While the headlines focused on how the daily commute would take place "in the sky" and that the new leisure activity of choice would be "hoverboard Quidditch", the report also contained some intriguing property predictions. While such predictions are best taken with a pinch or three of salt, it is fascinating how the overriding vision is of property development expanding into previously uninhabitable environments. Humanity will apparently turn its attention to building underground: huge "earthscrapers" burrowing tens of floors deep, offering a selection of living and working spaces and even sports grounds and leisure parks; luxury space hotels built outside our atmosphere as tourism turns intergalactic; and land reclaimed from the sea to form new floating cities.
From a legal perspective, these postulations offer up far more questions than answers when it comes to predicting tomorrow's real estate finance market. Will we now need to consider the potential subterranean development value of properties? How exactly does one value celestial real estate? What is the governing law of a floating city? How does one claim a proprietary interest on manmade islands or in outer space? Are we heading for a cosmic real estate free-for-all?
The new Samsung store
Returning to earth and more familiar bricks and mortar real estate, the new 20,000 square foot Samsung store, located in Coal Drops Yard near Kings Cross, raises some more immediate and less hypothetical issues for the future of real estate and in particular retail developments and investments.
The advertisements and website for Samsung's new retail space insist that it is "not a shop" and instead offer a myriad of alternative functions: music venue, lecture hall, catwalk, yoga studio and game arcade, to name but a few. There is also a free co-working space – a potentially savvy move as our employment habits shift towards remote and flexible working.
Promotional material also emphasises the creative opportunities offered by the venue; however it's also a space to display Samsung's own products and innovations. As such, it is kitted out to a very high technological specification, with a huge graffiti wall screen, 3D printing stations, DJ booth and car simulator. Furthermore, its vast space incorporates a high-tech show home exhibiting the living spaces of the future and the Samsung products that can be used to service them. While tills are strictly banned from the store, consumers are able to order the products on display to be delivered to their (real world) homes.
Dealing with a shop that's not a shop
From an investment perspective, the indefinability of Samsung's new space threatens to destabilise the two financial considerations that are at the essence of all real estate finance transactions: the value of the property and the value of the income from that property.
Firstly, considering the physical property that forms the subject and chief security of a real estate loan: how does one value a shop that does not call itself a shop and does not look or act very much like a shop? Samsung KX is unusual in that it is an exceptionally large space with a number of different functions that is occupied by a single tenant. Furthermore, the store is a high tech haven designed to Samsung's particular specifications, which would be challenging to adapt for a new occupier. The value of the building and its subsequent market value is therefore almost inextricably linked to the business that occupies it. For a valuer, this means it could prove difficult to estimate an objective market rental value that accounted for its current high-level occupant while also factoring in the limited number of potential alternative tenants that would equal Samsung's ability to fully utilise the venue.
As a new type of retail space, it is difficult to predict how the Samsung store and others like it will function in the long term. One consideration for investors and lenders, that will necessarily affect any valuations, is the tenancy duration and potential longevity of such stores. Does their novelty value mean they are best suited as short-term pop-ups to promote new products and innovations? It is difficult to predict, for instance, when Samsung's cutting edge show home of the future might require an even more futuristic upgrade. While pop-ups have the potential for short-term high-level gain as interest peaks, there is the risk of large retail spaces lying empty or under-utilised if there are not enough tenants with similarly advanced technological requirements available to fill it.
The alternative, that such stores will become a permanent fixture with longer tenancies, raises the issue of whether the income they generate is sufficient to power the large and costly venture. This brings us onto the second challenge, that of protecting and valuing the income of the property. Samsung's store again poses problems by eluding definition. Unlike traditional shops or purpose-built venues, there is no clear single income stream. Customers are free to use the space without charge or the obligation to make a purchase, as though it is a public space. This removes a steady stream of money into the venture. The potential sources of income instead come from larger one-off purchases: the paid-ticket only events and the orders of products displayed in the store. However, with no obligation to either attend or order, there is the risk that the building could make a loss. If these stores are the future, it is important that they prove that they are able to pay for themselves via such methods or they provide for an alternative source of income that can maintain them. If these challenges are not resolved, they will remain the reserve of established businesses with other significant financial resources.
For lenders and investors, it is important to work towards an understanding of how best to value these new types of retail space and their income potential. From a legal perspective, it is possible that they will lead to a rethink of financial covenants and property undertakings. In particular, the following points may need to be considered:
- How loan to value is calculated. Given the specific nature of the property interior, both a market value based on a similar tenant and a market value based on the plot without the technology (which may not be appropriate for a future occupier) may be required.
- Whether income covenants are required that reflect the different income streams for the property. There may be requirements for this to be above a certain level or even requirements in terms of the ratio of the streams relative to each other in order to balance risk.
- Whether the lender wishes to restrict whom the property can be leased to in order to ensure the expensive fixtures or infrastructure at the property are fully utilised and the property reaches its full market potential. Alternatively, an obligation to adapt the property to make it suitable for other types of occupier on the end of the tenancy.
- Covenants may be required that specifically relate to the maintenance of the technology infrastructure at the property as this is one of the main attractions and sources of income at the store.
The high street saviour?
Almost inevitably, Samsung KX and similar models are being touted as a solution to the declining British high street. Interestingly, rival tech giants' Microsoft and Apple also have interactive flagship stores, both of which are located in Covent Garden. The former has already billed itself as "more than just a store" with a gaming lounge and coding workshops, and the latter is renowned for being one of the first retailers to put its tablets and phones on display for shoppers to play with before deciding on a purchase. Along with the Samsung store, these attempt to lure consumers back to the shops by offering them experiences rather than simply products, most of which can now more easily and cheaply be ordered online
A problem with suggesting that these innovative concept stores are the solution to retail's woes lies in the fact that they are never located on actual struggling high streets. These stores are all based in central London in areas with a large amount of through-traffic, workers and tourists to sustain them. Furthermore, while large and wealthy companies are able to experiment with concept stores, it is harder for smaller struggling or new businesses to do so, especially while the market is uncertain how to treat the financing of such stores. While a big player like Samsung is seemingly a relatively low risk tenant with the support of an established retail technology business, it remains to be seen whether they are a viable option for companies that do not have the same financial backing or recognisable brand.
It is no secret that retail businesses are struggling and shops must offer more than a good product if they are to remain relevant and solvent. The Samsung store offers one potential innovative solution but that alone is not enough to save our high street. In particular, it is not certain whether other businesses will be able to echo this, especially when the value of such properties and the income they can sustain is unclear. Its financial uncertainty currently means it looks at risk of being the preserve of large, established names rather than opening up opportunities for new companies. What is clear is that Samsung KX offers a fun and unusual events venue merged with interactive advertisements of Samsung's technological products. As retail faces an uncertain future, offering a multi-functional space with varied offerings that can adapt to meet changing consumer demands – and keep the tills ringing – is currently the best protection.
(This blog post was researched and written by Natalie Starr, a solicitor in the Financial Markets and Products team.)
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