How COVID-19 has accelerated the evolution of retail

With the retail property sector already undergoing the beginnings of a seismic shift pre-COVID, lockdown restrictions exacerbated and accelerated this metamorphosis: foot traffic and physical visitation at traditional bricks-and-mortar retail shopping centres was replaced by click-and-collect and online deliveries.

In the investment-grade real estate sector, this evolution can be seen in the increasing values and sharpening capitalisation rates for industrial property, as logistics and warehousing takes the focus as a defensible asset sector with ‘tailwind’ support of this change.

Whilst traditional retail shopping centres experience the headwinds of online shopping and lockdowns, neighbourhood retail has experienced growth, driven by the tailwinds of convenience and accessibility. What’s fascinating about this retail evolution from an investment perspective is, as renowned real estate investor Sam Zell says, “we don’t buy markets, we buy deals".

For us at MP Funds Management, we have exposure to the retail sector via a 43,000sqm bulky goods retail centre near Sydney’s new airport, as well as exposure to a fringe Sydney CBD mixed-use development in Darlinghurst, with a substantial area of ground-floor retail, which will completely recharacterise and revitalise the area.

We continue to traverse a frothy period in the market, with inflation creeping into the fray, which will mean a likely interest rate rise at some point.

Liquidity is abound, pushing investment returns downwards due to the sheer weight of money in the market looking for a home. As always, we are seeking the best risk-adjusted arbitrage, so we hunt for mispricing.

Here is what we see. Just like any historic period that follows prolonged suppression, the ensuing subsequent boom time post-COVID will likely see a huge spike in retail visitation - however, this is unlikely to be enough to buck the trending change in the sector, but it will further revitalise pockets. It’s those pockets that we are most interested in.

The neighbourhood centre: the one that got away

“We don’t buy markets, we buy deals”. Last year, we missed out on a transaction, and it was the epitome of buying the deal as opposed to the market.

This high-quality defensible asset was able to pay starting net distributions of 9%+ because the acquisition value reflected an overall market that had been receiving a bad rap. This meant the buying competition was down, which enabled outstanding value and buying power.

Stirling Property Funds acquired the Coles-anchored Junction Fair retail centre in high-growth Newcastle for 5 percent below its valuation at the time, from vendor Fortius Group. The acquisition price was $44.32 million versus the valuation of $47million.

Stirling geared the asset to 49% on acquisition with a $24.8 million equity requirement, excluding the Stirling subordinated $2.4 million equity. The equity was oversubscribed within two weeks in the height of the first COVID lockdown. Stirling took a first-loss position on the asset by subordinating its cash equity participation.

Aside from the structured subordination with the lead manager, we liked that the centre was an 11,000sqm (NLA), Coles-anchored non-discretionary retail centre, with the potential for a 15,000sqm floorplate expansion.

Also, the opportunity benefited from being located in a high socio-economic area, with 14 percent faster population growth than Sydney metro, and with an average wealth 18 percent higher than Sydney metro.

Starting distributions were 9%+ and total return was originally forecast to be around 15%+.

Traditional retail upping the ante

As industrial property becomes the darling of the investment-grade real estate sector, buoyed by the friendly tailwinds of the retail-to-online evolution, Joshua Charles, Director of One Commercial, talks to the MP Report’s Property Investment Podcast about investment value in the sector. 

The mass exodus and sour sentiment in the traditional retail sector is exemplified domestically in Australia with Lendlease’s Prime Property Fund Retail, which in September 2020 shed almost a quarter of its value.

Units in the wholesale retail fund dropped 23 per cent to $1536.89 and the value of assets in the trust fell to $4.2 billion from $5.6 billion. With a huge number of investors wishing to exit the fund, the fund has given itself another three years to meet redemptions.

Providing a further layer to the narrative, the largest public bricks-and-mortar retail owner globally, Simon Property Group, has seen its share price more than double from $60 USD to $140 USD as a result of initiatives to evolve its traditional retailing centres into omni-channel retail. The company has more than 230 centres including world-famous The Forum Shops at Caesars Palace in Las Vegas, The Westchester in New York and Fashion Valley in San Diego.

Large-format retail

In 2019 MP Funds Management co-invested in the Crossroads Homemaker Centre, located close to Badgerys Creek and the currently under construction Western Sydney Airport. The centre has strong anchor tenants, including Bunnings Warehouse, Bing Lee and is in close proximity to a high-performing Costco.

We loved the asset because the 43,000sqm site, of which 40 percent has built area, will cater to a population projected to hit 300,000 in the next 20 years. The region’s rapid growth, as well as its proximity to the new airport, made the asset a stand-out.

Comprising many outdoor tenancies and large-format stores, Crossroads Homemaker Centre managed to weather the COVID economic storm.

With trading actually improving during the pandemic, driven in part by the centre’s proximity to nearby home builds and upgrades – two sectors that were propped up by government grants throughout the pandemic – and its big-name anchor tenants. The asset provides strong monthly defensible cash flow and has already exceeded IRR targets.

Revitalizing a precinct

The other retail project we have exposure to is a mixed-use project in Darlinghurst, on the fringe of Sydney CBD. This project will contribute to the revival of the Oxford street precinct.

While this is more of a development play as opposed to an income play, it’s the ground-floor retail that characterises this mixed-use development, and will contributes to vibrance and strong branding.

The retail component in Darlinghurst is similar conceptually to how Walker Corporation approached retail at the famous Woolloomooloo Wharf development. Whilst the premium residential apartments sold off-the-plan by Walker, the ground-floor retail was retained.

Walker strategically worked with huge incentives for premium retailers, so that a previously dingy area – characterised by housing commission – could be revitalised by the vibrant buzz of sophisticated eateries. Today it is one of Sydney’s most sought-after outdoor dining experiences and largely thanks to that vibrant ground floor retail precinct the apartments continue to grow exponentially in value .

In an evolving market, understanding the drivers of each of the sub sectors of the property market and each deal specifically will enable the benefit of riding tailwinds, avoiding headwinds and positioning for outperformance.

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