Recent media headlines featuring announcements of retail store closure are not fake news. The conclusions people are drawing from them, however, tend to oversimplify reality.
Before addressing the nine questions underlying these closures, and their impact on AREITs, let’s first examine the data:
|Announced Closures||Total number of closing stores owned by AREITs||Total sqm of closing stores owned by AREITs:||% of Net Lettable Area owned by AREITs:|
|Bardot – Womenswear chain (58 stores)
Curious Planet – Science retailer (63 stores)
Harris Scarfe – Discount department store (21 stores)
EB Games – Games seller (19 stores)
Bose – Audio retailer (eight stores)
Jeanswest – Fashion retailer (146 stores)
1. Why are these stores closing?
Competition is driving most of the closures. The entry of Zara, H&M, Uniqlo and other overseas “fast fashion” retailers, for example, has driven underperforming domestic retailers like Bardot, Jeanswest and, to a lesser extent, Harris Scarfe, out of business. Fashion has also been a factor in other recent closures, including Esprit and Marcs and the shrinking of Myer and David Jones.
What many forget is that retail has always been competitive. When a new entrant offers a better product range, lower prices or a more exciting retail concept, closures tend to follow. Inept or lazy management that fails to adapt might accelerate the decline, but history shows that retail chains come and go whether they do or don’t. Change is constant. Long term, this is good for the consumer but for investors in the midst of the “adjustment period”, not so much.
2. What is the impact on the AREIT sector?
The table above shows the limited impact of recent closures on the AREIT sector, affecting just 0.47% of the net lettable area (NLA) of the AREITs concerned. While not immune from closures, AREIT portfolios tend to be of a higher quality, with capable management teams focused on limiting exposure to underperforming and weaker tenants. That shows up in the data.
3. Why are we seeing more closures now?
Store closures traditionally occur after the December trading period, which tends to be the most productive and profitable period for retailers. This is a well-established trend in Australia and internationally. As a general rule, if a retailer struggles in December the rest of the year will be far worse. That’s why many retailers close the doors in the post-Christmas period.
While the tough economic and retail environment saw store closures move higher in 2019 than in the past two years, they were in fact lower than 2016, which included the departure of Dick Smith. It’s important not to extrapolate one or two bad years into a trend.
4. How much is online retailing affecting traditional “bricks and mortar” stores?
The growth in online retail is a convenient explanation for recent weakness in retail sales but oversimplifies things. After an extended period of exceptional growth in retail turnover (and retail property performance), the post-GFC period has seen a normalisation, assisted by weak economic growth and minimal wages growth.
We believe this cyclical normalisation to be a more important factor than online sales growth in explaining retail sector weakness. Of course, this is a more complicated issue to communicate in the media than, say, Amazon’s arrival in Australia or the rise of sites like Temple & Webster. But in our view, it’s the more likely explanation.
5. Are retailing conditions worse than before?
Probably, although the comparison isn’t entirely fair. This period of weakness was preceded by many years of very high growth in the years prior. That makes recent sector performance look even worse in comparison.
And, as mentioned above, there are other factors at play too. Weak wages growth, modest GDP growth of circa 1.4% p.a and low inflation of less than 2% a year has hit retail sales growth. Overlay the recent bushfires that have further deflated consumer confidence and the retail environment is tough. And online retail sales are growing, if not as quickly as they once were. These factors have made the market hyper-sensitive to further closures.
In the 2019 financial year, retail AREITs delivered net operating income (NOI) growth of 1.7%. That was certainly weaker than in recent years but remains in-line with overall economic growth, which has also slowed presenting a tough environment for many Australians.
6. Is retail property the weakest sector?
At the moment, yes. However, property sectors are like all other asset classes – there are periods of high growth and periods of low growth. Following the general economy’s lead, retail is clearly in a low-growth environment right now.
This, though, is not something for an investor with a long-term perspective to be afraid of. Periods of change and uncertainty are typically laden with opportunity. We believe this is a good time to invest in a large, well-diversified AREIT portfolio with a focus on high quality, well-located property assets, run by capable management teams that can mitigate risk.
7. I hear the term “barbell effect’. What does it mean?
At one end of the retail spectrum are high quality, super-regional and regional centres that dominate their catchments. Vicinity (VCX), owner of Australia’s largest shopping centre (Chadstone) and Scentre Group (SCG), owner of Westfield shopping centres in Australia, are good examples. At the other end are convenience centres close to home, owned by landlords such as Charter Hall Retail (CQR) and SCA Property (SCP). Both are strong performers. It’s in the middle where property owners and investors are getting squeezed.
Good property management is crucial. Landlords need to position their assets to capture changing consumer spending patterns and expectations. Scentre Group and Vicinity do this better than most with more food, services and experiential retailing options and fewer categories more susceptible to online (apparel, books, discount and department stores, for example). Convenience centres, meanwhile, must focus on being just that. Shoppers will continue their regular visits if they remain easy places to spend.
Both ends of the barbell offer a high degree of income security over the long term. Large format retailer Aventus Group (AVN) is another great example, providing the income security and asset quality we seek along with best-in-class management. AVN was the fourth best performing AREIT over 2019 (+43%), proving that not all retail is created equal.
Stuck in the middle are high street shops (thankfully not owned by any AREITs) and sub-regional centres that lack the convenience, product range and experiences of the better managed centres. With limited differentiation, less customer comfort, less convenience (particularly parking), high street retail is being hit hard by the growth of online retail. For obvious reasons, APN avoids property assets stuck in the middle of the barbell.
8. Is the barbell effect true of other property sectors?
Yes. There are superior and inferior locations and assets in the office and industrial sectors, too. Prior real estate cycles have featured periods of weak and negative rental growth in certain secondary office and industrial property markets. The trick is in knowing which locations, assets, tenants and managers are most susceptible to these impacts and avoid them.
By holding a large, diversified portfolio of high-quality property assets it’s possible to mitigate much of the downside risk of such occurrences impacting returns. The divergent returns from the underlying sectors is a key driver of the AREIT sector’s return consistency; it’s a big attraction for many investors.
9. What else is happening and what is APN doing about it?
The return of the Liberal government has turned residential property sentiment, which has led to higher house prices. The “wealth effect” from residential property should lead to improvements in consumer sentiment, assisted by tax cuts, which should eventually flow through to retailers.
The AREIT sector is ever changing and in February, as part of our review process, we’ll be questioning and challenging our REIT managers. Seeking out new information and synthesizing it with our deep research and review processes, we expect more new investment ideas and strategies over the coming weeks and months.
One thing will remain a constant, though. Working on the basis that the only certainty is uncertainty; we remain confident that we can deliver on our stated objectives of providing our investors with consistent income returns from a portfolio with lower-than-market volatility1. That’s our mission and we’ll continue to deliver on it.