This article is from the Australian Property Journal archive
Retail property forecasters in Australia are understandably apt to look at the market within a framework of demand and supply for more or less homogeneous categories of properties.
Once this demand/supply equation has been solved, it’s possible to come up with a prediction on whether yields will firm, cap rates will go up or down, and so on. Although the research must incorporate at least a top-down view of the direction of the economy and consumer spending, specific knowledge of retail itself is often minimal or nonexistent.
However, even the most high-profile retail property market “seers” can get away with this in Australia where –
1. The planning system generally ensures that retail supply is well-located and constrained in quantity
2. Demand for space by retailers is steady and predictable
3. The retail mix is a given since the candidates to take space in most developments are limited in number and for the most part already well known in the market
4. The major anchor segments (supermarket, department store, discounter) are oligopolies
5. Retail property ownership is consolidated and the market is relatively transparent
6. There is a steady supply of investor capital
These six factors are usually enough to ensure steadily increasing cash flow from retail operations and capital appreciation of underlying land.
However, as investors look increasingly overseas to places like the U.S. to earn higher returns on their money, reliance on the trusty old tools of the property analyst’s trade will not be enough for the long haul. That’s because many of the best investment opportunities in retail property exist in markets that bear little resemblance to Australia’s.
Even in the U.S. the oft-mentioned “cultural” similarities with Australia are greatly overestimated by analysts in their haste to paint a rosy picture. A U.S. investment strategy based on even the most diligent traditional kind of analysis will be found seriously wanting in the long run unless it incorporates a sophisticated knowledge of U.S. retail itself, as distinct from retail real estate. This is a whole different skill set.
To illustrate, re-examine the list above of six characteristics of the Australian retail property market. How many of these characteristics obtain in the U.S. market? The answer is just one, the sixth one—there is currently a very strong supply of capital flowing into shopping centres.
Australian capital is merely a tributary joining a larger stream of funds, both domestic and foreign, chasing returns in the U.S. market. The extraordinary supply of capital looking for a home in the past couple of years has driven down U.S. shopping centre cap rates (inflated shopping centre prices) pretty much across the board. However, like all inflations, it has blurred the distinction between good assets, assets of lesser quality, and outright sinkholes.
How can there be so much variation in the quality of assets?
The answer is complicated but at the risk of oversimplification we can explain it with a few simple propositions:
· Retail space is greatly in oversupply in the U.S. for a number of reasons and much of this space is either obsolete or nearly so. Unlike in Australia, the accommodative nature of U.S. planning regimes enables new space to be constantly created in the shadow of the old.
· Good retailers vie for a presence in, and focus their investments on, the best shopping centres. This is no more than a “flight to quality” whereby the good centres get better and the weaker ones get worse.
· Intense competitive forces flourish in most key merchandise segments, causing significant market share shifts among formats. These shifts are ongoing and result in a dynamic, changing retail landscape where older formats are put to the sword by newer ones.
· There are few oligopolies in key anchors segments and the competition is fierce and unrelenting. Even in the department store segment where consolidation has been going on for years, there are still a relatively large number of surviving national and regional players with widely varying prospects for the future.
· Shopping centre ownership is fragmented and transparency is limited, particularly on the strip center side of the industry where more than 35,000 properties are in private hands. These characteristics of the U.S. market reduce factors such as cultural likeness (an arguable proposition in any case) to a mere trifle when it comes to analysing market opportunity.
Moreover, the recent rash of retailer privatisations in the U.S. will make it even more difficult for the property investor because it reduces transparency and makes evaluation of tenant credit risk trickier.
But if U.S. retail cap rates are falling across the board, who cares? Unlike the last question, the answer to this one is simple—first, the U.S. competitive landscape, as outlined in the bullet points above, can quickly turn today’s winners into tomorrow’s losers. This has a direct bearing on the cash flow of a shopping centre and ultimately perhaps even its viability.
Second, in the event of a more sustained economic/consumer spending downturn (and the question here is not “if” but “when”) investment capital will cycle out of retail selectively, buoying those assets that are seen as defensive and burying those that are not. Put another way, the distinctions between assets of varying quality that are due to fundamental issues of retailer competitiveness will be focused on with laser-like severity.
By Michael Baker, editor of UrbisJHD.*
