The Innovators: Legal & General’s Retail Leasing Strategy

In this series, Bisnow highlights people and companies pushing the commercial real estate industry forward in myriad ways. Click here to read Q&As with all the innovators Bisnow has interviewed so far.

UK retail property is a dark and stormy place right now, and it’s not just because of the coronavirus pandemic — a lot of it is to do with the way retail property is leased. So one big institutional investor decided to fundamentally change the way it leases its retail schemes. 

For decades, the way British leases were structured, with long tenures and rent reviews every five years where the rent could only go up, worked just fine for property owners and retailers: Both sides had certainty and security. 

But as consumer habits changed, retailers became locked in to leases on high rents at unprofitable stores. Landlords had a choice of either cutting rents or risking a tenant walking away or going bust, leaving their units empty. The uncertainty has led to a huge plummet in retail property values, and the whole situation has only being accelerated by lockdowns and social distancing.

Before the pandemic hit, Legal & General Investment Management Real Assets, which owns 76M SF in the UK, decided that rather than ignore the issue, or try and sell out of the retail sector, as some of its peers are doing, it wanted to change the way it leased retail assets.

“We talked to our customers and our team and they told us that leases were becoming more and more of a barrier to success, rather than a springboard for it,” LGIM Real Assets Head of Retail & Futuring Denz Ibrahim told Bisnow in an interview.

As part of a wider overhaul of its retail holdings, including converting parts of shopping centres, high streets and retail parks to other uses, it is offering retail and leisure tenants four different types of lease, each with varying degrees of flexibility.

“We see this as something that allows us to protect value as we embark on the journey of making our assets more resilient,” Research Manager Matt Soffair said.

If retail is to reinvent itself, long-term owners will increasingly have to embrace the complexity that the sector now requires, and its creativity in doing so makes L&G a Bisnow innovator. 

This interview has been edited and condensed for clarity.

Bisnow: What made you decide to change the way you lease retail and leisure property?

Ibrahim: We launched this in the middle of the pandemic, but it’s something we were looking at before that, since I joined the company in October 2019. We are physically changing our assets, repurposing or improving or converting parts of them, but we wanted to change our philosophy, too. We talked to our customers and our team and they told us that leases were becoming more and more of a barrier to success, rather than a springboard for it. 

Bisnow: How does the new lease structure work?

Ibrahim: We’ve got four key packages, which are designed to appeal to different types of occupier. 

There is the flexi lease, which is a simple turnover-based model aimed at small and medium-sized businesses and startups, with shorter lease terms [three to 36 months] where they take white-box space. It can be super quick and allow a new type of occupier to come into our centres that traditionally might not have had access to it. 

We have the operational lease, which is aimed at midsized or national brands where a traditional lease doesn’t work for them anymore. That has a turnover lease for a slightly longer term [three to five years] with an owner lease break linked to performance so we can take back the asset if we don’t think the tenant is contributing to the performance of a wider scheme.

Then there is the flagship lease. There’s not much to say on that, but some resilient occupiers still want a traditional lease, but again there are a series of metrics — we have to see if they are driving footfall. 

Then there is the flexi flagship lease, which has the flexibility of a turnover lease, but for the duration of a flagship lease [five years plus]. Some brands might spend a lot on fit-out so need a longer lease to make a return on that, or they might want to test a market, so they need time to engage with their customer, but still want flexibility.

Bisnow: What does the new lease structure change for you and your occupiers? 

Ibrahim: Property used to be a sector where the landlord would lease space and then just step back. In retail that meant leasing space to a big brand on a long lease. Today, it’s an operational business — we talk about moving from being a librarian to an editor, you are curating an experience, and we are turning our retail assets into a platform for experience. Retail is now about the global and the local, about retail and nonretail, so we are not thinking about our retail assets in a holistic way: how you curate what you do in Poole might be totally different to what you do in Northampton, because the customer is different. 

So the different types of lease give our teams the flexibility to do the right deals at the right time for each particular place — you need to bring in different kinds of business that will appeal to the local customer. And for our occupiers, it gives them optionality and flexibility in the way they run their business. 

Bisnow: How do you see the financial impact of the more flexible lease structure, especially given valuers have traditionally ascribed greater value to property on long, fixed leases?

Soffair: We discussed this with a lot of different parties — occupiers, other landlords, investors — and valuers were definitely a key stakeholder that will help us to find the right solutions for retail assets. 

The way our turnover leases work, there is a base rent element and then an element based on turnover, and the ability for us to break leases is definitely something that gives us comfort.

But we see this as something that allows us to protect value as we embark on the journey of making our assets more resilient. Empty shops don’t have much value, whether they are on a traditional or a turnover lease. There is a change coming through more generally in that property is moving to more operational models in other sectors too, like offices, so this is not that different. 

A turnover lease gives you visibility on the cash flows of your retailer and of your individual unit, so as an investor you know how secure the income you are receiving is and how sustainable that income is over time. We think this is a big part of how retail will be curated in future, a move to an evidence-based approach. If your tenants are healthy and profitable, then your assets will be healthy and profitable, too. 

Bisnow: What kind of data does it take to make this strategy work? 

Ibrahim: The data piece is really important; as you make this shift, everything you do is responding to data. Knowing things like retailer turnover is partly about knowing how we drive the relevant audience. If we were a website, we would know everything about our customer, and we want to do the same thing: We want to know who is coming to our schemes, what the travel time is, what their spend is. 

Soffair: Typically property has relied heavily on data like footfall, we want to measure things more in real time, on a granular level. So that can be looking at things like credit card data or social media activity, right down to in-depth surveys and ethnographic data on how people use centres. As you move away from that lagging data like footfall to more real-time data, you can scale up what is working well and scale back what is not working more quickly. 

Bisnow: Have you managed to solve the perennial problem of how to account in turnover leases for sales which might originate in store but ultimately end up being made through a retailer’s website?

Soffair: We work very closely with our operators to understand their trading data and what is incorporated and what is not. We know and they know there is more value in the stores than just what is going through the till. 

Bisnow: Does a different philosophy mean hiring different kinds of people? 

Ibrahim: That starts with me and my team. I’m not a property guy or a surveyor; I’m a designer, and I meandered into commercial property somehow [before L&G, Ibrahim was head of Commercial Placemaking and Masterplanning at BNP Paribas Real Estate, and prior to that he was at Appear Here and the London School of Economics Cities Programme]. I’ve ended up here and I’ve taken the learnings I’ve had from the strategic to the asset level. We are hiring creative local minds who know how to drive engagement, and they are working hand in hand with the operational teams for our assets. We are repurposing parts of our assets, but 50 or 60% of them will still be retail so we have to curate that, and we are bringing in new minds to help us do that.

Bisnow: Most importantly, how have tenants reacted? Are you seeing any patterns in terms of who is taking up what kind of lease?

Ibrahim: The conversations we’ve had with our operators have been really positive. A lot of the conversations have been about the more flexible lease packages, because things are very Covid-driven at the moment, and there has been much more uptake from SMEs and smaller businesses because of that flexible element, and because we have that, we are able to talk to and offer something for those smaller, local businesses. We’ve been talking about things becoming more local for years, and the pandemic has driven that move towards localism. So we are seeing a lot of new startups coming into our centres, but a lot of retailers taking our operational leases, too. But it is in six months’ time, when things start to open up more, that we will really start to see the possibilities of finding new ways to flexibly do business with our operators.