The internet threat to supermarkets

Tim Nation asks if the rise in popularity of Internet shopping threatens the success of the traditional regional shopping centre.

Australian regional shopping centres have consistently outperformed other property sectors domestically, and comparable retail sectors globally.

But is the current hype about Internet shopping a threat to Australian shopping centres, or just a storm in a teacup?

The last few years have reinforced the fact that Australian shopping centres provide investors with a defensive property exposure.

Specifically, I am referring to regional shopping centres — the larger dominant centres featuring one or more supermarket(s), major department stores, discount department stores and a wide range of speciality shops.

Like the majority of asset classes, valuations of shopping centres have fallen during the global financial crisis.

However, strong income growth generated by these shopping centres, driven largely by Government stimulus in 2009, somewhat softened the blow to investors.

For example, while rising capitalisation rates implied a devaluation of 20 per cent, the income growth during the same period mitigated this to roughly 5-10 per cent for the best assets.

The second half of 2010 saw a reduction in retail sales and consumer confidence generally.

Flat sales were the theme of 2010 once the Government handouts from 2009 had filtered through the system. But despite a relatively subdued trading environment, shopping centres have performed strongly.

Strict planning regime

There are only about 65 regional shopping centres in Australia, and tight planning restrictions make it very difficult to build more.

There are only a limited number of tenants for the centres, and the last thing they want to do is cannibalise their existing stores.

Unlike the US, where shopping centres have popped up everywhere, there are far more controls in the Australian market.

Another thing that sets Australian shopping centres apart from their UK and European counterparts is that they do not compete against ‘high street’, which generally accommodates the majority of the speciality shops we see in our shopping centres.

Australian shopping centres tend to evolve from neighbourhood centres (smaller shopping centres with a supermarket and some speciality shops) through to sub-regional centres (supermarkets, a department store and speciality shops) through to the dominant regional centres.

This process is driven by population growth, the location of the centre, as well as the ability to secure development land around the centre to grow.

Australian population growth is forecast to remain at a very robust 2 per cent plus (unique among OECD countries) and is obviously a major driver of retail sales.

Supermarket presence

While planning restrictions are one factor, the presence of supermarkets in Australian shopping centres is another. In the global market, supermarkets tend to occupy stand-alone premises on the fringe of town centres.

Supermarkets generate ‘footfall’ (ie, customers) for shopping centres irrespective of economic conditions.

In fact, during economic downturns people tend to spend more on their weekly shop, since a nice meal at home is favoured ahead of eating out at restaurants.

Speciality shops and departments stores also benefit from the constant foot traffic created by supermarkets.

Positive returns

Investors are also looking at shopping centres, and more generally commercial property investment, as a hedge as we enter an inflationary environment.

One notable feature of Australian commercial leases is annual rental increases, generally linked to reflect the consumer price index plus a margin.

This margin could be 1-2 per cent depending on the strength of the local market and anticipated rental growth.

This means an investor’s income increases in line with the inflation rate, differing from other markets where leases are reviewed every five years to reflect the new prevailing market rent at the time of the rent review.

In summary, a strict planning regime limiting supply, and the presence of supermarkets driving regular foot traffic are both factors in driving long-term investment performance. Is the rise of Internet shopping going to threaten this long-term trend?

The Internet shopping threat

Retail sales in Australia total about $242.15 billion. While there is no specific data collected relating to the size of the online retailing market, estimates suggest online shopping accounts for about 4-5 per cent of retail sales — or $10-12 billion.

Approximately 40 per cent of the total online sales in Australia are conducted on overseas sites. It is fair to assume this component could be fairly sensitive to the relative strength of the Australian dollar and could grow/contract accordingly.

While still a relatively small component of total retail sales, this could grow to $17.7 billion by the end of 2014, a compound annual growth rate of 10.2 per cent. This assumes Internet sales follow a similar growth pattern to other western countries, where the market is far more mature than in Australia,

The growth in online shopping will therefore play a role in changing the face of Australian retailing, and shopping centre owners ignore it at their peril.

Having said that, it is unlikely to be the death knell for shopping centres.

Good shopping centre asset managers position the properties they manage on behalf of their investors ahead of change.

The world of retailing, like most things, is fast changing and dynamic. In the early 1990s, some predicted the introduction of the bulky goods format would erode market share from shopping centres.

Since then we’ve seen the demise of a number of music retailers, also touted as a major threat to shopping centres over the last decade.

But the shopping centres survived, because they refocused on providing the right leasing mix, creating the right design and targeting the right customer.

To maintain their relevance and defend market share versus online retailers, shopping centres need to ensure they offer a real point of difference and ‘experience’ for the shopper that can’t be replicated clicking a ‘buy’ button on their PC, iPad or iPhone.

Shopping centres will need the right mix of entertainment, dining and lifestyle offerings and position themselves as the modern day ‘town hall’ for their local communities.

In reality, the maturity of the Australian online retailing sector is years behind those of the US and UK.

In these markets retailers have identified the importance for their brands to remain visible in major shopping centres and, whether or not sales are made on-site, provide shoppers with an opportunity to view and feel their products even if they are later purchased online.

Australian retailers have some work to do building their websites and embracing online sales before this even becomes relevant.

It’s important to note online retailing has not been a ‘shopping centre killer’ in these markets, and that high quality shopping centres remain an important part of the broader retailing landscape globally.

With strong and pro-active asset management, Australian regional shopping centres are likely to remain an attractive asset class for investors.

Tim Nation is senior investment specialist for property at AMP Capital.