The £365m ‘Project Swan’ sale of three designer outlets to a Henderson fund belies the general financial meltdown. Christine Eade reports

‘Fund buys three shopping centres with debt and equity from European lenders.’

It sounds like a headline from the archives, considering today’s troubled times.

The story broke only three months ago, when, after a year-long marketing campaign, funds in a limited partnership sold designer outlets at Cheshire Oaks, Bridgend and Swindon to Henderson Global Investors’ UK Outlet Mall Fund for £364.5m.

Although there are seven weeks left of 2008, it is certain that this will be the biggest property investment deal of the year.

The action started in August 2007 when the owners of the outlet malls, developed by McArthurGlen in the 1990s, decided to sell. Among them were Morley, AXA Real Estate Investment Managers, Liquid Realty and McArthurGlen itself. They nominated Keith Manning, a fund manager at bp Pension Fund, to sell the outlets.

He instructed CB Richard Ellis and it was agreed that CBRE would receive an undisclosed percentage of the sale price. Wisely – for property prices were already falling, deals were being pulled and bankers were speaking of a ‘liquidity crisis’ – an abort fee was also settled, so that the hundreds of man hours of due diligence would not go unrewarded if there were no buyer.

Manning, a veteran of the sale of BP Pension Fund’s Berkeley Square Estate, approached Greg Nicholson, chairman of CBRE’s capital markets division. Nicholson codenamed the instruction ‘Project Swan’ because, as a keen shot, he always named disposal instructions after birds.

Nicholson explains the reasons behind the decision to sell.

‘The assets were held in a limited partnership that could come to an end over the next 18 months. It had come to the point where they didn’t want to continue holding exactly the same percentages that they held. Some wanted to sell and others wanted to buy and bring in new investors. In the end, it was the collective decision of the team to sell,’ says Nicholson.

Manning asked for valuations and Nicholson, who brought in his capital markets and real estate finance teams, recalls what happened.

‘There is a huge amount of financial and management information involved when you are grappling with 340 base-rent-and-turnover leases. There were the monthly billings, which you had to reconcile with what was coming in annually. There was a need for forensic and robust due diligence,’ he says.

Underlying strength

Each lease needed separate scrutiny because of the differing sales volume achieved by each retailer before a top-up rent had to be paid.

‘Prior to going to the market, we had to get the message across that people were buying a business,’ says Nicholson. ‘One of the key elements we had to demonstrate was the underlying financial strength of the assets. ‘But there could be savings in management. It shouldn’t be taken as read that McArthurGlen would continue as manager. The prospective buyer might want to have an alternative by managing it itself or bringing in a third party.’ CBRE’s design and marketing team produced a shocking pink ring binder containing 72 loose-leaf pages – paid for by the sellers. It was illustrated by more than 100 photographs and diagrams and divulged information previously hidden from a prurient retail property industry. This information included: the average trading density in the three outlets of £345.65/sq ft; the fact that 91% of the 80 retailers had renewed their expired leases in the last four years; that Bridgend’s annual net income was more than £7m from 240,000 sq ft; Cheshire Oaks’ forecast that income was more than £12m from 328,000 sq ft; and Swindon’s gross income – £6.88m from 214,000 sq ft. Nicholson found it remarkable how little research was available on designer outlets.

As with all property data, the most important figure was the asking price: £400m. That would have led to a yield of 6.12%. With hindsight, and knowing that the price was £35.5m less than ‘offers in the region of’, Nicholson explains his position. ‘At the time, we were assuming completion in March 2008 that would have shown a net yield of 6.12%, rising to 6.74% by December 2011.’

However, marketing did not begin until February. The pink loose-leaf binder, accompanied by a financial model that set out the prospects of the outlets against the economic situation, resulted in Nicholson making 24 laptop presentations to prospective buyers. The one and a half-hour pitch was made to UK funds, Land Securities, ING, Apollo, Moorfield, Frogmore, US shopping centre owner Simons and German funds such as Allianz. This took place against a background of investors chipping away at asking prices of other property – and then chipping away some more, before buying bargains. In April, Nicholson called for best bids, and was surprised to receive half a dozen from the UK and Europe. By 23 April, he began earnest discussions solely with Henderson, while Moorfield was underbidder. McArthurGlen’s management contract was safe because it already managed Henderson’s factory outlets in Europe.

Tenants bust

There followed a tumultuous three months. Patrick Knapman, capital markets partner at Cushman & Wakefield, which acted for Henderson, recalls: ‘One or two of the tenants went bust, which caused an issue, but we found extra income that we weren’t expecting.

However, the cost of debt had increased, and that had a significant impact on the price. We had to report back to the investors, who had their own view about where they wanted to see the price. They told us the maximum they were prepared to pay, and the price came down.’

In May, the Financial Times estimated the price at £380m, but Knapman and Henderson negotiated the price down to £377m.

Knapman adds: ‘Then the cost of oil went through the roof, and I remember asking:

What happens if it is $200 a barrel and marks the end of car-borne retailing?’

The chipping continued. The price dropped to £372m, then £371m, then £370m, and it finally ended at just above £364m.

The sellers say that the yield was between 6.7% and 6.8%. Henderson says that it was more than 7%.

Contracts were exchanged on 28 July and the sale completed on 22 August.

The funding was in place after Henderson raised £181m of equity during the three months it was negotiating the purchase and created its UK Outlet Mall Fund. This is a 10-year, close-ended fund into which Henderson had put money, together with MV Services, a Dutch asset manager.

Henderson then turned for debt funding to Bayerische Landesbank.

Nicholson says: ‘We have a good relationship with Bayerische LB, and we could help behind the scenes to facilitate that debt because we knew so much about the portfolio [of outlets]. I was more concerned about Henderson’s ability to secure the equity than the debt.’

Despite the price chip, Nicholson says: ‘I must say it was a remarkable result, given the circumstances and the profile of the market. When we went to the market, bank debt was extremely scarce, and a number of major investors were sitting on the sidelines.’

Luckily, oil prices stabilised, and trade at Cheshire Oaks and Bridgend remained constant, while it increased by 5% in Swindon, possibly because John Lewis opened its first homeware clearance store there.

The swan glides on, although Nicholson doubts if its smooth swim could be repeated in the current investment market.

Henderson to go mall out

Managers of UK property funds have a reputation for passivity. They buy assets, hire managers and bank the rent.

Yet last August, between exchange and completion of the three designer outlets, Neil Varnham, Henderson’s director of retail property, made a proactive statement.

‘We will immediately begin an active management programme to extract performance by introducing new retailers, increasing marketing activity and commencing capital projects to enhance the desirability of the assets to both the consumer and the retail community,’ he said.

Andy Rich, who will manage the newly set-up UK Outlet Mall Fund, will be responsible for the practical working out of this unfundlike mission statement.

His first and biggest task is to revive the lapsed outline planning consent to turn Swindon’s 50,000 sq ft Long Shop into designer outlet units.

McArthurGlen converted Swindon’s 19th-century locomotive works into a designer outlet in 1997 at double the cost of new build. The Long Shop, which is parallel to the London to Bristol railway, is a listed facade intended for a later phase of designer outlet shops.

In 2005, McArthurGlen got Swindon Borough Council’s refusal to grant planning consent overturned on appeal. But the plan stalled because of possible ground contamination.

Rich says that the fresh application will be little different from the original application.

‘The sea change has come in the catering offer. It is quite traditional at Swindon, with a food court for people who like Harry Ramsden’s. But there is a demand for a more upmarket offer.’

The plan is to move retailers into the redeveloped Long Shop and use the vacated units as restaurants that can open out on to a piazza created by the Long Shop becoming a new side to a square.

The priority at Cheshire Oaks is to buy the freehold, because Henderson owns 144 shops on a long lease from the Church Commissioners.

‘Cheshire Oaks is enormous,’ enthuses Rich. ‘There is a long list of tenants that want to come into the scheme. But it hasn’t got all the tenants in the right place. We’re going to move the tenants around to have the high-end fashion retailers in the same place, the homeware retailers in the same place and so on.’

Rich sees Bridgend, on junction 36 of the M4, as an alternative to the Town Centre, because a supermarket, hotel and restaurant are close to the designer outlet.

This, he believes, will be achieved by decking over the car park to increase the number of spaces. Parking, eating, drinking and bargain-hunting will become more straightforward.

Source: http://www.propertyweek.com, 07.11.2008