COVID-19 has created challenging economic conditions for Australian and New Zealand retail operators, the full effect of which is yet to be felt by the industry. However, while many of the specific final impacts on operators remain uncertain, what is certain is that the fortunes of Australia and New Zealand’s retail sectors are intertwined with those of the retail property sector. The twinned public health and economic crises currently ravaging retail operators across both countries is sure to have just as significant an impact on the property market that supports it.
This has been most keenly felt by owners of larger centres hosting predominantly discretionary spending such as apparel or department stores. The values of many of these centres are falling quickly, with many listed property trusts announcing reductions in the carrying value of the assets on their balance sheets as a result of the lockdown.
While some local analysts fear a similar situation to that faced by the US retail property sector – where up to a quarter of the country’s 1200 malls are in danger of collapse – the reality is likely to be much less dramatic in Australia and New Zealand. Sharp reductions in in-person retail spending as a result of social distancing and a rise in unemployment – combined with the loss of all retail tourism – are likely to have a significant impact on the sector. However, as Australian and New Zealand shopping centres are traditionally anchored around non-discretionary retail such as supermarkets, the contraction is likely to be painful but non-fatal for many local property owners.
With rent concessions and wage subsidies in Australia and New Zealand set to wind back in both countries, how well your portfolio weathers the turmoil beyond this will depend significantly on the actions you take now.
Co-designing the new normal for retail
Responding to this crisis requires foresight, patience and potentially a willingness to compromise. While the tendency when crises bite is to slip into a reactive mode of thinking, heavy handedness on the part of property owners has the potential to do more harm than good to the long-term viability of their portfolio, potentially resulting in more vacancies than you can sustain.
Simply put, rental yields will not return to their pre-COVID-19 level until the retailer is back to full health. Most landlords understand this, aware that it’s better to have a retailer in store and earning – even with rent deferred or reduced – than it is to have an empty shop front. When retail businesses fail, property values fall, so it is in your best interest to ensure that your tenants have the support they need to weather these headwinds.
What we have heard from operators during this period is that they want two things from their landlords: support and flexibility. This has materialised in the industry in a number of ways. First and foremost is in the length of the lease – many operators in this environment are categorically refusing to commit to a standard five or ten-year commercial lease. Increased uncertainty and changes to the structure of their businesses means that retail operators are instead seeking much shorter lease terms of around three years.
The second – and potentially more significant – change we have seen emerge is in a shift away from leases with a base rent. In order to more flexibly respond to peaks and troughs of demand as public health measures tighten and loosen, many tenants are instead demanding a move to turnover rent wherein rent is calculated as a fixed percentage of their gross takings for the month. This is a trend that has its roots prior to COVID-19; the move to online shopping by some operators – with its significantly lower margins – meant that they could not wear the cost of their rent, leading to a shift towards more flexible lease terms. COVID-19 has accelerated this movement, making the discussion all the more essential for both landlords and tenants.
However, this moment also offers a great opportunity for enterprising landlords. Those willing to work with their tenants as an equal partner, to share in the financial risk associated with getting through this period stand to reap significant financial gain in the long-term. An operator who’s equipped for this environment, who has a business model that embraces the multitudinous ways that consumers want to shop and who has a strong product can flourish in this transitory period and the post-COVID-19 normal. Shifting to turnover-based rent payments for this tenant can deliver a significantly higher yield than a conventional lease, allowing both landlord and operator to achieve success together.
Remedies for property owners
While government support measures such as JobKeeper and rental relief in Australia and the Wage Subsidy Scheme in New Zealand have helped many retail tenants stay solvent and trading, others have been less fortunate. Well known names such as Aussie Disposals, Seafolly and Tigerlily in Australia and The Warehouse in New Zealand have already either entered voluntary administration or announced significant restructures, citing COVID-19 as the reason for their unprofitability.
Maintaining the profitability of the asset for property owners means either finding another tenant or finding another use for the property. As finding a tenant during this period of contraction willing to take on the lease as well as the cost of moving and refitting can be difficult, this does not mean that these assets have to become a drain on your portfolio.
Many property owners are taking a more holistic view of their portfolios, freeing themselves from the idea that ‘like’ needs to replace ‘like’ when it comes to retail property. These investors are seeking to reposition existing retail assets to better meet the daily needs of people during this uncertain period. With many consumers forced to change their behaviour during the lockdown away from in-person retail and towards online purchases, repurposing retail spaces into office space, gyms, medical centres, and even large footprint businesses such as colleges and cinemas could be the way to secure the profitability of your asset into the future. Abroad, we have also seen investors in similar situations reposition their retail spaces as residential apartments, a trend that may follow here.
At Bentleys, our position is that those property owners who seriously consider the utility of their property beyond narrow short-term ideas will be the most successful in this uncertain time. There is a future in retail property – the tendency to occupy large amounts of prime, well-positioned real estate means that there is significant earning potential in these assets even during an economic downturn. While more radical than simply finding a replacement tenant of the same size, dividing larger retail spaces into several smaller leases, or repurposing them entirely can open the door to more diverse, stable income streams outside of retail. While these may not deliver the same rent as before, they can offer a stability and long-term safety that other tenants cannot currently deliver.
This is a bold step, and one that should be taken on an informed basis. Ensure that you are making confident, effective decisions for your business and your portfolio assisted by Bentleys’ advisory service, regardless of the market you’re operating in. Discuss your goals with your local Bentleys advisor today.
We, at Bentleys, are doing everything we can to help businesses come out of this challenging time in good shape.
We will continue to update our COVID-19 resource hub with important developments, so please return soon.
Disclaimer: This information is general in nature and should not be relied on as advice. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs and seek professional advice before making any decisions based on this information.