During the COVID era, you called the operators and offered a discount, a reduction without knowing what would happen in the following months. No one else did that. They were forced to close their store, forcing them to pay you the rent, they would be paying it, let's say, from their savings. We opted for a moral decision which was nothing, the rents were forgiven, we entered with the same occupancy with which we left COVID, while our competitors, who called us, of course, by phone to curse at us, were all between 700 and 1000 lawsuits, while we had 45. Those who complained told me, 'But you're stupid, shopkeepers have no memory.' 5 years later here, Ismael, and we still remember. Or don't you plan to participate in some way in the future in that online sales that brands do within your shopping center? It's a difficult nut to crack, but you also have to know your role. We are the infrastructure provider. What is important is the retailer. You also have to let people enjoy, not always try to stick your spoon in to make their profitability smaller. A hidden camera and we didn't notice. It's not the speech we are used to. It's you have an 11. I'm going to raise your rent so you reach 14 because I understand that at 14 you live like a king.
Good afternoon everyone, welcome to the fourth season. Jordi Carlos, we are Jordi Farrey and Carlos Vila and today we are at Lum space in Ruiz Picaso. Spectacular. Thank you for letting us use this space and we have a top-notch guest, fourth season. We had to start strong. Very strong. Welcome, Ismael Clemente, CEO and founder of Merlin.
Thank you very much. It's a real pleasure to be here with you and I hope we have a good time and can comment on whatever you want.
Ismael, thank you very much for being here with us today. How do you go from founding a startup to having one of the most important SOCIMIs in Spain, if not the most important SOCIMI listed on the stock exchange?
I think basically it's the result of a mix of work and of course also chance and luck. We had the bad luck of losing our jobs in the middle of the worst of the great financial depression in 2012. And we also had the bad luck that at that time the possibility of finding a job with a little payout, as my mother says, was very complicated. So we five colleagues who left the bank where we worked had to sit down and reinvent ourselves and start a new project from scratch. That project initially, since the only money we had was the severance pay from the bank, was an asset management boutique where we did more of a consulting role, support in management for international funds, rather than a company we couldn't afford to set up properly. And so we were for a while and it went well. We were comfortable working with different international funds, with some very well-known ones, and we made a place for ourselves in the market again. But what happened was that those funds gradually drifted towards the world of non-performing loans, the bad loans, and we didn't like that at all, so we had to practice a second resurrection from the dead, we had to say, let's see what we do now. And then we saw that there was a newly created figure in Spanish legislation, the SOCIMI figure, and we believed it would allow us to raise some money in the market and that would now allow us to found a company, a company with employees, with problems, with people retiring early, with churros with chocolate to celebrate someone having a baby. That was the idea behind it, and we applied ourselves to that from 2014 onwards. We had more luck than expected in terms of fundraising, because the Spanish cycle was so damaged that we found that a lot of foreign hedge funds considered it reasonable, though it wasn't obvious, to give us money to buy assets in the hope that with all those assets we would create a company that made sense and could be successful in the future. And so we did. What happened then is that when the company started to take the right steps and began to increase in value, all those hedge funds withdrew and institutional funds came in, and until today the company has been growing, and today it's more or less big, and the success or merit has been to simultaneously combine asset operations, buying, developing, building things, with liability operations, raising capital through capital increases or debt when it was time to raise debt. That's the story.
All these moments you've lived through since you founded it, right? In 2014, I think you're the first Extremaduran, one of my favorite lands, a great unknown. What is your escape? Because everything you've told us is about the first payout, problems, you start, you start to grow, you billed more than 500 million last year. How do you find your escape in the countryside in Extremadura? What do you do to relieve a bit of the weekly pressure?
Well, you've described it yourself, 'Campo.' I mean, on weekends, if a bomb goes off in Madrid, it's rare that it catches me. Usually, it's hard to make it to Friday for something, but even if it's just to sleep, even if it's late, I try to leave, not necessarily to Extremadura. Extremadura, of course, is my land and I go there when I can, but to other places in Spain. I love nature and I love hunting. Specifically, a modality called 'recho,' which is basically dressing up as a tree and chasing animals in the field. That's what I like. I'm lucky that my children also like it, and so we spend hours and hours doing little kid things, lying on the ground in the most curious places in Spain. It's very good for getting to know rural Spain, driving on secondary roads, getting to know the bars where you eat this or that stew, getting to know wonderful people who help you a lot to change the register from the ordinary work week. You talk about things that are unthinkable here in Madrid. Like how the sowing is going, if they're already starting now, we're already in September, if they're starting to bellow, if they're not bellowing. Yes, the famous bellowing, which is spectacular and if you haven't experienced it, I recommend it because it's spectacular. Every CEO has their relaxation moment, totally, and we all bellow at some point. [Laughter] 100%. Well, you know that the bellowing also applies quite a bit to urban life. Politicians are almost always in bellowing mode, and in the business world there are also some moments of bellowing. Totally, totally.
Ismael, speaking of hunting, at what point did Merlin decide to go hunting for shopping centers in the Spanish market?
Well, from the beginning, and I've often thought about why. I think simply because of tradition. We came from having been, in my case, 16 years, and almost all my colleagues, a little less, but because we spent a lot of time working at an international bank that had different management strategies. We had started our journey at an American bank, and what we did was, since we were on the balance sheet, that bank had a fairly humble balance sheet, so we did mostly venture capital, small investments that sought big returns. The first one we did in Spain was an investment, curiously, in shopping centers in Catalonia called Filo SA, a listed company that belonged to Lagunaro, Mondragรณn Corporaciรณn Cooperativa, and two Danish pension funds, and it went through a significant crisis around 1996, and we had to do a capital increase to reduce the number of creditor banks from 28 to 8 and give the company a new life. And from that rescue, let's say, the company started to do very well, and in 2002 we sold it to a joint venture between ING and Sonae. So all those years we were in contact with retail, with shopping centers, and so the experiences you have when you're in your twenties are not forgotten, and I enjoyed it a lot. I remember that after a series of events, it ended up landing at the company first as CFO, but immediately as CEO, Pere Viรฑolas, who today is the CEO of Colonial, which has moved into the turbulent world of offices, but at that time he was doing centers, and Pere for me was God, I was a kid and I learned a lot from him because he had a lot of substance. He had worked on the Barcelona stock exchange, he was a very well-known financier, he taught at ESADE, and so I spent my life in Barcelona, I was as happy as a partridge, I left on Mondays, came back on Fridays, Barcelona seemed incredible. On top of that, I'm a Barรงa fan, so even more so, and we like that. We're three Barรงa fans sitting here. It's hard, eh? It's hard nowadays, and none of us are Catalan. [Laughter] So that's how we started with the centers, and then within the ecosystem of Deutsche, the open-ended German funds had centers. In Spain we had a couple of large centers and we had to manage them. So centers were always part of our life, and when we started this Merlin adventure, the first thing we thought was why not have centers? And the first one we bought was not small, it was Marineda, not bad, eh? Yes, yes, it was a huge center, and then later many more came in as a result of the absorption of Testa and Metrovacesa, and we ended up with a significant portfolio, and since then what we've tried to do is give sense to that portfolio by trimming those that didn't fit our philosophy, which are basically either assets with urban locations or assets with suburban locations but dominant, centers with an average stay of 2 and a half hours, and the urban ones, on the other hand, with 45 minutes average stay, maybe you make more sales per square meter than in a suburban one, but those are different ways of approaching retail, and that portfolio we have today is the result of that reflection and the passing of the years, we've been removing and adding.
Today you have 12 shopping centers, 11 in Spain and one in Portugal. Have you ever considered going outside Iberia and conquering a center in France, Italy, Germany?
No, we've never done that. We've never considered that because, well, I think all Spaniards in school are taught to walk with a heavy foot, because we always think that the Nordics, Germans, English, etc., are much smarter than us because they've been eating better for many years. That is, Spain is a poor country and we don't value ourselves in a somewhat prudent way. So we've always thought that if we go abroad, the center we end up buying will be the one our competitors don't want. That is, we won't make mistakes, and we don't have enough critical mass in Spain to allow ourselves to make a mistake. If in Spain we had 45 centers and instead of having 130 million in rental income we had 13, then buying a center in France and it not being a huge success at first and having to work on it and turn it around would be more manageable. But with our current size, if you go out there and make a mistake, the market will hold it against you because we don't yet have the size to do stupid things out there. It's still a small company, even if it seems not, it's small. By international standards, quite small.
Then, one of the things you said is the issue of how you put the care, right? In the shopping centers. Jordi and I were talking before we started, that you were the first in the COVID era, in a very smart way, you called the operators and offered a discount, a 30% reduction without knowing what would happen in the following months. No one else did that. With a counterpart: if you didn't accept the 30, there was no reduction. The operators at that time, the instability generated that it was a helping hand. Was this whole strategy thought out in a few hours, a few days? How was that moment of crisis in such a short time that you gave this solution that was so impactful for the market? And I think that from there, essential bonds were created between people from companies that have gone beyond just rents?
I quite agree, but again it was a succession of relative coincidences, and let me explain. When my wife, who is always much more intuitive than I am, suddenly said, 'We had a child there in England, going to the supermarket to buy things, I don't know what.' I said, 'This woman is crazy, but if nothing happens, nothing happens, nothing happens, nothing happens, it came upon us like storms in no time.' So the reflection that provoked that in me, and that has served me later to learn in life, is when you have to make decisions in those environments, you feel more alone than anyone, because everyone looks at you looking for solutions, and you are not God. You have solutions, but poorly. So I thought and reflected, and at night I had a very bad time, I would wake up, I had my moments of breaking down, of crying, of praying, because I am Christian, so I prayed and said, 'Damn, God, give me a little knowledge to know how to organize this, because they didn't teach me this at university.' So initially we did generic things, generic things aimed at safeguarding the company's liquidity. We said, 'Come on, let's draw down all the lines.' And I remember we sat down with about 100 or 1700 million in liquidity. We drew down all the bank lines, and we knew that would have a financial cost, drawing down the lines would make the company much less profitable during COVID, but on the other hand we already knew that by drawing down all the liquidity lines we weren't going to die, we would have liquidity to keep going through whatever. Second, we took all the general costs, everything that was variable, superfluous, and we did a general shave, and we had an exchange of opinions with the most relevant members of the staff. 'Hey, how do we do this? In anticipation of a drop in activity, there are two ways to react: either you get rid of staff or you talk to everyone and cut variable compensation.' We opted to cut variable compensation, and the salary and wages line of the company was reduced to less than half. We cut all the variable pay. The staff understood it perfectly and understood that there are two solutions: either you reduce yourself by 50% or you put 50% of the people at home. Since it could be you, people quickly develop a certain solidarity spirit, they say, 'Look, it's better we all reduce, all together, all together, like Fuenteovejuna, and it will pass.' So that was also interesting. Then we took all the CAPEX, all the investment programs we had, and we said, 'Let's see, what is absolutely necessary and produces cash flow tomorrow? What is not absolutely necessary and does not produce cash flow tomorrow, we postpone.' So we also lightened the investment line of the company quite a bit to preserve the liquidity we had accumulated. And after all that, in bullfighting terminology, we had already stopped and calmed the bull. Then from there we felt a little better and started to control. Now we're going to look for some kind of measure that protects us in the future, even if it costs us money in the short term. And the first one came from a conversation with Sergio, with Luis Lรกzaro, with the retail team, that is, damn, if these people have been forced to close their store, which is how they generate the money, forcing them to pay you the rent is not right. They are going to be paying it, let's say, from their savings because they are not generating anything. So we opted for a moral decision: nothing, the rents are forgiven, they are forgiven, not financed, not given a loan with interest to pay back, no, they are forgiven. And the 30% is a coincidence, it wasn't 30. The 30 came about because it turned out to be the number of months you were closed relative to the total months of the year, but it was what they were closed, that is, while they are forced to be closed, we don't charge rents. So that served us, of course, to keep the centers open, which by the way was mandatory, so at least people continued to pay the common expenses, but they appreciated it a lot. We didn't make distinctions, which is very Spanish, between small and large. 'Ah, small ones yes, but large ones can go to hell.' No, no, no. Large ones are also children, also children of God. So we applied the same measure to the large ones, and then it's true that bonds were developed: we entered with the same occupancy with which we left COVID, the number of rebus sic stantibus lawsuits we reduced to about 45 and we won them all, while our competitors, who called us of course by phone to curse at us, had between 700 and 1000 lawsuits, while we had 45. And then you're absolutely right that in all subsequent closure programs, the bullets have always passed by us, by our side. We've had tremendous luck, no one has closed anything, and everything that sometimes when a company needs a center to reduce this brand or that other, it's usually done in a negotiated way, looking for if there is another within the same group that can substitute, or if not, we take care of finding a substitute in time. We've been quite lucky, coherence solutions that common sense in this sector often doesn't apply.
Yes, and we appreciate the moral part of the decision you made, but I think in the long run financially it was a very smart decision, it was bold, and I think the rest of us have repaid you later, either because we didn't close or because we didn't request additional relief, while with others we were forced to do so because there was more confrontation in negotiations.
I remember that those who complained told me, 'But you're stupid, shopkeepers have no memory.' And I said, 'Memory, everyone has memory.' 5 years later here, Ismael, and we still remember, so we do have a lot of memory. Everyone has memory, and in the end I think it showed a lot and generated good vibes. Look, there was a risk, eh? And the first year that measure, this measure is quantifiable. That measure cost us 71 million euros of cash flow in the first year and 44 or something like that in the second. So, hey, that's 115 million or so, and my shareholders at the general meeting could have told me, 'Hey, this money is not yours, it's mine, I'm the shareholder, why are you disposing of it?' I could have said, 'No, no, man, this is rational, this makes sense. I think I'm doing it for the good of the company.' But they could have told me, 'I don't agree. No, there is no good of the company here. Demand it and claim it in court.' No, we were lucky that the shareholders at that time more or less appreciated the way we managed and there wasn't a single dissenting voice, neither on the board nor among the shareholder base, and that's wonderful. But I could have, I mean, I could have gone back to Badajoz permanently, you know? [Laughter] Without a return ticket. Effectively, I could be there. I could be there now dedicated to... Well, maybe it would also be a happy path for you to dedicate yourself. You never know where the paths lead you. I still have a little bit left, I still have a 14-year-old daughter who still needs some resources until I get her a little settled. So I still have a while before I can afford that luxury.
Today, retail within Merlin Properties' income portfolio represents around 25%, approximately 120 out of 510, more or less.
Yes, yes, they are more, almost 130 out of 530. Yes, yes, 25%.
25%. Do you intend to increase this weight or do you want to stay there?
I'll answer you with my hand on my heart. I would have loved to increase this weight. In fact, in the last two years we've talked about it internally, what we should have done is bought one of the centers from our competitors that were getting smaller or leaving Spain. And we haven't done it. Why? Because of cowardice, because listed companies are cowardly, the board of directors becomes cowardly, and the shareholders become cowardly. So when you are every day in a kind of perpetual reproach of shopping centers, 'But my brother-in-law told me they are going to disappear, because with online commerce they are going to disappear.' Then, 'No, COVID has changed shopping centers forever. They are all going to be variable rents, there will never be fixed rents again.' The amount of nonsense we've had to listen to about retail expressed by people who have never set foot in a shopping center in their lives, or have not set foot with management eyes, they have only stepped in as customers, is tremendous. When we bought Almada in Portugal, it was a big deal on the board of directors. Explain to them that in Portugal there is still goodwill, people still pay key money for stores. Explain that the center is today our largest individual contributor of rents to the company's portfolio. All that is very difficult to explain. At that time what they saw was a spectacular capital expenditure on an acquisition in Portugal that gave a reasonable but tight yield, and they didn't think about what could be done with that yield through management improvement and fine-tuning the rent level. And today, looking back, it has been a very successful decision, but it almost got us thrown out. That is, it's very complicated. I would have loved it. Today in Spain, the one who arrived and established shopping centers wherever he pleased was Unibail-Rodamco. So any of their centers that they didn't want, starting with Splau, ending with Bonaire in Valencia, or of course if they had sold La Maquinista, which was talked about for a while, any of those centers to us would have made our eyes sparkle because with those centers you can do wonderful things. But we didn't dare. Listed companies are like that, a bit cowardly. Being contrarian is something that happens in movies, but you can only be it once in a while. If you are very contrarian very often, you usually end up contrary in the SMAC, doing the conciliation of your dismissal.
Totally. Merlin normally doesn't develop shopping centers, it buys them already built, open, operating, and then you improve them, you enlarge them, but generally you don't develop from scratch. If you had to develop a shopping center from scratch, what would it be like?
Look, we don't develop shopping centers, but it's a sign of the times. The one who had the opportunity to develop them was Robert de Balkany in 1978 when he arrived in Spain and there was nothing. And the guy arrived and said, 'Damn, let's see, a plot that I like, this one, La Vaguada, he bought it and developed a center there.' And then he started setting up his squares here and there. He chose the locations and set up the centers. What happens? 40 years fast forward, the shopping center asset class is a mature asset class, and we have to recognize that. When an asset class is mature, new developments have to be done with a dropper. We wouldn't mind developing a shopping center from scratch. If we did it, surely starting from scratch and with a not very high land cost, we would do something more like X Madrid, with a significant component of leisure, experience, food and beverage, etc., but with much more retail. In X Madrid the retail is small, there isn't as much retail, and because it's so tilted towards leisure, the retail is a little displaced there. While if you make a shopping center of 120,000 square meters and dedicate 30,000 to leisure and the other 90,000 to retail, everyone will know that it's also a retail center. So it would probably be like that, and the reason we haven't done it is because of that saturation. In the end, no one has proven it scientifically, but it seems that the equilibrium is around 300 and some meters per 1000 inhabitants of GLA. In the UK, problems started from 600-650, and in the US 2800. So clearly, you're asking for trouble. So in Spain, in all cities where starting from a situation of equilibrium of 300 something meters per 1000 inhabitants, there has been a large opening, and A Coruรฑa is a perfect example. There is a large opening, the meters per 1000 inhabitants go to 500 or 600, and then a small earthquake occurs and a couple of centers lose out in that earthquake, which could be the one that opened or two of the existing ones or three, and through closure, retail per 1000 inhabitants falls back to that 300 something, which seems to be the equilibrium. So there are very few places in Spain where you can really now build a center from scratch without breaking that equilibrium of the force. That's why we have bought things that existed. We don't rule out, if circumstances arise one day, doing one from scratch, but you have to understand that, just like in offices, you are in a completely mature market. In logistics, we started from a blank sheet, so we have self-developed, sometimes with delegated developers, sometimes ourselves, 85% of our portfolio, and in data centers 100%. Because we are like Robert de Balkany, we have arrived in a country where there is nothing, and all the capacity has to be built from scratch, so we do it ourselves from scratch, 100% of what we have and what we will have in the future we are building. But in centers it's not like that.
Within this model, is there any ideal size financially speaking for a shopping center development? We see centers of 250,000 square meters of GLA and we see centers of 70,000 square meters of GLA. Is there any point where you say, no, from 100, between 120, 150, for example, is the ideal financially speaking, the optimal?
Look, critical mass is important. I think, in fact, if you've noticed what we've been doing in many of our shopping centers, we've been buying co-owners, because you know that shopping centers in Spain are often atomized, the supermarket owns its part, several stores have also bought their part, and then, as we've had opportunities, we've been recovering weight in the owners' community because we believe that to have options you need to have space to place them. In the end, one fails, another improves, another worsens, and you change them within the mix, but for that you need space. So I think there is a minimum around 50,000 square meters. But careful, we are always talking about concepts of more or less dominant centers, so as a minimum, I would say rather 70,000 square meters. In an urban center where access is fundamentally pedestrian, well, from 30,000 you're fine. We have centers like Arturo Soria Plaza, which is a slope, a very small thing, but it's a very small thing in a neighborhood with very high purchasing power, and obviously it's our best performer in terms of sales per square meter, but it's a rarity. The norm is centers that do very well, Lario, Saler, Porto Pi, which have pedestrian access, they are fundamentally urban centers, but there are also people who come by car because they come to do the monthly shopping and they have a parking lot and a piece of supermarket there, and you can also do big shopping. But they are very pedestrian centers. For urban centers, we'd like between 30 and 50,000. For suburban and dominant centers, between 70 and 100 is what we think is reasonable. Once you go beyond that, like with Marineda, then there aren't that many retailers, so you have to fill it, and that's a problem.
This has happened in many places that make 300 commercial units, and you have to fill 300 units, there aren't enough brands for that. I've read that you know we are quite nerds about this.
In Marineda you hired a very well-known marketing agency that said that Marineda, if you look at it from space, they confuse you with Vigo. It's so big that they confuse you with Vigo. I love that. We have 6,000 parking spaces. There are 5,999 ways to lose your car. It's crazy. That's why the size, we can say it's crazy, we don't know them, we send them a greeting, great.
It's brutal. But earlier you spoke, and in your words there is always balance. What is the balance that you think there should be between the shopping center, real estate, and online in your centers? What is that balance personally?
Look, we would like to have a crystal ball and we don't, but what we did from the beginning, we have a series of peculiarities in the way we manage our shopping centers, and one of them is that from the very beginning, from 2014, we were concerned about online and we tried to make ourselves compatible with online as much as possible. We have done things that have worked better and others that have been experiments that were not accepted by customers. So, peculiar things we do in our shopping center division. First, it is managed together with logistics, and you say, 'How can that be?' Because online has two faces. When online goes up, logistics does well, and when online goes down, physical centers do well, which is what is happening now. Online has plateaued, it's no longer growing at double digits, it's growing at single digits, and that means physical sales are doing very well. It's also true that low household debt and the fiscal policy that everyone has money in their pockets helps, and that all goes directly to spending in centers. So this joint management allows us something that is competitively very interesting: 30% of our logistics clients have the warehouse directly with us, not with the logistics operator, but with the client. Why? Because the head of real estate of the company is the same, the guy who manages logistics and the guy who manages the stores in the shopping centers is the same. Once you have established a relationship and created a bond of trust with that person, they want to secure a certain warehouse to serve a certain city, and they take it directly, and then they hold a tender for the provision of logistics services, for the vanning and trucking, but the warehouse they take directly, while almost all our competitors, the one who takes the lease contract is the logistics operator. That's fine, but the logistics operator always operates with very tight margins, the income statements of logistics operators are not very big. So it's a small competitive advantage, but the other side of the coin is that from the beginning we saw shopping centers as a natural extension of logistics itself. So we started putting lockers, we started encouraging clients to create return points for goods, because reverse logistics kills them from a cost perspective, and we encouraged them to have facilities from a parking point of view, etc., to have the return at the physical point of sale in the shopping center, which generates a certain impulse purchase. And we always understood how online works, how physical works. We tried to bring them together, we tried to create a marketplace, we tried to inventory their stocks and create a marketplace produced by us so they could sell. But we discovered that nobody likes to photograph their inventories, give you prices, and appear on your marketplace. They don't like it. This is like when they said that after COVID everything would be variable rents. In the end, you say, 'Well, I have no problem with variable rents, but I have to audit your cash register.' 'Well, it doesn't matter, put the rent, put the rent, put the rent.' Effectively, let's talk about fixed.
Let's talk about fixed rents. So in the end, variable rents haven't taken off despite all the talk and despite being told that they would go through the roof because they are variable, that hasn't happened. And with marketplaces we've tried, but it hasn't been possible either. But we are always attentive to making life easier for online retailers that also have a physical store, right? Because in the end they are two distribution channels and we benefit from both, one via logistics and the other via the shopping center. So that's our way of being and operating. Full connection.
But does that mean that in the future you don't plan to somehow participate in that online sales that brands make or that we brands make within your shopping center, because that's a complicated can of worms.
