arrangements. In simple terms these allow supermarkets to sell their stores to property investors and put in place long-term lease arrangements. It does not take a genius to recognise the fact that a reduction in the perceived value of these properties will ultimately impacts rents charged when the next appraisal comes round.

This will come as a major shock to many investors in the UK supermarket sector which has been seen as a safe pair of hands for some time. It is the introduction of relatively low-cost supermarket competitors which has changed the dynamics of the UK sector so dramatically. In the short to medium term it is unlikely we will see a major recovery in the value of the U.K.’s more traditional supermarket property assets and some investors involved in sale and lease back arrangements may take a significant hit.

Are sale and lease back arrangements sensible?

In terms of sale and lease back arrangements these allow the previous owner of the property to release capital tied up in the assets and use this for investment elsewhere in the group. On the other side of the deal, long-term property investors are able to acquire properties at market value and charge market rates for long-term lease arrangements. It is only when these arrangements come to an end and they are then valued on market terms at the time that some property investors may well feel the pinch.

It is difficult to say at this moment in time when or how property investors will be impacted by this move to reduce the value of various store assets. If there is small print in the lease arrangement protecting rental income going forward for a relatively long period of time then this will give investors some breathing space. However, if the rents are based on the market value at the time then some investors may well see a significant reduction in their rental income and ultimately the value of the underlying property itself.

Conclusion

We have seen many sale and lease back arrangements in the U.K. supermarket sector over the last few years. These allowed supermarket companies to release capital for investment elsewhere in their group while giving property investors a perceived “safe” long-term investment. The reduction in profitability of the U.K.’s traditional supermarket chains has caught many people by surprise as has the ongoing reduction and write down in property asset values. Much will depend upon the small-print of individual lease back arrangements but some property investors may well take a bath in the short to medium term.