The Great Retail Reset

Illustration by Raymond Biesinger

Illustration by Raymond Biesinger

On London’s crumbling high streets, two massive real-estate investors are banking on opposing strategies.

In 2018, Blackstone became the U.K.’s largest small-business landlord.

That year, Blackstone partnered with the U.K.’s largest privately owned property company, Telereal Trillium, to buy an entire portfolio of commercial real estate off British government-owned Network Rail. It seemed like a good investment: Network Rail, swimming in £46.5 billion ($63.9 billion) in debts, had delayed £162 million in investment in the portfolio. Tenants — thousands of them, renting sometimes damp, sometimes noisy railway arches for businesses including bakeries, hair salons, and car garages — were long overdue for structural inspections to make sure the trains could still run safely overhead. And because Network Rail still owned the tracks, the British taxpayer would foot the bill to inspect and maintain the structures, while Blackstone could focus on filling empty arches and revaluing tenanted ones.

The U.K.’s official national audit body said the portfolio had the potential for a 54 percent rise in rents over the next three to four years “owing to market conditions and irrespective of a sale.” Long before the sale, Network Rail had been trying to bring the rents up. But with debt mounting, a sale was seen as preferable. The subtext: It would take a private entity to max out the value of the assets.

Even before Covid-19, a commercial real-estate portfolio of that size was risky. As an asset class, U.K. retail property has become almost untouchable. The U.K. has more square feet of store floor space than any other country in Europe. It also has more shopping centers, department stores, and insolvency regulations — including company voluntary arrangements that make it easier for retailers to break leases. That’s before you even get into the shift to online shopping.

Then Covid struck, and the U.K. government made a decision that sounded the death knell. In April 2020, it banned commercial property landlords from demanding rent arrears or evicting tenants. Then, in September 2020, the U.K. hospitality industry warned that businesses would collapse if the moratorium was lifted — and the ban stayed.


Blackstone, with $649 billion under management, could weather a year without £80 million of rental income. It could wait out an 18 months’ suspension of rent increases and a moratorium on evictions that continues until March 2022. But it cannot escape the fact that the U.K. government has fundamentally changed the rules of the game. Where once an investor thought it owned a lease with a reliable income, comparable to a bond income, it now owns a relationship with the underlying market — in other words, a tenant. More than 70 percent of investors believe that U.K. landlords and tenants will have to consider new models for leases after the pandemic, according to a survey by PwC.

It’s not just Blackstone. In the U.K., institutional investors and pension funds with commercial real estate in their portfolio have been forced into this cuddly arrangement — in the knowledge that shareholders everywhere are watching. Real-estate investment managers are finding their work is becoming more about the service, whether that’s making the space more attractive to tenants or being more flexible about contracts. Angus Johnston, U.K. leader of real estate at PwC, says the relationship between landlord and tenants is irrevocably changed. “You’re going to have a more symbiotic partnership between landlords and tenants,” he says. “Increasingly, landlords are going to be providing space, whether it’s retail or office, on a more flexible basis, with rents that are more tied to performance. Landlords are not deaf to the whole ESG agenda. The social aspect to that is something people are increasingly aware of.”

Some investors are taking radical measures. In April, Legal & General Investment Management (LGIM), which manages £1.3 trillion in assets, launched what it is calling “a blueprint for the future of the high streets.” The trick? Fill all that empty store space by giving it to entrepreneurs — for free.

“I’ve never owned a shop before in my life,” says Hope Dean, who now runs a plant store in a shop that had been empty for six years on Kingland Crescent, an unloved shopping street near the train station in Poole, a seaside town on England’s south coast. Dean was working as an events manager when her job was swiftly made redundant by the pandemic. A week after she started working on a business plan for a plant shop, she heard about the opportunity to take on an empty retail unit on Kingland, with free rent and business rates for the first two years.

Even so, half her family thought she was crazy. “It’s still a massive risk to open a shop in the pandemic,” she says. “The world is so uncertain. Most people want to expand on their business at home, not take on the risk of a whole shop. I’ve worked out how many plants I have to sell a week to break even.”

Giving away store space was not a decision LGIM took lightly. Kingland had been in the works since 2018. But as the pandemic accelerated the decline of brick-and-mortar stores, LGIM started to think about its real-estate portfolio more like the build-to-rent sector: Build something people want to rent and offer them a short lease. “In that case, the owner has to be good at producing what occupiers want and at filling gaps,” says Bill Hughes, head of real assets at LGIM. “And retail has become closer to that: You may as well get on the front foot and provide what occupiers need rather than signing long leases that might not be appropriate ten years from now. It’s much more important to look at what they want around ESG, to look at carbon capture.”

This is a massive change of mindset for real-estate investors. A few years ago, LGIM investors, which include corporate pension funds and public-sector funds worth trillions, might also have thought the idea of giving away rentable shops to first-time entrepreneurs was crazy. In the 1990s, most U.K. funds of this scale had real-estate investment trusts split into different asset classes — with around half in retail, around 30 percent in industrial real estate, and around 20 percent in office space. Retail real estate was given such a big allocation because it was considered the most secure investment, written on long leases and offering an investor ten or 25 years of secure income. But in the intervening years, alternative asset classes have emerged: build-to-rent property, storage, even prisons and schools. “The universe of investment is wider, and the appeal of real estate has materially changed,” Hughes says. “Clearly the world has changed. There are lots of features, but with the emergence of online retailing, this sector called retail has been facing headwinds for some time.”

That’s something of an understatement. LGIM was tight-lipped on exactly how many retail assets it owns, including shopping malls, retail parks, and U.K. high streets, which are the equivalent of U.S. main streets. But the £4.5 billion portfolio started causing headaches even before tenants of these assets had a chance to get into arrears. In March 2020, days after Prime Minister Boris Johnson ordered the U.K. into lockdown, LGIM, Janus Henderson Investors, BMO Global Asset Management, Columbia Threadneedle Investments, and Aviva Investors announced restrictions on their flagship property funds, freezing more than £10 billion worth of investments. A year later, M&G’s U.K. property fund was still to reopen. It was a stark reminder that real estate as an asset class doesn’t lend itself to quick, easy sales.

In a note to investors sent on May 22, 2020, LGIM said its £2 billion U.K. property fund had collected just 76 percent of the rent owed by the end of March. Offices had delivered 88 percent of their rent, but retail just 61 percent. The property fund would not reopen until October, seven months later. Something, it seemed, needed to be done. The conditions were new, but the underlying problems with retail as an asset class had been on the minds of investment managers at LGIM for some time. In October 2019, they had hired Denizer Ibrahim as head of retail and something they called “futuring.” Ibrahim, who describes himself as a “recovering architect,” came to LGIM with a background in urban planning and a mandate to completely rethink how LGIM did retail. Ibrahim had spent time at BNP Paribas working on something called commercial placemaking that was supposed to bring together two streams of real-estate asset management: rent yields and occupiers and the underlying spaces and places. Then one day, he realized something was missing: the consumer. “Real estate was very fixed, and consumer expectations were very fluid. I believed the future of retail was about agile, flexible environments. So I jumped ship,” he says.

At LGIM, Ibrahim is living out his consumer-driven fantasies. In LGIM’s shopping centers, he’s transforming corridors into experiences in a bid to engage consumers as they drift between stores. In Eastbourne, another south coast town, LGIM is transforming another shopping center with swings, roundabouts, and seating on the theme of play. Each center will have an events program with book clubs, chess, exercise classes, and yoga — plus art on the walls and more flexible, ad hoc retail opportunities like market stalls for entrepreneurs. “This is not as expensive as you may think,” Ibrahim says. “And every product piece of the initiative has their own ROI and KPI attached to them, plus a data analysis team and a data dashboard. Everything we’re launching is being measured to work out how we create a holistic strategy.”

Then there’s the free rent. As part of the project, LGIM Real Assets is giving ten businesses a shop on Kingland, where Dean opened her plant shop, with no rent or business rates for the first two years. It is also launching a local market for up to 15 vendors. LGIM owns the Dolphin Shopping Centre next door to Kingland and hopes that by resurrecting the high street, it might inject “identity and vibrancy” into the town center as a whole. Entrepreneurs like Dean are happy. When I called in June, she said journalists were calling every day to hear about the scheme. A glowing piece in The New York Times had just come out touting LGIM’s work in Poole and its new leasing model, offering tenancies as short as three months and contracts with rents based on the company’s earnings, known as turnover leases. It did not mention that LGIM’s fund had been suspended, nor that 40 percent of retail tenants had not been paying rent. By this summer, Legal & General Group’s share price was trading back around pre-pandemic levels of 270p on the FTSE 100, having hit 157p in March 2020, when the funds were forced to close.

LGIM made a bet: Two years of no income will be rewarded by creating a sustained stream of income that will grow in line with inflation, creating security of income over the long term. “I don’t think it’s right to abandon towns and cities around the U.K. just because the retail proposition isn’t working,” says Hughes, head of real assets. “If owners and local authorities don’t do this, it’s quite hard to see how these towns and cities will recover.”

Perhaps even more importantly, Hughes says, in an era where ESG is king, the social responsibility plays out well with stakeholders and shareholders. “We’re not saying the Dolphin Centre is doomed; we’re saying it requires careful, thoughtful, remedial activities to give it a long-term future,” he says. “The project is time consuming and intensive, but once it picks up momentum, we will end up with an asset that will reward our activities — and reward the pensioners.”

Blackstone has taken a very different approach. Right away, its purchase of commercial real estate in railway arches marked a departure from the fund’s usual “buy it, fix it, sell it” strategy of refurbishing unloved properties and selling them for a huge profit, in favor of a buy-and-hold approach. It formed a joint entity to buy and manage the arches with Telereal Trillium, which manages assets worth £8 billion. They called the new entity The Arch Co.

The deal, worth £1.46 billion, was among Blackstone’s biggest British real-estate investments. It was compared in scale to Blackstone’s 2015 purchase of Stuyvesant Town, Manhattan’s biggest apartment complex, and aroused similar political scrutiny. Meg Hillier, the politician in charge of Britain’s Public Accounts Committee, called the deal a “fire sale” to plug a debt, and asked the U.K.’s National Audit Office to look into it. The deal struck fear into the hearts of mechanics, breweries, and bakeries across the country — business owners who had already been facing steep rent increases when their properties were publicly owned. In 2016, tenants of the railway arches had formed a trade association called Guardians of the Arches to oppose steep rent increases. It opposed the privatization of the arches during the sale — and although the privatization succeeded, the tenants managed to get Blackstone to sign a charter, an informal agreement to hold regular meetings and communicate any changes.

Commentators called the deal “a bet on the economic prospects of Britain” in the aftermath of Brexit and in the middle of what many had already identified as the terminal decline of the high street. Adam Dakin, managing director for new business and services at Telereal, denied that The Arch Co. was planning to drive up revenue solely by raising rents, pointing out that 900 of the arches were vacant at the point of sale, mostly due to poor condition, and were ripe for redevelopment. Then the pandemic hit, and what was a bad situation for U.K. retail became immeasurably worse.

In 2020, the British high street lost two behemoths: department store Debenhams and Arcadia Group. Almost 30 million square feet of retail space permanently closed across the U.K. in 2020 alone. These colossal brick buildings, once filled with vibrant concessions, bored teenagers, and middle-aged women queuing with trays in lunch canteens, now lie dark and empty in the center of many U.K. towns, their shuttered doors a physical manifestation of the rot that has set into the retail sector. Elsewhere, a trail of smaller dominoes was falling. Every day of 2020, an average of 48 shops, restaurants, and other leisure and hospitality venues closed permanently across England, Wales, and Scotland, according to figures compiled by the Local Data Co., a research provider, for PwC. The U.K. government passed the Coronavirus Act in March 2020, which enabled it to provide rent relief to small-business tenants, leaving landlords like The Arch Co. without payment for rent in March and beyond. The real sting for tenants would come further down the line: Once the moratorium expired, tenants would find themselves on the hook for all of the rent in arrears.

When the pandemic hit, The Arch Co., under pressure from tenants, agreed to suspend rent negotiations with tenants and set up a £10 million hardship fund, which it said would pay for rent-free periods for 1,450 of the most severely affected tenants. Guardians of the Arches said the offer was a “result” for tenants: “Many businesses would not have survived — they were considering going into liquidation rather than having to carry the burden through the crisis.”

Since the rent moratorium ended in July, The Arch Co. has reverted to renegotiating rental contracts. Hanna Ozkoch, who runs the Arches Cafe, a working-men’s cafe in Bethnal Green, said The Arch Co.’s plan to more than double her rent from £16,000 to £35,000 was “totally impossible.” “We serve working-class people and just can’t charge obscene prices,” she told a journalist from the London Times in December. “That’s why so many small businesses are leaving.”

There is one thing standing in the way of a spate of evictions: The U.K. government’s ban on changing the locks in pursuit of Covid-19 commercial rent arrears, which was recently extended to next March. That ban is significant: Many tenants will not be able to afford to pay back the money owed, and in many cases, The Arch Co. has said it will not allow any more rent arrears discounting.

The future for many of these tenants is unclear. Over the summer, The Arch Co. made two announcements. In August, Glenny, a U.K. property management company, announced that it had been appointed to market a portfolio of 114 Arch Co.-owned units in London with rental value worth £2.1 million a year. The Arch Co. said these properties needed capital investment — investment that required borrowing beyond the power of a public entity like Network Rail. A lot of that capital expenditure had to be paused because of Covid, but as the lockdown eased, The Arch Co. was preparing to bring empty arches — which make up a quarter of the portfolio — back into use. It came on the heels of the news that The Arch Co. was getting a new chief executive, Craig McWilliam. McWilliam previously worked at Grosvenor, an ancient, global property company owned by a royal, the Duke of Westminster.

Ask James Seppala, head of real estate in Europe at Blackstone, how his strategy has changed in the last three years and he’ll tell you Blackstone is interested in three areas: logistics, rental housing, and life sciences. “The pandemic has both accelerated and disrupted certain trends,” he says. “We believe it has accelerated the shift toward e-commerce — on the one hand, benefiting the logistics sector, but on the other, impacting certain subsectors within physical retail.”

In logistics, it’s the “last mile” that he finds most interesting. “Covid-19 has accelerated the growth of e-commerce penetration, particularly in continental Europe, we believe, where e-commerce was relatively under-penetrated.” He points to the success of Mileway, a logistics company owned by Blackstone that focuses on the last mile before delivery. Mileway has grown to occupy 14 million square meters across ten countries. “As consumer preferences continue to evolve, our sense is that the demand for distribution centers in infill locations may increase.”

Enter McWilliam, a man from a family of surveyors — his father and his wife are both in the trade. McWilliam initially cut his teeth in private equity and investment banking. He once boasted that prior to joining Grosvenor, he had bought a building off it on behalf of Fortress Investment Group, a U.S. investment giant, and had sold it on for £1 million more than he had paid — before he had even signed the contract.

At Grosvenor, he made a name for himself as an expert in securing planning rights during his work on a former biscuit factory in south London. In 2018, Grosvenor applied for planning permission to convert the old factory site into more than 1,300 homes to rent. When permission was initially rejected by the local council in 2019, McWilliam doubled down, writing articles in the press about how the company would “throw ourselves open to public opinion” and seek “a fairer balance of power between community, planning authority, and developer” to win support for the new development. A year and an intervention from the mayor of London later, Grosvenor was granted permission to convert the site into more than 1,500 homes to rent.

That experience matters with a portfolio where surveyors are heading to arbitration over the issue of how much the retail space is worth per square foot — and how value might be increased by raising rent, changing the size of the lease, or changing the use. In mid-August, a handful of business owners gathered in an arch in east London to discuss these developments — and how they could resist rent hikes and eventual eviction. A quarter of The Arch Co. portfolio across the country is empty — but occupation is increasing in this part of east London. Seventy-five percent of units were filled in 2019, and The Arch Co. is now in talks to fill the remaining properties. Tenants have noticed that the kinds of businesses coming in are not the same as the ones leaving. The family-owned cafes and the migrant-run mechanics are shutting up shop. Outside, Deliveroo drivers on bikes pull up near shuttered archways bearing small signs for chain restaurants. Mopeds line up in front of open arches filled with rows of metal shelving, bursting with dried goods and household cleaning products. Blackstone said the sudden influx of speedy grocery-delivery companies in this part of London is a result of demand from these companies for space, rather than the result of any company strategy. In this prime urban location, companies like Weezy and Zapp say the arches are ideal places for business. Erin Peyman, head of property at Weezy, says the company has been working together with The Arch Co., using its property location requirement list to look for its next fulfillment centers.

Residents, however, have complained of the constant noise from mopeds coming and going at all hours, while existing tenants fear the death of local ecosystems of businesses that once served one another. “The risk here is that a landlord will operate on a maximum rent model and there will be an over-saturation of a particular business type to the detriment of the estate,” says Leni Jones, managing director of Guardians of the Arches. The Guardians have called for local and central governments to review how rent valuations are conducted.

“Is the only way to resist to threaten to move out?” asked Ben Mackinnon, who started the E5 Bakehouse ten years ago. The bakery and cafe occupies two arches right under London Fields train station and employs 100 staff. After the moratorium on rent increases ended in June, Mackinnon and several other tenants on the street were facing steep rent increases to match new tenants on the street. “They’re asking top-dollar rent for shabby conditions,” he told the other traders at the August meeting. “With that downpour a couple of weeks ago, we had rain coming through the ceiling.” Among tenants, the mood is combative — a world away from the “symbiotic partnership” described as the future of commercial real-estate asset management.

When it took over the portfolio, The Arch Co. introduced an affordability mechanism as part of its tenants charter, drawn up in consultation with Guardians of the Arches, with the aim of keeping a diverse mix of businesses in the arches. As part of this effort, it agreed to stepped rent increases, relocation options, and rent concessions in the form of “side-letters.” These are private arrangements between a tenant and The Arch Co. to pay less than the contracted amount, in return for financial information from the tenant, including audited accounts, to determine how much it can pay. The Arch Co. says this information is necessary to establish concessionary rates. But some tenants have said that the information requested is excessive. Side-letter deals risk inflating the market, Guardians of the Arches has warned, as the contracted amounts are often different from the amounts being paid. In an interview with the London Times, Jones said that without transparency of rents, “the entire commercial renters market will be in crisis across London and nationally within the next three years.”

Nonetheless, The Arch Co. says its occupancy figure has remained stable throughout the pandemic — a remarkable achievement given the rates of closure for small businesses nationally. In December 2020, one year after it took on the portfolio, The Arch Co. said its churn rate, or the number of businesses leaving, was 7 percent, down from 11 percent under Network Rail, while 150 arches had been brought back into use. Small- and medium-size enterprises still made up 90 percent of occupants, unchanged across the year. The Arch Co. said it had cleared 50 percent of the backlog of outstanding rent reviews within the first 12 months, lower than its target of 80 percent because of the onset of Covid-19. Guardians of the Arches said that although The Arch Co. hasn’t lost any tenants, some have surrendered part of their lease, giving them less space.

Blackstone describes the arches as a “unique portfolio” within its real-estate division. But there are signs that it is increasingly hunting for assets to give both institutional and individual investors exposure beyond the traditional portfolio. “Because in today’s backdrop, where rates are so low, where a traditional 60-40 portfolio just isn’t generating enough return in both appreciation of the underlying assets and also income, investors and advisers are realizing that to generate the income and return on a risk-adjusted basis, [you need alternatives],” Todd Myers, senior managing director and chief operating officer of Blackstone Private Wealth Solutions, told Citywire. This month, Blackstone raised €250 million ($290 million) for its Blackstone European Property Income Fund, giving private investors access to its flagship European Core+ real-estate fund, usually reserved for institutional investors. “You may not need the daily liquidity, which a stock and bond portfolio provides. We would suggest, as would most CIO offices, by having almost all assets in a daily liquidity structure, you give up return and income,” Myers said.

Blackstone’s flagship European Core+ fund, launched in August 2017, now has nearly $17 billion in assets under management. Blackstone says it delivered a dividend yield 340 to 440 basis points higher than government bond yields in the 12 months to August 2021, and offered investors a hedge against inflation, since real-estate income increased faster than inflation over the last decade. Seppala says Blackstone’s size gives it access to vast amounts of data, allowing it to pursue bigger margins within its portfolios: “The scale of the portfolio we manage gives us access to large amounts of proprietary data and real-time information, which is incredibly helpful in informing and guiding our investment strategies.”

LGIM would not confirm where Kingland sits within its fund portfolio, saying only that its retail assets are found across a number of funds. Its Managed Property Fund, a £3 billion fund containing 70 assets, is around 20 percent invested in retail, including warehouses and shopping centers. There are signs LGIM is trying to reduce this fund’s exposure to retail: In the second quarter of 2021, it disposed of four assets, including two high-street shops and a retail warehouse park. Meanwhile, the LGIM U.K. Property Fund, which has over £2 billion in assets, offered investors a 7.96 percent return in the 12 months through June 30.

The changing makeup of these portfolios is a signal to investors that the landscape in commercial real estate has irrevocably changed. “The basis of a lot of the decisions that were made in the past have been undermined by what has happened [during the pandemic],” says Johnston from PwC. “There’s going to have to be a reset, and that’s never an easy experience.” Johnston says investors will increasingly find themselves in a situation where the financial viability of the investment is linked to the success of the tenant — and that investors will get ahead by using data creatively to figure out how to change the terms of their offer.

“The whole question of the data that you need to be a successful landlord — how you decide what data you need, how you collect it, how you analyze it, how you distribute it — is going to be a really interesting piece,” Johnston says. He says landlords are going to have a much closer understanding of the financial performance of their tenants and the different ways in which value is accrued to the tenant through the tenancy — just as The Arch Co. is requesting to see the financial data of its tenants, and as LGIM is using turnover leases for new tenants and leveraging data analytics to be more fluid and flexible in the way it fills legacy shopping centers.

“There is going to be a role for real estate in retail going forward,” Johnston says. “And I bet that in the future, people make money out of it too.”