Rental reset needed to address occupancy costs

Federation centres, novion, shopping centreSpecialty retail rents will need to reset in the coming years to de-escalate increasing occupancy cost ratios as slowing sales weigh on tenants.

That’s the view of JLL researchers who have predicted that re-leasing spreads for specialty stores will decline by .5 per cent in 2018 and remain negative to a 3.5 per cent decline by 2020.

Re-leasing spreads, a measure of leasing terms on renewals, have increased by a cumulative 4 per cent since 2015 but JLL has suggested that lacklustre sales will usher in a change due to downward trends in specialty sales growth.

Annual rents increased by approximately 3.2 per cent per annum as at December 2017 with inflation of 1.25 per cent, outstripping total retail turnover growth for specialty stores, which increased by 3 per cent per annum over the same period, JLL said.

“A reset in rents will be necessary to avoid upward pressure on occupancy cost ratios,” researchers said in JLL’s annual shopping centre investment review.

“We believe that retailers will continue to seek more sustainable occupancy cost ratios at lease expiry, given cash flow pressures in terms of competition-led discounting, slowing sales growth and a rising cost base.”

JLL1

But a 3.5 per cent decline in re-leasing spreads by 2020 still implies cumulative rent growth of 13.5 per cent or 2.6 per cent per annum for tenants renegotiating their leases over the next few years.

The figures come as a myriad of high profile brands are actively considering consolidating their store portfolios to reduce costs and free up capital for investment in online, including Myer, Specialty Fashion Group, Oroton Group and Premier Investments.

Centres look to food as department stores consolidate

Sub-regional centre owners are responding to changing conditions by increasing their exposure to tenants whose offers can’t be replicated online, such as food and beverage traders and services providers – but these tenants also pay more rent.

Food and beverage rents are around 48 per cent higher than apparel rents, 30 per cent higher than general retail and 50 per cent higher than homewares rents.

Food and beverage retailers now account for 17 per cent of specialty floorspace in retail centres, up from 13 per cent in 2009, JLL researchers found, driven by contraction in homewares and leisure tenants.

JLL 2“The motivation for the change in the use type is therefore clear,” researchers said.

“In a low-growth environment, and in a retail sub-sector where the leasing and retail sales risks are to the downside, the shifting tenant mix primarily reduces risk to some extent.”

Meanwhile, as department stores like Myer and David Jones face headwinds, with the former announcing store closures, JLL has said it has become more cautious on the sub-sector.

“The realistic scenario is that store network rationalisation and space handbacks will continue to occur in the least profitable locations as leases expire,” researchers said.

Outlook strong

Despite reports that centre owners are finding it more difficult to secure tenants, JLL said that it expects vacancy rates to remain “resilient” in 2018, noting that there will be challenges in the leasing market as landlords replace underperforming retailers.

This echoes Scentre Group chief executive Peter Allen’s warning to retailers that are unable to keep up with the times last week.

“There’s no doubt the industry’s evolution will continue, as those brands that no longer perform or are relevant or desirable to customers will fall away,” he said.

JLL did say that it expects the Australian macro-economic backdrop to improve through 2018, following initial signs that wage growth may be set to recover in recent weeks.

It is forecasting annual wage growth at 2.6 per cent, up from the 2.1 per cent per annum average over the last three years.

Transactions strong

INDOOROOPILLY_SHOPPING_CENTRE_STORE_FRONTMixed views about the health of the retail sector drove the second highest year of retail property investment activity on record in 2017 as owners looked to refine their portfolios.

$8.8 billion worth of retail properties were transacted last year on the back of several mammoth transactions in the second half of 2017, including the $1.1 billion Vicinity Centres/GIC asset swap and the sale of 50 per cent of Indooroopilly Shopping Centre for $800 million.

More assets valued at over $300 million transacted in 2017 than in any other year on record as the changing and competitive nature of the current retail environment prompted asset owners to adjust their exposure to different asset types in search of greater diversification.

“Investors clearly have a diversity of views on the outlook for the Australian retail sector, which stimulated near-record levels of asset trading,” JLL’s head of Australasian retail investments Simon Rooney said.

JLL is expecting another strong year in 2018 despite buyers reportedly taking a cautious outlook on retail investments as the divergence between high and low-quality assets grows.

“While e-commerce is weighing on shopping centre sales growth, some of the cyclical drivers of retail spending are showing more positive signs of a recovery in the short-term,” JLL’s director of retail research Andrew Quillfeldt said.

“Lower quality retail assets have been most affected by changes in the retail industry, but quality retail assets are continuing to perform well.”

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