NAIOP Panel Discusses Trends in Retail Sector

December 13, 2011

By James Speakman

A full house at the Four Seasons Hotel attended NAIOP Vancouver's December breakfast to hear an expert panel discuss development trends in the retail sector. Eric Carlson, CEO, Anthem Properties, moderated the discussion, posing questions to Brian Kozak, Senior Vice President, Western Canada for First Capital Realty Inc., John Horton, President, Shape Properties Corp. and Scott Lee, Principal/Broker, Northwest Atlantic Brokerage.

The Current State of the Market

Eric Carlson started by asking the panel what affect current global economic turmoil is having on their psyche. Generally, the feeling was that the economic story in Canada is still positive, with tenants and landlords both moving forward with their Western Canadian projects. Scott Lee noted that the US-based tenants which he represents remain cautiously optimistic and continue with their growth plans in Canada, while Canadian retail tenants continue to consider expansion opportunities.

Eric Carlson noted his perspective that the current recession has not resulted in as much turnover among tenants as in previous recessions. Brian Kozak concurred, noting that tenant defaults have been very rare in First Capital's portfolio and that where they have occurred other tenants have taken up the vacant premises. He noted that when Blockbuster Video went bankrupt, 17 of the 20 vacancies which resulted were filled almost immediately. When asked to compare this to centres in smaller markets, John Horton noted that tenants in markets such as Port Alberni may need more “hand holding”, but overall they are surviving.

When discussing whether rents are increasing, staying flat or going down, John Horton felt that rents across all markets are generally flat, even in Class B properties, and they may even be increasing in some urban settings. Certainly, there has not been widespread rental decreases.

Overall, then, Eric Carlson summarized the current state of the market as being one with cautiously optimistic tenants, no rental compression and vacancies which are quickly refilled. Overall, “it's not so bad”, and certainly better than the current experience in the stock market.

Target Stores

Eric Carlson asked the panellists to relate their experience with Target's recent expansion into the Canadian market. Scott Lee, whose firm acted as Target's broker, advised that Target saw the Zellers stores as a unique opportunity to buy into a portfolio of good real estate and to use Canada as their first international expansion. Brian Kozak noted that First Canadian wasn't able to come to terms with Target, which had specific lease requirements, on all of its stores, but that Wal-Mart stepped into many of the stores which Target did not take. Of the 17 Zellers in the First Capital portfolio, 13 were taken by Wal-Mart, two by Target and two remained as Zellers stores.

John Horton said that having Target enter the Canadian market has been great for landlords and consumers, as it provides further competition in the retail marketplace. Shape Properties has ended up with a few Target stores in its portfolio. In terms of what will happen with the stores which are remaining as Zellers, John Horton said that they may end up in "liquidation" mode, with landlords having to eventually work with Zellers to reconfigure the space.

US Retailers in Canada

In response to a question about what other US retailers are coming to Canada, Scott Lee mentioned several tenants who are either currently opening stores or are in the planning stages, including Anne Taylor, Express, JC Penny, J. Crew, Kohls, Marshalls (who have already opened stores in Toronto and are opening in Western Canada starting in 2013), Dicks Sporting Goods, Nordstrom, Kate Spade and other higher end fashion retailers.

In response to Eric Carlson's question regarding the recent consolidation among Canadian tenants such as Canadian Tire (taking over Forzani Group) and the Dollar Store (now Dollar Tree Canada), Brian Kozak noted that smaller retail formats aren't working for many non-fashion retailers. In order to compete with US retailers coming to the market, Canadian retailers will have to consolidate and create larger formats. John Horton noted that a positive result of both the influx of US tenants and consolidation among tenants is better “credit”. That is, Target has a much better financial rating than Zellers and Canadian Tire is similarly better than Forzani. Even though there may be fewer Canadian tenants as a result of consolidation, US retailers will replace them. New tenants will backfill space in each discipline (food, sporting goods, etc.).

The Availability of Capital

Eric Carlson asked the panel to comment on how recent economic volatility has affected the amount of capital available for real estate investment and development. Brian Kozak said that there has been no effect at all – that North American capital markets continue to provide a surplus of capital for real estate. He noted that with bond yields rising in Europe there may be another liquidity crisis in the near term, but currently both public equity and conventional debt financing are in ample supply. John Horton concurred, noting the "hunt for yield". Although Shape Properties relies on private equity (as opposed to First Capital, which is publicly traded), accessing capital has not been an issue for them. Eric Carlson likewise agreed, noting that the de-leveraging of corporate and bank balance sheets in 2008 and 2009 was short-lived in Canada, and that with an abundance of capital available for real estate, the bigger issue has become finding opportunities.

Capitalization Rates and the Economics of it All

This led to the inevitable discussion about capitalization rates, with Eric Carlson posing the question of whether they will continue to stay at their current historic lows. Brian Kozak's view is that cap rates for Western Canadian properties will stay where they are or, possibly, go even lower, due to the stability of the market and amount of capital chasing investment opportunities. John Horton also predicted reductions in cap rates, although it will be more prevalent in urban markets, and noted that cap rates are only one part of the investment equation, another being whether you believe you can add value through redevelopment, re-tenanting or simply renewing leases as they come due at market rental rates.

In terms of rental rates, Eric Carlson asked if landlords can expect to get higher rents in the absence of renovating or re-positioning their centre. Scott Lee noted that anchor tenants cannot be expected to agree to pay more, despite evidence of landlords incurring higher land, servicing, construction and approval costs, and that landlords will have to look to other tenants to make up the difference. For landlords to get higher rents, they will have to add value to their centre in some way.

The discussion then turned to development. Responding to a question about the bigger obstacles to development, John Horton said that municipal approval requirements continue to be set at higher levels, including in smaller and outlying markets, with officials looking for more in terms of landscaping, design, store fronts, etc. All of this adds to development costs. Brian Kozak noted that each market presents different challenges. In Vancouver, it's land prices and availability, pointing to a recent sale of a one acre parcel on Lonsdale in North Vancouver for $19 million. In Calgary, the issue is obtaining zoning approval and in Edmonton, which he described as the Wild West, it's just trying to keep up with what else is being built in your market. With respect to Edmonton, Scott Lee observed that despite the abundance of new retail space in that market, retail sales growth is very strong.

Non-Traditional Development Opportunities

Eric Carlson asked the panel about development on First Nations lands. Scott Lee said that his clients had worked on several First Nations developments, with anchor tenants recognizing that some of the best land opportunities are on First Nations. He noted that there is a growing acceptance of working with First Nations, although it does present challenges.

With respect to infill and mixed use developments, which seem to be the case for most Vancouver projects, John Horton noted that most shopping centres in Greater Vancouver were built in the 1950s, 1960s or early 1970s, and renovated 30 years later, and are now ready for their next renovation, which will include an expansion component. He pointed to Shape's acquisition of Brentwood Mall and Lougheed Town Centre, both of which are planned for major re-development, and to Anthem Properties' plans for re-developing Station Square Mall in Burnaby.

Eric Carlson noted that although all three examples have historically been major retail-only centres, given construction costs and stable rents, none of the re-developments will work without significant residential components. Along those lines, Brian Kozak said that although First Capital doesn't have a lot of residential development experience, it recognizes that in order to successfully re-develop existing centres in Greater Vancouver you need to have residential expertise.

Eric Carlson then touched on the subject of retail "going vertical" as part of urban mixed-use projects. He noted that parking is a significant issue, with underground parking stalls costing $30,000 to $50,000 per stall to develop and construct, and that retailers (particularly anchor tenants) will have to recognize that their standard parking stall ratios will not be available. Scott Lee said that the US retailers which he represents are not used to the concept of “vertical” retail, coming from markets where the traditional development scheme is sprawling suburban, big box centres. However, many are recognizing that they will have to catch up to the reality of retail in a podium under residential, not just in Vancouver but in other major markets in Canada and the US.

The Political Question

No such panel discussion can occur without at least a brief discussion of the British Columbia political scene. Eric Carlson asked the panel if they are worried about the prospects of a new government in British Columbia. John Horton noted that Shape Properties has taken on a significant amount of product and re-development work, and is focussed on its business rather than the political situation. Scott Lee noted that all retail tenants are concerned about labour costs, but that by and large they will live with whoever is in power. Like John Horton, Brian Kozak said that First Capital is focussed on its business at hand.

Thinking of Others

One final note. As is usually the case with NAIOP's year-end breakfast, an effort was made to think of those less fortunate during the Holiday Season. Attendees had been asked to bring a non-perishable food item for the Greater Vancouver Food Bank Society, and were reminded in the closing remarks of the Food Bank's significant need, not only at this time of year but also throughout the year, and encouraged to make a donation.