March 2011 Retail Investment Report 1

Research

This crisis has represented not only a turbulent time but alsofundamental change in the way this industry will be driven in thecoming years.

Indicators towards the new environment will be:

• Shopping centres are meeting points: it is not only about creating apurchasing experience but also a social experience.

• Tenant´s interest to be part of a scheme will be a fundamental keydriver for its survival.

• Scheme´s stakeholders need to learn to live with higher vacancyratios: transform vacancy into an opportunity to differentiate intenant-mix.

• Purchase/sales processes with a different approach: equity buyersmake the rules.

• Tenancy schedules already reflect all the bad news: incentives areno longer incentives, they are new rent levels.

Spanish retail market

a NEW PARADIGM for 2011

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Vacancy ratesThe general increase in vacancy over all shopping centresmeans that only very prime centres are able to boast the highlevels of occupancy that investors were used to seeing before2008. This is equally reflected in new projects where it is nowcommonplace to see shopping centres open with vacancy ratesin the region of 20%.

Changes on the Spanish market over the last few years haveuncovered what can be perceived as real structural vacancy; avacancy that is likely to remain uncovered into the medium termuntil the Spanish economy recovers. In today´s climate, shoppingcentres with vacancy rates of between 5% and 10% can now beconsidered the norm and not necessarily an indication of poorperformance. At the same time, schemes with up to 18% vacancycan be considered as in need of management and only those withover 18% as really problematic.

This structural vacancy raises issues for investors when benchmarking the quality of a centre and capitalising rental income.Investors are finding new formula for assigning value to vacantspace based on higher yields, sustainable ERV (EstimatedRental Value) and offsetting with deferred payments dependenton future letting.

* Without petrol stations.

Source: INE

Figure 2

Consumer confidence index

Figure 1

Retail Sales 2007-2010

• Four shopping centre transactions took place in 2010,reaching a total volume of approximately 314 million Euros.

• The first quarter of 2011 has already seen DoughtyHanson purchase two shopping centres from SonaeSierra for 120 million Euros.

• Additionally, there has been much interest surroundingschemes such as San Cugat and Puerto Venecia as wellas the Royal Bank of Scotland loan portfolio.

• Continual demand from international and pan-Europeaninvestors as well as opportunistic funds is leading tofierce competition for prime assets.

• The sustained gap between purchaser and vendor priceexpectations, together with a general lack of product inline with investor criteria, is resulting in a continuedabsence of investment activity.

• Unstructured and badly managed sales processes havedamaged the marketability of many good products,leaving them loosely hanging on the investment marketwhilst investors have moved on to new opportunities.

Key points


march 2011 investment report

Outlook

Sales

According to Spain´s National Statistics Institute (INE), the fallin sales continues to slow which is reflected in the stabilizationof consumer confidence, a positive sign that the worst is over.

Figure 3

Evolution GLA

Source: ICO

Source: AECC

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Rent levels

As the Spanish market moves towards stabilization, in generalrental discounts, despite their continual presence, arebecoming less weighty in terms of both value and duration.

Knight Frank estimates that over half of all existing leasecontracts have been reviewed over the last 36 months meaningthat income from at least 50% of shopping centres has nowbeen adjusted to market rent. Investors ready to invest over thenext year will do so off lower adjusted rents, offering potentialincreases dependent on market recovery and centreimprovements.

The table below shows the average rent levels registered in2010 according to different activities.

Category Average 2010 ERV €/sq m/month

Auto Center 12 - 13

Cinemas 10 - 11

DIY 10 - 11

Electronics 12 - 13

Fashion 20 - 22

Food 10 - 11

Gym 16 - 17

Household 15 - 16

Jewellery 53 - 59

Leisure 9 - 10

Phone 54 - 60

Restaurants 23 - 25

Services 25 - 28

Sports 13 - 15

Toys 14 - 15

Table 1

Average rent levels

Retailers

Knight Frank believes that retailers will drive the future successof schemes, choosing only those centres that meet criteria interms of location and catchment area and those which offercomplementary operators and attractive rivals, hence,commercial mix being as important as ever.

Many new international brands such as Apple, Deichmann,Ardene, Butlers, Hollister, Abercrombie & Fitch, Cos, Forever 21,Aldo, amongst others have sought to benefit from adjustedrent levels in order to enter the Spanish market. However, manyof these brands are having difficulties in finding units that fitspace requirements in their first preference locations, as themost prime centres continue to boast high occupation levels.

This has created an opportunity for managers of well-located,but less prime shopping centres to offer attractive incentives tothese new operators, who due to lack of space in the very primeschemes, are now beginning to consider more secondarycentres where space is available. This is allowing managers tosubstantially improve commercial mix by offering a differen-tiating element in terms of new brands in order to compete withthe more prime and fully let schemes.

The experience and capacity to manage vacancy correctly cancreate an excellent opportunity to improve the attraction powerof the scheme, through the introduction of new anchor tenantsand original retailers, specialization or refurbishment. Theopportunity to specialize in specific activities is a concept thathas been little developed on the Spanish market, but one whichallows the creation of a highly differentiating element. Equally,refurbishment which permits the centre to offer a more modernand user friendly design, can allow smaller schemes to offercustomer convenience as a way of competing with largercentres. Both new projects and refurbishments need to takeinto account that shopping centres need become meetingpoints: it is not only about creating a purchasing experiencebut also a social experience which is increasingly important toconsumers.

Source: Knight Frank

Figure 4

Prime Shopping Centre Yields in Europe (%)

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Investment Demand

The continued absence of investment activity is by nomeans attributable to lack of demand, as despite thecountry-risk perceived outside of Spain, international andpan-European investors remain interested in seeking wellconsolidated, dominant shopping centres, located in thelarger Spanish cities, whilst opportunistic funds continue tobe in pursuit of discounted prices.

Despite the continuous, albeit gentle, decline in sales, thegeneral view is that shopping centres remain a good longterm investment option, particularly in times of recession,as although private consumption remains lower than inprevious years, consumers do continue to shop.

This has been seen throughout the rest of Europe whereshopping centres remain a key investment. Directinvestment in retail assets in Europe has been estimated tobe up by almost 70% compared to 2009 which has resultedin a general yield compression across European marketsover 2010.

Many investors considerthis year as a window ofopportunity to invest inSpain, taking advantage oflower rents and with theexpectation of being able topurchase off higher yieldsthan those now available inother traditional Europeanmarkets.

Some investors arebeginning to readjustinvestment criteria to thenew market situation toinclude centres withvacancy that offer valueadded opportunity.However, it remains difficultfor investors to obtainadequately priced financefor the purchase of non-core products to beworthwhile.

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Supply

Changes on the Spanish retail market mean that only veryprime centres are able to boast the occupancy ratesgenerally sought by investors. This is creating fiercecompetition for this type of product. An example of this isthe frustrated sale of prime shopping centre San Cugat inBarcelona, owned by Altarea. This deal has generatedmuch interest amongst traditional Spanish shoppingcentre investors as well as new players. However, despiteaggressive offers reflecting yields in the region of 6%, thetransaction has not yet been completed due to the pricegap that still exists between vendor and purchaserexpectations.

In general, lending banks have not created the distressedopportunities that opportunist funds have been expectingand have opted to refinance debt before foreclosing onassets. However, as refinancing could become moreexpensive, this could lead to a change in the dynamics ofthe market with banks increasingly considering the sale ofexisting loan portfolios at discounted prices and vendorshaving to take steps towards closing the price gap.

The exchange of outstanding loan portfolios is providing aplatform opportunity for new funds and internationalinvestors looking to enter the Spanish market or to increasetheir exposure in Spain; their secondary aim, in many cases,being to recover possession of the asset in the future.Despite the complicated legal process involved in thisrepossession, this type of process has created speculationconcerning potential direct asset transactions.

There still remain value added opportunities for experiencedinvestors to invest in well located secondary centres withpotential to improve tenant mix via re-letting and moderni-zation management plans.

Four shopping centretransactions took place in2010, reaching a totalvolume of approximately314 million euros which isdown by almost 40% interms of volume whencompared to the fourtransactions which tookplace in 2009 (500 millioneuros approx.).

In addition to shoppingcentre transactions tworetail parks changedownership in 2010amounting to a furtherinvestment volume ofapproximately 53 millioneuros. It is worth noting inparticular the transactionof the Meixueiro retailpark in the north westerntown of Vigo en Galiciawhich was purchased byHenderson for approxi-mately 35 million euros ata yield in the region of7%, confirming thedemand for this type ofproduct.

Transactions and Yields

We should also note thesale and lease backtransactions carried outby Eroski, amounting toover 245 million euros toinvestors WP Carey, AEWEurope and Tristan CapitalPartners, and Rockspring.These transactionsincluded the transfer ofalmost 50 supermarketsas well as 2 retailwarehouses.

The first quarter of 2011has seen the purchase oftwo shopping centres byDoughty Hanson for 120million Euros from SonaeSierra. Plaza Eboli islocated in Pinto in theSouth of Madrid and has aGLA of approximately31.000 m², including theowner operated Eroskihypermarket (11.400 m²approx.). El Rosal islocated in the town ofPonferrada (northwest of Spain) witha GLA of approximately51.000m² and is anchoredby a Carrefourhypermarket. The twoschemes are fashionbased and include brandsfrom the Inditex andCortefiel groups, as well asH&M and C&A. Both sufferfrom vacancy rates of between15-25%. The blended yield forthe two assets is estimated at7.75%.

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Figure 5

Investment volumes

Shopping Centres

Vendor Purchaser Shopping Centre Location GLA Volume*

Multi Corporación Corio C.C. Espacio Torrelodones Torrelodones, Madrid 18.970 65.000.000

Avantis Alpha Tiger Centro comercial H2Ocio Rivas Vaciamadrid, Madrid 49.516 83.300.000

Eroski ING Centro comercial Bilbondo Basauri, Vizcaya 37.834 50.000.000

Eroski Deka Centro comercial Ballonti Portugalete, Bilbao 52.523 116.000.000

Retail Parks

Vendor Purchaser Shopping Centre Location GLA Volume*

Family Office Confidential Parque Ronda Sur Murcia 9,247 18.000.000

Confidential Henderson Meixueiro Vigo 18.200 35.000.000

* Knight Frank estimated volume

Table 2

Transactions 2010

Shopping Centres

Vendor Purchaser Shopping Centre Location GLA Volume *

Sonae Sierra Doughty Hanson Centro comerical Plaza Eboli Pinto, Madrid 31.000 35.000.000**

Sonae Sierra Doughty Hanson Centro comercial El Rosal Ponferrada 51.000 85.000.000

* Knight Frank estimated volume* * Transaction does not include Eroski hypermarket or cinemas – GLA transaction estimated at 17.600 m²

Table 3

Transactions 2011

This transaction shows thatexperienced investors remainconfident in the Spanish retailmarket and are seeingopportunities to acquire valueadded assets involvingsecondary cities or second-tier shopping centres whichrequire management,particularly with regards tovacant space.

Additionally, Eroski arecurrently in advancednegotiations with rivalsupermarket operator Leclercfor the purchase of 7supermarkets in Madrid,whilst there continues to bemuch interest surroundingdeals such as San Cugat,Puerto Venecia, both stillpending closure, as well asthe Royal Bank of Scotlandloan portfolio.

In the latter, Knight Frankadvised an internationalfinancial services firm in theirDue Diligence, providingopinion and advise on over 12retail assets, held as loansecurities, located throughoutSpain, with a total GLAexceeding 185.500 sqm.

These movements, togetherwith the transaction carriedout by Doughty Hanson andthe purchase of the Ballontischeme in Bilbao by Deka atthe end of last year, underlinethe renewed interest andconfidence from Internationaland German funds forSpanish retail.


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As in our previous report,Knight Frank predicts thatyields will continue toremain stable, prime yieldscontinuing at 7% andsecondary at 8%. Returnson 10 year governmentbonds compared to returnson commercial propertyshow that the spreadbetween debt and realestate assets is narrowing.The expected rise ininterest rates will againdecrease this gap. A lessermargin between bonds andprime office yields makesthe purchase of retailassets increasinglyattractive.

Figure 5

Yield differentials



As we have seen, increasein investment activity hasalready led to yieldcompression throughoutEurope, making Spanishreturns increasingly moreappealing. This willcontinue to generatesufficient interest to keepyields stable and couldeven lead to yieldcompression over the next12 months particularly inlight of the competition forprime assets. Potential forasset management,alignment of priceexpectations and financewill remain key totransactions over 2011.

Mario Verdyguer DuoHead of Retail Investment - MRICS

[email protected]

Elaine BeachillInvestment Retail - MRICS

[email protected]

Mario La Piedra

Valuations Retail

[email protected]

Investment Retail

www.knightfrank.es

Suero de Quiñones, 34-36

28002 - Madrid

T: +34 91 59 59 000 F: +34 91 575 73 23

© Knight Frank 2011. This report is published for general information only. Although high standards havebeen used in the preparation of the information, analysis, views and projections presented in this report, nolegal responsibility can be accepted by Knight Frank Retail or Knight Frank Spain for any loss or damageresultant from the contents of this document. As a general report, this material does not necessarily representthe view of Knight Frank Spain in relation to particular properties or projects. Reproduction of this report inwhole or in part is allowed with proper reference to Knight Frank Spain.

José Díaz Mérediz-HeviaRetail Partner

[email protected]

Rosa Madrid Retail [email protected]

Figure 6

Prime Yields - 10 years government bonds yield


March 2011 Retail Investment Report 1

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