THE slump in retail spending and the pessimistic outlook for consumer sentiment has resulted in property trust analysts signalling a possible 10 per cent downgrade in rental outlooks.
Also forecast is a rise in bankruptcies if conditions in the retail sector deteriorate further.
At most risk are specialty stores, which pay higher rents within a shopping centre than the "anchoring" department store chains.
Despite the profit warnings issued by all retailers and the gradual decline in the government's retail sales data, the retail property sector was viewed as being immune to the risks due to the long-term nature of lease contracts.
However, as more tenants move into bankruptcy or are forced to close, the pressure is now mounting on landlords. Most of the big shopping centres in Australia are owned by trusts, including Westfield, CFS Retail, Stockland and GPT.
Matthew Bertram and Ian Randall, research analysts at Deutsche Bank, advised in a note to clients that recent profit guidance from several listed retail groups has increased investor concerns on both the outlook for the discretionary retail sector and the flow-on to the Australian real estate investment trust retail portfolios.
"Whilst for most A-REITs exposure to turnover-based rent is not material, the risk to retail portfolio income streams lies in: the level of rent achievable on renewals/re-leasing; potential occupancy declines (in part driven by tenant failure); and potential for development returns to fall short of targets," the Deutsche Bank researchers said.
"As a sensitivity, we have allowed for a 200 basis point reduction to portfolio occupancy for all A-REIT retail portfolios (equating to additional specialty vacancy of 250-480 basis points across portfolios) and rental declines on releasing of up to 10 per cent.
"Such a scenario would see our 2013 financial year earnings per security estimates down by between 1.6 per cent for Stockland and 7.1 per cent for Westfield Retail Trust."
Mr Bertram said that in the event the second half of the year remains fragile, "in our view the risk would be for a further round of specialty bankruptcies/corporate failure".
"We expect the most likely time frame for material bankruptcy risk would be February 2012," he said. "While for David Jones the sales clearance period in June-July is a significant profit driver, for a number of smaller specialty tenants the Christmas trading period will likely be the key contributor to profit."
One bright light is that A-REIT portfolios are insulated in the near term from negative market rental growth due to the lease structures in place. Most leases are fixed for five years, with a 5 per cent rise; others may be reviewed more frequently, with a rise of the CPI rate plus 2 per cent.
Simon Wheatley, the executive director of real estate investment research at Goldman Sachs, said the slump in consumer sentiment last week, combined with the David Jones downgrade and commentary that the present retail conditions are unprecedented, have led him to take a negative view of the sector.
"Further, weakness in house prices is likely to undermine confidence and consumers' willingness to spend," Mr Wheatley said.
Frequently Asked Questions about this Article…
What is causing the slump in retail spending and why should investors care?
The article says falling consumer sentiment and weaker retail sales have driven a slump in retail spending. Everyday investors should care because this weakness can pressure retail tenants, increase bankruptcies among specialty stores, and flow through to retail property trusts' rental income and earnings.
Which retailers and landlords are most at risk from weaker retail conditions?
Specialty stores are highlighted as most at risk because they typically pay higher rents in shopping centres than large anchoring department stores. Major shopping-centre owners named in the article include Westfield, CFS Retail, Stockland and GPT, which could see pressure if specialty tenant failure rises.
How could weaker retail trading affect A-REITs and retail property trust income?
Deutsche Bank analysts warn that risks to A-REIT retail income include lower rent achievable on renewals/re-leasing, occupancy declines from tenant failure, and weaker development returns. They modelled scenarios of falling occupancy and rental declines that would reduce A-REIT earnings.
What downside did analysts model for rental outlooks and vacancy, and how would that hit earnings?
Analysts allowed for a 200 basis-point reduction in portfolio occupancy (equating to an extra 250–480 basis points of specialty vacancy across portfolios) and rental declines of up to 10% on re-leasing. In that scenario they estimated 2013 earnings per security could fall between about 1.6% (Stockland) and 7.1% (Westfield Retail Trust).
Are retail property trusts fully protected from negative market rental growth?
Not fully, but A-REIT portfolios are somewhat insulated in the near term by existing lease structures. The article notes most leases are fixed for five years with around a 5% rise, while others are reviewed more frequently with increases tied to CPI plus 2%, which delays immediate market rental falls hitting income.
What did analysts say about the risk of specialty store bankruptcies and a likely time frame?
Deutsche Bank researchers warned that if the second half of the year remained fragile, further specialty bankruptcies or corporate failures were likely. They suggested the most likely time frame for material bankruptcy risk would be February 2012.
How did David Jones and consumer sentiment influence analysts’ views on the retail sector?
The article reports a David Jones profit downgrade and a slump in consumer sentiment prompted a negative view of the sector from Goldman Sachs’ real estate research. Analysts said those developments, combined with unprecedented retail conditions and weakness in house prices, could further undermine consumer willingness to spend.
What should everyday investors watching the retail property sector monitor next?
Based on the article, investors should watch retail sales and consumer sentiment data, profit guidance from listed retailers (including updates from major department stores), vacancy and rental re-leasing outcomes for specialty tenants, and any signs of rising tenant bankruptcies — all of which can affect retail A-REIT income and earnings.
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