Kempen Real Estate Update: Will Australian shopping centres survive the retail thunderstorm?
News about struggling retailers are making headlines in the news every day. Retail landlords are not immune to this trend with lagging share prices in recent years confirming this. However typically where there are losers, there are also winners. We have written previously about the buying opportunity in US Retail. To identify the winning retail landlords one needs to thoroughly understand how their assets are positioned in relation to the threatening trends the retail sector is fighting today.
In our investment process we formulate our view based on discussions with market participants, management teams and our own inhouse research. These views guide us in our data collection for research on how these trends will play out. Having access to more information does not make better informed decisions. Having access to the right information and analysing it consistently leads in our opinion to the best informed decisions to capture the opportunities arising from these trends.
For Australia, we track data on 2288 submarkets to determine the strength of the catchment areas of individual shopping centres. A submarket is a group of zip codes. A catchment area is the group of submarkets which is serviced by the shopping centre. Each catchment area is graded based on the attractiveness. In the map below this is visualised for Sydney for both the largest listed REITs and non-listed funds.Source: Kempen as of 17 January 2019
Each dot on the map is a shopping centre and the size of the dot represents the size of a shopping centre. For easy interpretation we have coloured our proprietary scores for both the submarkets and shopping centres with red being the worst and dark green the best. The well-known Bondi Junction owned by Scentre Group is highlighted as an example.
The success of a shopping centre is in our view determined by its tenants and how these tenants are performing. If a shopping centre caters to the evolving needs of its catchment area, tenants will be able to growth their revenues and will likely continue to operate their shop within the centre. This creates a good bargaining position for the landlord to increase rents. The affordability of rent is often measured as a percentage of sales generated in the shop. The higher the sales productivity, the higher a rent a landlord can charge.
A different way to visualise how well a shopping centre is positioned to weather the storm is to look at the strength of the submarket and compare this to the current sales productivity. A highly rated submarket with increasing future household income, high and increasing future population density, high and increasing home values etc means sales productivity per square foot should be high and growing. On the other hand, strong submarkets can also attract new developments and hence depress sales productivity of competing shopping centres.
We plotted the submarket score versus the sales productivity for all assets of Vicinity Centres below.
Source: Kempen as of 17 January 2019
Vicinity Centres has recently embarked on a strategy which in our view enables them to better weather the retail storm and improve the portfolio quality whilst reducing debt. At 3rd October 2018, Vicinity Centres announced the disposal of a portfolio of 10 shopping centres to Shopping Centres of Australasia (SCA) at a 7% discount to June 2018 appraisal value or a 7.1% cap rate (these assets are coloured red in the above chart). In addition, they announced that they will dispose of the eight asset of approximately AUD 1 billion portfolio of shopping centres to a JV called VKF set up with Keppel Capital (coloured turquoise). Lastly, Vicinity Centres has instructed Jones Lang LaSalle to sell 5 shopping centres (coloured orange).
Based on our analysis, we believe that whilst these are the steps in the right direction, there are more shopping centres which should be sold to reduce leverage. Shopping centres in weaker submarkets (low score) will likely see pressure on sales productivity which reduces the rent affordability ultimately resulting in declining rents and valuations.
Appraisal values tend to be more backward looking, failing to fully incorporate future trends. This is especially pronounced in a sector like retail that is experiencing a lot of transformation today. This presents an opportunity to create alpha if assets and portfolios are analysed in a consistent manner. Using the same methodology as described before, we analyse all retail assets owned by the listed REITs in Australia.
We use the information to score each individual asset and determine the capital expenditure and rental growth going forward. These determine our cap rates which we use to value the assets. These Kempen cap rates are different from the last cap rates reported by companies since they are more forward looking. Below we show our Kempen Quality Grades which determine the cap rate estimates for each individual asset owned by the listed REITs.
Source: Kempen as of 17 January 2019
So who owns the best portfolio? This is an easy question. The best assets have the lowest cap rates as they are forecast to have the highest future rental growth in combination with the lowest capital expenditure. Based on our analysis, Scentre Group scores best. However, this does not mean an automatic buy for our portfolio as share prices fluctuate on a daily basis creating mispricings and therefore changing relative value within the cluster on a daily basis .The beauty of our job is to identify and exploit these mispricings and thus add alpha.
As at 31 December 2018, the Kempen Global Property Strategy held shares in Mirvac Group but not in Charter Hall REIT, GPT Group, Scentre Group, Shopping Centres Australasia, Stockland and Vicinity Centres. As at 31 December 2018, the Kempen European Property Strategy held no shares in Mirvac Group, Charter Hall REIT, GPT Group, Scentre Group, Shopping Centres Australasia, Stockland and Vicinity Centres
The views expressed in this document may be subject to change at any given time, without prior notice. Kempen Capital Management N.V. (KCM) has no obligation to update the contents of this document. As asset manager KCM may have investments, generally for the benefit of third parties, in financial instruments mentioned in this document and it may at any time decide to execute buy or sell transactions in these financial instruments.
The information in this document is solely for your information. This article does not contain investment advice, no investment recommendation, no research, or an invitation to buy or sell any financial instruments, and should not be interpreted as such. This document is based on information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such.
The views expressed herein are our current views as of the date appearing on this document. This document has been produced independently of the company and the views contained herein are entirely those of KCM.