This article was sponsored by QIC. It appeared in PERE’s Retail Report supplement alongside its July/August 2019 issue.
Retail property in developed markets is struggling across most of the world; as the retail business digests the impact of e-commerce, stores have closed and investors have shunned the sector.
Australia has not been immune to these problems, with rents flat at best for the past two years and muted transaction volumes. The launch of Amazon Australia last year did not cause the expected meltdown, but some retail analysts expect it to dominate the market within seven years.
However, QIC, one of Australia’s largest retail landlords is upbeat about the future of brick and mortar retail, believing there is plenty of room for growth in both online and offline sales. Based in Brisbane, QIC owns 22 major Australian shopping centers across the country. PERE’s Mark Cooper talks to Matthew Strotton, global director, capital, at QIC Global Real Estate about his reasons to be cheerful about the prospects for the group’s retail portfolio.
Q We hear a lot of pessimism around retail investing right now; is this justified?
In my 20-year career, I have never felt the level of scrutiny we are getting in the retail sector today. I am not sure I would categorize it as pessimism, but there is a range of unknowns around retail which have yet to be fully answered. Our retailers have been disrupted; they have had to virtually reinvent the way they invest in their business. And retailers have had to contemplate a new future for their business in both physical stores and online, trying to strike an effective balance between the two to maximize sales, and to maximize recognition of their brand.
The pessimism is focused on capital markets. Capital markets are driven by investor demand and the supply of good stock. At the moment, what we are seeing is a reticence, at almost at all levels, from investors regarding the retail space because they are concerned about the unknowns regarding the position of retail.
However, our retailers are going through this tech-led evolution, but they are now emerging, and what has happened along the way tends to grab the negative press with respect to bankruptcy, store closures and store rationalizations. But what that means, in its simplest form, is that retailers are reinventing themselves and adapting to the new market.
Q Looking specifically at retail real estate in Australia, is there more cause for optimism?
Over the past 12-28 months, there has been a combination of factors which have placed a great deal of uncertainty over households in Australia. House prices ran up a long way and have faltered. The banking enquiry meant less lending from the big banks and that put pressure on household finances. And finally, the federal election created uncertainty. All of those factors, from my perspective, have been a significant contributor to lower confidence.
Today, we see all those factors mitigated by the liberal party’s election win, which delivers political certainty, and the prospect of additional interest rate cuts coupled with an adjustment of the rules associated with home loan serviceability, which should see falls in house prices bottom out and allow for improved household refinancing, and support retail sales. So there is going to be a vastly different picture looking forward and a vastly different proposition for retail in this country.
Q Talk us through the positive fundamentals you are seeing right now in the Australian market, which make retail real estate an attractive investment proposition?
The outlook for the Australian economy remains robust and among the strongest of the major advanced economies and Australian consumers are generally in good financial shape. Over the next decade, we forecast Australian real GDP growth to average a solid 2.6 percent per annum, in line with the trend in growth seen over the past decade. We have had nearly 30 years without a recession, unemployment is low and we have a public infrastructure boom, which will drive growth.
It is also important to remember that even though we have been at the bottom of an economic cycle, we are still, as a business, recording positive net operating income growth, as are our peers in Australia. We are still achieving momentum in leasing. All of these operating fundamentals remain in place, but were somewhat anaemic, which is representative of a trough in the economic cycle.
Q QIC’s recent report on the Australian retail sector says that online sales are expected to grow from just under 9 percent to almost 16 percent in the next decade. What impact will this have on brick-and-mortar retail?
It is important to put that figure in context. What it tells us is that 74 percent of sales will come from physical retail platforms. Moreover, we do not see this online growth necessarily coming at the expense of brick-and -mortar retail. It is not as if retail businesses are either purely online or purely physical or that they are competing for a finite market. A substantial amount of online sales are linked to a retailer’s physical presence and a lot of growth in the future is going to be through omni-channel retailing rather than purely online sales.
Our retailers, certainly the most successful of them which are ahead of the curve, are reaching a point now where they have firmly cemented their future. Like us, our retailers are focused on providing an experience that cannot be replicated on digital platforms but work in synergy with them. They have worked out how their business is going to be built: around the success of a physical location, augmented by an online presence, both of which enhance their brand and amplify the interest of consumers to come and buy.
Over the next decade, we expect brick- and-mortar retail sales to expand by an average 3.2 percent per annum. This is only about 80 basis points below the 4 percent growth expected for overall retail sales during this period.
Q In this new retail landscape, how should investors in the sector adjust their strategies and portfolios?
I would have them come back to the drawing board on retail. Come back to quality and locality, come back to value enhancement through cycles. Come back into positioning for growth. Come back into diversified income streams. Fashion was at one point effectively 100 percent of rental income and that is down to 60 percent today. There has been significant growth in food and beverage stores and that will continue, as will growth of health and wellness facilities. Active management of the tenant mix will not only boost a shopping center’s resilience to e-commerce, but it will also target areas with stronger growth prospects due to shifting consumption patterns.
Our business after all is not retail. Our business, from our perspective, is investing in communities and generating a diversified income stream that we continue to grow cycle after cycle. I firmly believe the retail sector, particularly regional shopping centers, has just experienced its first super cycle from the inception of the shopping center concept to maturity. The institutional real estate market in Australia is only 40 years or so old and the major shopping centers are younger than that, so not even middle-aged yet.
So investors need to be looking at the next 25 years and how those centers and those locations will develop. In Australia, the planning system protects those locations and the ownership by entities like QIC, which can take a long-term view and invest capital for the long-term, which means they can be developed as community centers. In the future, they will be more densely developed and with a greater mix of uses.
Inevitably, we will augment the expertise that we have in-house, which is retail and entertainment-focused, and focused on enlivening communities, and enhance our resources around office and residential, sub-sectors such as short-term accommodation, education and medical. Nonetheless, the way in which we deal with this next super cycle needs to be more patient, more cautious. The fundamentals of budget management, of capex management are as important as ever and there are still unknowns, and you do not throw cash at unknowns.
Retail is going to become more management intensive over time and it is going to be increasingly important for investors and managers to be close to their retailers and understand what is driving them. We spend a lot of time on this and that is what is needed to be able to generate leasing tension, which drives rental growth. I also think it is inevitable that our market will become closer and closer to Asia. That is most definitely our future, and there are things we can learn from our northern neighbors and apply to our hometowns in terms of vertical retail and retail-led mixed use.
Q Is the retail investment opportunity uniform across Australia? Are you seeing pockets of opportunity in particular locations?
In one sense, the opportunity in Australia is uniform and more so than in other countries. This relates to the planning regime in our country. Everything from the manner in which we operate leases, charge insurance, manage insurance, the issuing of title, is uniform across our country.
For real estate generally over the past few years, there has been quite a variance of performance between Sydney and Melbourne, and Perth and Brisbane. However, there are signs that the resources sector is on the up again, which is good for Perth and Brisbane. Growth in the resources sector means more migration into Queensland and Western Australia and that is good for retail. We like Perth as a long-term market and have a retail asset there but the market has been subject to greater cyclical variations. We are actively considering new acquisitions in that market.
However, our investment decisions are based on bottom up fundamentals. The idea of comparing Perth and Melbourne, Sydney and Brisbane, is different for offices, compared with retail. For retail it is vastly longer-term, and if anything is more granular for our investment decisions. Will an asset or an area enable us to generate outperformance because it is growing more strongly than the city or the country as a whole? We are not aiming to ride the cycle and sell out at the top, but to manage assets through cycles.