A recent survey by Altus Group found that not all real estate asset classes are going to be impacted the same way as a result of the COVID-19 pandemic but retail will be the hardest hit.
Colin Johnston, President of Research, Valuation & Advisory at Altus Group, said retail will undergo some structural changes with many bankruptcies taking place and there will be questions about malls going forward and how they will be impacted by social distancing as well as the impact to experiential retail.
Altus Group surveyed 115 Canadian commercial real estate executives from pension funds and life companies, publicly-traded corporations (REITs), private companies, and brokerages to gain insights on the short and long-term impacts of COVID-19 on the retail sector. Topics discussed include challenges associated with physical distancing measures, rental relief programs, vacancy, and overall sector risks.
Johnston said respondents feel there will be an increase in capitalization rates for retail properties and respondents also felt there would be challenges with maintaining rental rates.
“When you talk about capitalization and rental rates, those are things that drive values. Vacancy drives value as well,” said Johnston.
“If you look at StatsCan’s retail sales, what’s held up really well is grocery, pharmacy, and general merchandise . . . A lot of them are deemed essential businesses but they’re also located in what I would call open strip plazas. People were able to get to them. It’s the enclosed shopping centres which have really predominantly fashion tenancies and restaurants and food courts and things like that, those have been impacted a lot.”
Key findings from the survey include:
- Most owners and managers surveyed (80 percent) already had one or more rental relief programs for their retail tenants in April, while 20 percent were reviewing options;
- Retail tenants were more likely to obtain rent abatement or reduction from their landlord (30 percent) than office tenants (19 percent) or industrial tenants (10 percent);
- In the context of non-essential business and mall closures, many retail owners proactively designed and allocated rental relief programs based on retailers’ risk profile and exposure to the dramatic impact of being forced to shut down;
Owners prioritize short-term relief for retailers who can get through this crisis. COVID-19 is accelerating the bifurcation of weaker/stronger retail concepts that had started before the pandemic hit;
- For retail and mall reopenings, physical distancing will be challenging, with respondents concerned about costs associated with physical distancing measures;
- More than half of survey participants are expecting cap rates of retail properties to increase over the next 12 months. Retail is also the least likely to be the target of opportunistic buying strategies;
- Key assumptions are more significantly impacted for retail properties than for other asset classes, especially for lower quality assets, for which 87 percent of respondents expect rental rates will decrease over the next 12 months; and
- For retail tenants, probability of renewals is expected to be lower than before the pandemic, and market participants also anticipate longer lag vacancy periods. These assumptions have not changed as significantly as they have for other property types.
The future of shopping centres is a topic of much debate these days.
“I think what you’ll have for some of those tier two malls or some of those enclosed community malls, those older ones . . . you’ll probably see some heightened obsolescence of some of those centres quite frankly because some of them were struggling pre-COVID and now the question is how many retailers are going to open back up and how many are going to be able to pay rent,” said Johnston.
“Some of the tenants in those centres already were paying what we call variable rent as they were only paying a percentage of their sales . . . Foot traffic is going to be less and there’s less reason to go to the mall and people are concerned about going to the mall. That’s going to be difficult.
“What you’re also going to see I think potentially is a flight to quality.”
Johnston said he believes some landlords will reduce rents to compensate for increased vacancy. This will give some tenants the opportunity to upgrade from a tier two mall to a tier one mall.
“We’ve seen this phenomenon in the U.S. Since 2016, there’s been 25 of these sort of enclosed older community malls that have been converted to distribution centres. What happened is they start to die a little bit. What they do have is a big site with ample parking so it’s good for trucks and trailer storage. It’s close to highways. And it’s also close to a population base. So it’s good for last mile fulfillment and we can all see how e-commerce has accelerated,” said Johnston.
“The issue is do you give up on your enclosed community mall? Do you go for rezoning to city council and try to do something perhaps a little bit different? It was certainly a phenomena we saw in the U.S. which had a lot more retail per capita than Canada but it’s something potentially I could see happening up here.”
There will be more secondary malls in the future looking at alternative uses which could mean distribution space or residential development perhaps. And the traditional retail use will probably be augmented with different uses such as daycares, and government and medical offices.
