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Kempen Real Estate Update: How to Future – Proof Your Shopping Centre

10 February 2020

When you think about a place where you can buy whatever you are looking for across sectors and brands, what comes to your mind? A shopping centre? Or Amazon? Or do you rather prize environmental sustainability and follow the NOwnership trend to reduce shopping altogether?

Real Estate

Many observers of brick-and-mortar retail conclude that shopping centers are crumbling at their foundations due to changing consumer habits and expansion of online retail. It is easy to notice that the retail real estate industry is undergoing one of the most profound transformations in its history. Although it is true to believe that many locations will not survive, it is hard to deny that most shopping centers have a lot going for them in terms of being well-located real estate with good transport links, ample parking, and other amenities. Many investors have also concluded that, rather than disappear because of the growth of e-commerce, shopping centers are critical to the omni-channel retailing equation. We also believe that today’s world offers shopping centers an opportunity to reclaim their status as the pillars of modern retail. However, this cannot be done without aggressive innovation, complete re-imagination of how to engage with consumers, and significant financial means. What then do shopping center managers need to focus on?

First, engagement with communities and delivering services they want is crucial for long term success. Shopping centers should be places where communities come together, and therefore need to broaden their appeal as a consumer destination and not just a shopping location. Due to continually changing shopping patterns, retail assets need to offer something that cannot be ignored or accessed through a screen: they need to become cultural hotspots, community-serving, and genuinely useful. Therefore, we are seeing an increase in entertainment-based experiences in shopping centres: cinema, amusement park, water park, indoor ski slope, or live music area, among others. Experiences do not have to be big and costly though, and can be focused around convenience. This might include taking a vacant unit and repurposing it into a click-and-collect point with fitting rooms so customers can pick up, try on and return items all in one go. Sometimes putting a playground for children generates more activity and income for an asset than a struggling retailer. Offering free space for yoga classes on the roof of a shopping center might also improve customer loyalty and increase traffic in the shops below. 

Second, if current trends tell us anything, it is that the commercial centers of the future will not be retail first. Shopping centers should enhance their purpose by becoming retail-based mixed-use neighborhoods where communities can live, work, shop, dine and play. Commercial centers of the future will look more like mini towns, with residential, offices and co-working spaces, hotels, health and beauty services, food and beverage, gyms, entertainment, events, and – yes – retail. However, there is no golden mix for uses in a mixed-use environment. Real estate is a local business, with demand driven by demographics, existing supply and community preferences. Therefore, mixed-use projects often target a specific consumer segment such as young urban hipster professionals, or senior living environments. These highly curated “lifestage centers” offer a demographic-specific and appropriate set of residential, retail, restaurants, entertainment, and services, to ensure more frequent visits, and higher income for a property. While adopting an asset to specific demographics, the asset owner should also purposefully position properties to be the real estate of choice for the widest selection of tenants and uses, with physical structures that can be readily modified to highest and best use cost effectively over time. Placemaking strategy that sets retail centers apart needs to be adopted and should include visionary planning, distinctive design, thoughtful and strategic merchandising, and diverse mix of tenants.

“Future-proofing shopping centres will require aggressive innovation, complete re-imagination of how to engage with consumers, and significant financial means. Capital preservation and sustainability of future cash flows should therefore be on top of investors' minds. ”

Moreover, it goes without saying that sustainable environmentally-friendly solution should be a part of every real estate project. Investing in digital technology intended to improve the shopping experience and engage tech-savvy consumers is also what leaders in the space are busy with. The list of innovations is long, and we have only mentioned few. If at this point of reading you think that all the creativity and skill that needs to be utilized to transform a retail asset of the past into a commercial center of the future is going to be painfully hard and often impossible, you are likely right. There will probably be numerous casualties, costly mistakes, and the ongoing need to constantly adapt to changing consumer expectations. But the real difficulty has not even been mentioned yet. And it is: the money to fund the transformation. Or lack thereof.

Shopping centres are among the most capex intensive assets around, and capex and redevelopment needs are on the rise. At the same time, as tenants have more bargaining power, elevated vacancy rates will likely pressure market rents decreasing revenues of shopping centres. Therefore, it makes us uneasy to observe that most European public retail REITs carry too much debt and pay legacy dividends that are too generous. We believe at this point in the cycle loan-to-values should be low, and dividend payouts close to legally required minimum. We continuously engage with European retail REITs to raise awareness that we find their levels of leverage and dividend payouts unhealthy, especially if underpinned by fragility of the underlying asset class. Our line of thinking was often received with skepticism, but management teams are starting to open up. Even assuming that not all capital will be needed immediately, and no cyclical downturn in European economies will negatively compound what is an already intensifying structural headwind of e-commerce growth, we believe that most shopping centre REITs in Europe have insufficient liquidity to face the task of adapting their assets for the future. The result of capital shortfalls could materialise in the form of lower asset values due to postponed redevelopments and/or a weak financial position, and in increased costs of distress, which might play an important role over the long term for the share price performance. This could be especially relevant to small cap REITs, who have less access to capital due to their scale and as such have a clear disadvantage when deleveraging. With good examples of US-based retail REITs whose management teams have maintained disciplined balance sheets, we believe it is imperative that their counterparts in Europe take action to remedy weak balance sheets in case redevelopment needs accelerate.

The world of retail is changing dramatically, and landlords’ ability to attract tenants and maintain the competitive nature of commercial centres are important inputs not only to potential returns, but also to the companies’ going concern. Hence, we believe that capital preservation and the resilience of future cash flows should be on top of investors' minds, and we urge European public REITs to demonstrate just that. 

Important Information

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. 
KCM is licensed as a manager of various UCITS and AIFs and to provide investment services and is subject to supervision by the Netherlands Authority for the Financial Markets.



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