PORTFOLIO POINT: Shops and offices are feeling the effects of economic change, and investors should think about how this affects their portfolio.
I believe that long-term superannuation investors need to think about reducing any exposure to commercial property. I am not forecasting a calamity but a series of events during the past 10 days has increased my apprehension.
One of the events is watching the Lowy family actually offloading part of their equity in a large number of centres to Australian and overseas institutional investors. It will enable Westfield to develop more centres and, if all goes well, greatly increase their return on capital. But it makes me edgy so let me take you on the journey that brought me to that conclusion.
When you are determining your investment strategies or selecting a particular stock to buy or sell, you normally rely heavily on professional advice and analysis. But sometimes when you look around you can see events taking place that grab your attention and it is often worthwhile to combine the professional analysis with your own observations.
Today I will relate two experiences I think contain an investment strategy message, a message that I don’t think is being embraced by the market – or at least not fully embraced.
My first experience came from yarning to one of the younger guns in the office, who told me that he had gone off to Levi Jeans to buy a pair of Levis. The salesman was most attentive and had given him lots of choices and handled the whole transaction in a most professional manner. That sales person had clearly been well trained on how to sell to customers.
But then our man went into the change rooms to try on the jeans and took the trouble to take out his iPhone and check what he could buy the same product at on the net. The price in the Levi store in Australia was just a little above $140. On the net and purchasing from the US, the same jeans were selling for a little above $40. That’s a hundred dollars difference and it’s far too much.
I suspect that differential will be repeated in many upmarket retail outlets because they pay high rent and they’ve invested heavily in skilled staff. Our office young gun actually bought the jeans from the store (we are obviously paying him too much) because of the service. But he will never return to that store, nor will his friends. A major re-engineering of that business, including a rent reduction, is required. But they are not alone.
My second experience was to be with a group of people who said they almost never went into their bank branch. And then I noticed that a recent State of the Nation report from Roy Morgan Research shows that internet banking is threatening to overtake branch banking in the retail sector – so many purchases are made via EFTPOS these days, the money is banked automatically so shops no longer need to lug the day’s takings to the local branch. That’s going to create a rethink of branches by all banks.
In fact, with customers and retailers alike doing more banking online, it could lessen the need for branches and make the banks more profitable. It is certainly different to the situation 10 or 20 years ago when there were the mass branch closures, which left customers nowhere to go.
Banks lost large numbers of customers, who took their business elsewhere in disgust. It will be difficult to find tenants for former bank branches, which are purpose-built. These two events are signals of a change in the way we are buying goods and services in this county. And it is simply not going to be possible for a great many shop owners and retail centre owners to charge the same amount for rent. If they try to continue charging high rents they’ll simply either send their tenants broke or force them to go elsewhere.
Large shopping centres currently sell on very attractive returns so not only could rents fall but yields (that is the yields achieved on commercial property sales rather than rental yields) could rise, which would be a double whammy.
If that process develops, it will reduce retail property values and it may also affect the availability of finance for the retail sector. These are early days and the market has not fully taken this change into account. It is likely that the centres that are least-affected will be those that include supermarkets or downmarket retailers among their tenants. But if you are running an upmarket retail operation, you may need to reduce your rents and change your staff practices to be able to compete with online retailers.
And just to underline this change, JB Hi Fi has been one of the great exploiters of the customer traffic attracted by large shopping centres. JB’s model was based on the strategy that if they sited their stores in a successful shopping centres they would not need to spend as much on promotion because shoppers would be near their stores anyway. JB Hi-Fi is now struggling; the model they have used is not working as well as it did in the past.
A great many Eureka Report readers use listed property trusts, now more commonly known as A-REITs, as a way of gaining secure high-yield income. In the past that strategy encountered problems because too many trusts were highly leveraged. Today most trusts are no longer highly leveraged so they are much safer proposition.
However, they are now facing a change of considerable proportions in the retail sector of their portfolios and retail values could fall. And it is possible that this fall will extend into office developments. In the future, the way we work may involve a much greater decentralisation of labour. That will be particularly so if we get a National Broadband Network.
This week I also spent some time talking to Stockland CEO Matthew Quinn. He believes office property is not going to be a good performer because it is a commodity product where supply is relatively easily generated. Moreover, we are going to see a reduction in the number of office workers as the finance industry contracts. Accordingly, he is reducing the Stockland exposure to commercial office buildings.
Stockland believes that the big regional shopping centres, such as those controlled by Westfield (although the Westfield name is never mentioned by Stockland), are in a dangerous position because about 46% of their revenue comes from clothing retailers – they are dominated by medium-priced or upmarket clothing stores. And it is these stores that internet penetration will be at its highest and sometimes will get to 25–30% of the total market. Rents will be under great pressure.
Quinn believes shopping centre growth will come from those centres that are dominated by supermarkets and non-discretionary retailers. Stockland is taking its money out of commercial office blocks and investing into these food-dominated centres, making sure that they are not too big.
This is the reverse of the Westfield strategy. Most superannuation funds, when investing in commercial retail and office property, invest in major listed vehicles. In other situations, smaller investors own shops in centres that may also run into trouble because of the online pricing pressures.
Superimposed on this is the fact that middle-income Australia is under pressure and we may be seeing a narrowing of the disparity between middle and upper income Australia, and those at the low end. All these variables make retail investment the subject of much greater risk than we have ever attached to it in recent decades.
The price of property stocks has risen in recent weeks so it is a good time to conduct a review of your percentage holding. You don’t have to throw it all out but just make sure it is not too big in your overall portfolio.