Piggy in the middle
Elections are decided by the inbetweeners because there are more of them.
In the shopping centre industry, there are three analogous categories, called A, B, and C centres, or first, second, and third-tier centres if you prefer.
Although the first group gets most of the media attention, it’s really the condition of the middle group that determines the health of the industry, because it is the one with the most centres – these are the industry’s stout-hearted workhorses, if you will.
So how these second-tier centres decide to respond to technology, globalisation, and consumer spending changes will not just determine whether they rise to A, fall to C, or stay where they are will set the tone for the whole industry.
To get the flavour of what mid-market shopping centre owners in Australia are increasingly up against, it is worth taking a look at the situation in the US, where the processes taking hold in Australia have already been extant for a number of years.
On the surface at least, the signs are very encouraging. The US real estate recovery is continuing smoothly, with declining vacancy and rising rents across most shopping centre formats.
Capitalisation rates on retail property have been falling for some time, and did so again in the first quarter of 2014, almost breaching seven per cent, despite a shift in the mix of transactions toward lower quality centres.
Even new development is back on the agenda. In 2013, shopping centre openings rebounded almost to pre-2009 levels, and 2014 is on track to be stronger still.
Most of the new space is pre-leased so there is little about it that smacks of the disastrous speculative kind of development of years gone by.
Only in the regional centre category is new development still becalmed, primarily because of the scarcity of anchors for these centres now that full line department stores are no longer expanding and discounters prefer power and community centres.
It is notable that all of the positive trends are happening despite two very strong headwinds. First, roaring growth of e-commerce sales, which increased by 17 per cent in 2013 to reach $263 billion according to the US Census Bureau.
Second, big box retail chains that lease gobs of space in US power centres are downsizing both their store fleets and the sizes of their stores.
It is as wearying for me to mention it as it is for readers to hear it, but I would be remiss not to reiterate that e-commerce has materially and permanently altered demand for big box retail in categories such as office supplies, books, digital media, discount department stores, and consumer electronics.
Despite the fact that the headline figures suggest the US shopping centre industry as a whole is adapting well to change, not all is well in this paradise.
The problem is not at the industry level, nor even that specific formats are significantly more troubled than others – average performance metrics are fairly stable across shopping centre types. Nor is it a problem of a growing gap between the best centres and the worst centres, the haves and the have nots.
Rather, it’s a widening gap between the best shopping centres and the ones in the middle.
During this cyclical recovery, retail chains have not adhered to the pattern of previous ones in which they took the best space first and gradually moved downstream into B space, causing occupancy and rents to increase in the lesser quality centres with a lag.
Sure, they have still taken the A space, but after that many have held back, keeping their powder dry while waiting for new shopping centres to open or more of the existing A space to become available. This is putting middle of the road shopping centres under terrific pressure.
How, if at all, is this relevant to Australia?
Australian retail chains have become assertive about striking more favourable renewal deals across the board, and this is affecting all sub-regional and regional shopping centres to some extent.
But second-tier centres are particularly vulnerable. These are either sub-regional or undersized regional centres in the suburbs of Australia’s capital cities.
Many have neither the land, the location, nor the demographic profile to facilitate an expansion that would catapult them into the A category.
Without major redevelopments, they will not be able to attract the global retailers that require purpose built space or the domestic chains that are ‘rightsizing’ their store portfolios. Moreover, these centres will be increasingly prone to cannibalisation as e-commerce becomes more developed.
Of course, a return to the party years of consumer spending of the first half of the last decade would solve everyone’s problems. I’ve yet to meet a single economist who is predicting that. So these B centres will need to retool as their American counterparts are doing. But how?
There is no one size fits all model for future proofing these shopping centres. Instead there are multiple models that will be informative in different situations.
Most of them involve rejigging the mix away from the numbing dependency on mass market fashion and home goods.
Sometimes it will involve more food service, entertainment and non-retail services as some industry professionals have already pointed out. But this only scratches the surface of the possibilities.
Luckily, neighbourhood centres seem almost immune to all the turbulence. In the US, neighbourhood centres with strong supermarket anchors continue to thrive.
Vacancy in the sector has been declining, but is still a high 10 per cent, partly due to the prevalence in the US of strong freestanding supercentres, supermarkets and warehouse clubs that continue to savage centres anchored by poorer supermarkets.
In Australia, neighbourhood centres have little to worry about on that score because of a total absence of supercentres and the near total absence of large freestanding supermarkets and warehouse clubs in capital city suburbs.
It will take a combination of factors to change that, among them, a significant relaxation of planning laws to make it easier to open freestanding supermarkets, and a greater willingness on the part of the supermarkets to expand merchandise assortments and deliver incremental services such as high quality food service.
For now though, neighbourhood centres look pretty safe. It’s their larger brethren that are feeling a bit like piggy in the middle.