The European retail property sector saw a sharp deterioration in performance in 2020, with S&P Global Ratings' rated companies reporting a drop in like-for-like net rental income of 15.2% and a 6.2% contraction in property value on average. This is broadly in line with our previous estimates, and mostly reflects large rent concessions, unpaid rents, and lower occupancy rates, as retailers struggle to cope with government restrictions to contain the spread of COVID-19 and the pandemic's economic fallout on top of mounting competitive pressure from e-commerce (see "COVID-19: Implications For European Real Estate Investment, As Tenants Begin To Suspend Rent Payments," published March 26, 2020, on RatingsDirect).

However, most companies are demonstrating sound financial discipline that is mitigating the impact of valuation losses on credit metrics and potential refinancing risks. Many have significantly reduced investments and cash dividends, made disposals (although relatively limited in the current context), and built up large liquidity provisions. In 2021, we expect debt-to-debt-plus-equity ratios will remain stable or increase slightly from additional negative valuation, after a sharper increase in 2020 in most cases. That said, liquidity and EBITDA interest coverage ratios should remain strong, while debt to EBITDA will likely gradually improve toward 2023 from the severe hit it took last year as revenue recovers.

For 2021, we assume the sector will post only flat-to-modest EBITDA growth of up to 10% on average, since potential increases in tenant bankruptcies, vacancy rates, and rent losses from ongoing restrictions in first-half 2021 may offset landlords' ability to collect higher rent as the pandemic and restrictions abate in second-half 2021. We also assume a further 5% valuation loss on average this year, reflecting the potential revenue impact of additional shopping centers closures in 2021 on appraisals.

We continue to see long-term secular risk for European retail landlords due to consumers' changing habits and the aftermath of the pandemic eroding tenants' capacity and willingness to pay a rent. We are concerned this may translate into lower rental growth and occupancy rates for landlords in the medium to long term.

To reassess the long-term growth prospects and rating implications for European retail landlords, we performed a sector review this March. As a result, we downgraded three of the 10 companies we rate in the sector, and lowered the business risk profile positioning of two companies. The majority of companies still carry a negative outlook to highlight further downside risks over the next six to 12 months. This review comes 18 months after we signaled the first signs of the market weakening due to the e-commerce penetration and placed half of retail property ratings on negative outlook (see "Europe’s Retail Property Market Is Showing Signs Of Weakening," published Sept. 26, 2019) and 12 months after we placed Europe's entire retail property sector on negative outlook following the pandemic's outbreak (see "COVID-19 Will Likely Ruin European Retail Property Companies' Efforts To Contain Competition From E-Commerce," published April 1, 2020).

Table 1

Performance Will Only Partly Recover In 2021 From Sharp Deterioration

While the sector faced strong operating pressure in 2020, performance diverged between some countries and asset types. U.K. and large destination shopping centers were more severely affected than other retail landlords. Retail REITs in Nordic countries fared better due to fewer restrictions and higher governments support, although uplifts on rent renewals (or releasing spreads) appeared weaker in this region.

Net rental income sharply declined in 2020, and we expect only a modest rebound in 2021.  This is mostly the result of large rent concessions, unpaid rents, and lower occupancy rates during the year. Among our rated European retail property owners, the largest declines were reported by Ceetrus S.A. (-27.4%) and Unibail-Rodamco-Westfield SE (URW; -26.4%), with URW's U.K. portfolio in particular reporting a like-for-like loss of 49.3% versus 19.1% for continental Europe. This is in line with our expectations of a 15%-30% decline for the sector (see "COVID-19 Will Likely Ruin European Retail Property Companies' Efforts To Contain Competition From E-Commerce," April 1, 2020), and our view that the U.K. market remains particularly exposed to risk of rent renegotiation (see "COVID-19 Is Only Part Of The Threat Facing U.K. Real Estate Companies," published Nov. 16, 2020).

Chart 1

That said, we are mindful that the profit and loss reporting for 2020 is not fully comparable from one retail landlord to another. This is because 2020 net rental income may not reflect the full amount of rent lost during the year. We understand that the bulk of retail landlords have reported most rent losses in their 2020 net rental income, but that International Financial Reporting Standards allow the impact of cancelled rent to be streamlined during the remaining lease's duration for leases that have been modified (for example using an extension). Some provisions for doubtful debtors have also weighed on EBITDA rather net rental income. For this reason, we are focusing our forecasts for the next 24 months on EBITDA evolution rather than net rental income.

Vacancies increased by 2 percentage points on average in 2020 and may rise further this year.  Retail landlords in Europe we rate reported vacancies climbing to 5.4% at year-end 2020 from 3.4% at year-end 2019 on average, often resulting from bankruptcies and difficulty releasing spaces during the year (see chart 2). This uptick is relatively moderate but higher than historical levels. We think it may rise further, as bankruptcies could surge when government support diminishes.

Chart 2

Average rent collection rebounded to 85.5% at year-end, but we expect a full recovery by mid-2021.   Issuers struggled to collect rent in 2020, with collection rates barely reaching 50% on average in the second quarter. Although rates have recovered in recent quarters, despite resurgence of the virus, we remain conscious that discounted or differed rent is still deemed collected, so long as it is part of a landlord agreement. We expect rent collection to fully recover by mid-2021, as restrictions on shopping centers should ease as vaccination progresses in Europe.

Spreads on releasing are lower than before, but remain surprisingly flat to slightly positive in most European countries.   Retail REITs' capacity to negotiate higher rents for the same space under new leasing agreements (releasing spread) has been significantly lower than in previous years--both in terms of the number of new leases and the percent increase. However, the releasing spread remained flat-to-slightly positive (up to 5%) in most European countries despite retailers' strongly negative sales and difficult rent renegotiations (chart 3). This excludes the U.K., the Nordics, and the Netherlands, where negative releasing spreads already started before the pandemic.

This trend is highlighted by the following entities we rate:

• Klepierre S.A. signed 951 leases in 2020, with +4.5% rent reversion, versus 1,598 leases in 2019, with a +8.2% reversion.
• Mercialys reported a +5.0% reversion in 2020, versus +9.2% in 2019.
• Carmila S.A. signed 293 renewals in 2020, with a +2.2% reversion, versus 390 in 2019, with +6.9%.
• URW signed 935 leases in continental Europe (excluding the U.K.) in 2020, with a +1.6% uplift, versus 1,367 leases in 2019, with +12.0%.

While we continue to think rental growth could gradually decrease over time because of increasing competition from online retail, we think the maintenance of positive releasing spreads during the pandemic is a positive sign for the brick-and-mortar retail sector.

Chart 3

Disposal volumes were limited and we do not expect they will materially rise this year, but properties closed slightly above or close to their last appraisal value for some of our rated REITs.   While uncertainties continue to weigh on the retail investment market, a few retail property companies received a price for assets they disposed of during 2020 that exceeded their previous appraisal value. These include:

• Mercialys brought in €245 million for selling one Monoprix site to PICTURE Asset Management, and three Monoprix sites and two hypermarkets to SCI AMR (a vehicle jointly owned by Amundi Immobilier and consolidated by Mercialys on an equity basis) at or above appraisal value.
• Klépierre disposed of noncore assets for a total consideration of €155.6 million (excluding transfer taxes, total share), 3% above valuation.

We do not assume disposals that are not yet signed in our models for 2021 and 2022 given the European retail investment market remains subdued, but these transactions somewhat support the reliability of the third-party asset revaluations reported by the companies we rate.

Solid Financial Discipline Is Mitigating Credit Metric Deterioration

Most retail REITs saw their credit metrics deteriorated in 2020. However, many have limited the impact by reducing investments and cash dividends, and, to a lesser extent, by selling off assets. Although we do not expect revenue to fully recover before 2023, we foresee that the credit metrics of most European REITs we rate will recover to rating-commensurate levels by 2022. We note that some entities have more headroom than others.

Preventative deleveraging is mitigating the impact of revaluation losses on debt-to-debt-plus-equity ratios.   Although companies' debt-to-debt-plus-equity ratios took a hit from a sharp decline in property values in 2020, we do not expect significant further weakening from our base-case expectation of further devaluations in 2021 of about 5%. For the 10 European retail property issuers we rate, the average ratio in 2021 should remain 3.4 percentage points higher than in 2019 (42.2%, see chart 4). However, a further valuation loss of more than 10% would likely put pressure on all our ratings (see chart 5).

Chart 4

Chart 5

Debt to EBITDA jumped up in 2020 as a result of weaker revenue and EBITDA generation, but should recover gradually as revenue stabilizes.   This was the most affected ratio for retail REITs due to the sharp drop in EBITDA, but we believe the ratio could recover from the current historical high by 2022 (see chart 6). Current restrictions on shopping centers may lead to further rent losses and renegotiations in 2021, but we expect revenue will gradually increase as vaccination ramps up, and debt-funded investments should remain contained due to companies' current financial discipline.

Assuming zero revenue growth, debt to EBITDA would take more than two years to recover on average, but the ratio would still return to levels in line with current ratings as early as 2022 (see chart 7).

Chart 6

Chart 7

EBITDA interest coverage remains robust in most cases, thanks to low interest rates and some liability management exercises.   EBITDA interest coverage weakened slightly to 4.5x in 2020 from 5.7x in 2019, on average, due to weaker revenue generation. But overall, this ratio remains higher than its long-term average, as a result of several years of low interest rates, and successful liability management strategies. We expect the ratio will recover gradually as revenue ramps up and investments remain contained.

Chart 8

Chart 9

Liquidity provisions are healthy, boosted by a record level of issuance, and refinancing risk is remote.   The retail REITs we rate built up strong liquidity provisions, with large bond issuances over 2020 (€7,021 million in total in 2020, versus €6,050 million in 2019) to refinance debt maturities well in advance and maintain large available revolving credit facilities to cover refinancing needs over the next two years. Capex and investment needs are moderate. At the start of 2021, we estimate that total cash and undrawn bank lines represented twice the volume of debt maturities due this year (see chart 10). Our liquidity multiple was about 2.7x on average for companies (excluding URW, which is significantly larger than average peers) as of Dec. 31, 2020, a significant increase from 1.9x as of Dec. 31, 2019.

Chart 10

E-Commerce Will Erode Demand For Retail Property, But Continental Europe May Fare Better Than Other Regions

We continue to forecast deterioration in the fundamentals of the retail property sector, mainly as a result of the pandemic accelerating e-commerce penetration, a weakening tenant base, and investors' aversion to the sector. There are also a few mitigants in Europe, such as the low risk of shopping center saturation, somewhat resilient releasing spreads, and leases terms that remain largely fixed in most countries so far.

Fundamentals will continue to deteriorate

Rapidly increasing e-commerce penetration is weighing on retail property demand.  We signaled e-commerce as a gradually emerging threat to the sector a few years before the pandemic, but the public health emergency has accelerated the change in consumer sentiments and shopping behavior. We believe e-commerce will pick up across major regions in Europe in coming years and have a lasting impact on how the retail sector operates. We note the U.K. remains the most exposed country.

Tenants' capacity and willingness to pay rent is reducing.  Retailers in shopping centers were already going through difficult times before the pandemic, with the rise in e-commerce reducing footfall and sales. Rents have become an increasing burden for retailers (see chart 11), with many reducing their number of shops and developing online sales channels either as a complement or alternative to brick-and-mortar shops. The intense level of rent negotiations between retail tenants and landlords during the pandemic demonstrates that retail REITs' tenant base is not robust or diversified enough to absorb such external shocks (contrary to office landlords, which had more limited negotiations with their tenants and maintained high collection rate).

Bankruptcies increased in 2020, albeit moderately, thanks to government support plans, with the retail and restaurant industry being among the most affected. We think bankruptcies will increase further in 2021 as government support diminishes, and continue to weigh on retail REITs' occupancy ratios, which were already down 2 percentage points in 2020 on average versus 2019.

Chart 11

Valuations will likely continue to decline in 2021.   In the second half of 2019, private asset valuations of retail assets (by independent property appraisers) started showing the first signs of weakening in Europe. The decline in property value was mostly linked to an increase in yield, since revenue was still rising but benchmark transactions were lagging. We saw a sharp decline in valuation in 2020, but this time also from lower cash flow expectations by appraisers, mostly as result of the pandemic, in addition to a further yield expansion. We believe retail property values could drop further if distressed sales come to the market at highly discounted prices, which we have not observed among out rated companies so far.

Chart 12

Financial investors in the public capital markets have also been punitive to retail property owners. Discounted share prices and higher credit spreads than other property segments highlight debt and equity investors' perception of the sector and investors' reduced appetite for this asset class.

Continental European retail landlords enjoy some mitigating factors relative to the peers in other regions

Low retail density and e-commerce penetration still support organic growth.  Although demand from tenants may diminish over time, supply appears relatively limited. The density of shopping centers per inhabitant in Europe significantly contrasts with that in the U.S. for example (see chart 13). We also observe than e-commerce penetration in Continental Europe remains significantly below China and U.K. (see chart 14). This has notably enabled most European retail REITs to post resilient organic growth continuously since the 2008 recession--with the exception of 2020.

There are some disparities in Europe though, and we believe that Nordic countries could be more at risk of shopping center saturation, although the region's tougher weather conditions generally support more footfall in shopping centers.

Chart 13

Chart 14

Rent levels remain resilient so far, despite all the past and current challenges.  Most retail landlords across Europe have been able to maintain or increase rent in lease renewals. In 2020, we noted a smaller number of renewed leases than in past years, but still accompanied by price revisions that were flat or even positive. Increases were materially lower than in previous years, but remain encouraging given the severity of the situation in 2020. We see negative revisions mostly in the Nordics, the Netherlands, and the U.K.

Lease terms remain widely fixed, for up to 95% of rents.  We understand that the share of variable rents still remains very limited and the lease terms remain largely fixed in most European countries for the REITs we rate. Only a couple of large fashion retailers (such as H&M or Inditex) have negotiated a large portion of their rent being based on turnover. But variable leases remain moderate in percentage of aggregated rents (about 5% on average) and might not apply to shopping centers in very prime locations, where even large brands still expect to pay fixed rent.

We believe, however, that the portion of fixed rent may decrease, especially in the U.K. For instance, Hammerson (not rated) publicly stated that it was willing to accept a higher portion of variable rent. In our view, a more prominent proportion of variable rent would likely weaken the revenue predictability of a REIT.

Looking Beyond The Pandemic

We may be able to revise all negative outlooks in the sector to stable once we are able to assess the full impact of pandemic on REITs' ratios and key performance indicators. This will depend on the success and speed of the vaccine rollout and consequent easing of restrictions, which are still currently weighing on most European shopping centers. Moreover, better visibility on long-term rent growth prospects post-pandemic and economic recovery for the retail sector could be key when reassessing our ratings on European retail REITs.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

• Industry Top Trends 2021--Real Estate: Recovery In The REIT Sector Could Be Long And Uneven, Dec. 10, 2020
• COVID-19 Is Only Part Of The Threat Facing U.K. Real Estate Companies, Nov. 16, 2020
• European Retail Property Companies First Half Results Highlight Looming Risks, Sept. 3, 2020
• European Corporate Credit Mid-Year Outlook 2020, July 30, 2020
• COVID-19 Will Likely Ruin European Retail Property Companies' Efforts To Contain Competition From E-Commerce, April 1, 2020
• COVID-19: Implications For European Real Estate Investment, As Tenants Begin To Suspend Rent Payments, March 26, 2020
• Europe's Retail Property Market Is Showing Signs Of Weakening, Sept. 26, 2019