Retail REIT Fundamentals
- Dec 03, 2014
By Merrie Frankel, Vice President/Senior Credit Officer, Moody’s Investors Service
Retail REIT Fundamentals Improve, Industry Outlook Stable
The ongoing improvement in real estate fundamentals for retail properties, with occupancy rates, leasing spreads and renewal rates all rising, bodes well for the credit quality of the retail real estate investment trusts (REITs) we rate. As a result, we do not expect to make material changes to our ratings or outlooks for most investment-grade retail REITs in 2015. Our outlooks are stable for 19 of the 24 retail REITs we rate, positive for two and negative for one, with two on review (one for upgrade and one for downgrade owing to event-driven circumstances).
Retail sector will grow modestly in 2015
We have a stable outlook for the U.S. retail industry, which will grow modestly over the next 12 to 18 months, with little in the way of imminent product launches or other catalysts to motivate cautious consumers. Home improvement, drug stores and auto retailers will bolster growth while apparel and footwear retailers will outperform in 2015. Discounters/warehouses will improve somewhat, but still underperform the industry. Consumer sentiment is the mainstay of the retail sector. We expect holiday sales to increase by close to 4 percent in 2014, which would be a modest improvement on the 3.3 percent 2013 holiday sales growth and similar to the International Council of Shopping Centers (ICSC) holiday growth forecast of 4 percent –the largest gain in three years.
Landlords retain pricing power, bolstering rents
Re-leasing spreads continue to widen partly because limited new supply is bolstering landlords’ pricing power. Some small businesses are still feeling pressure, which adversely affects inline store leasing and landlords’ ability to increase rents. However, more national tenants are moving into shopping centers, changing the complexion of these centers because fewer individual mom-and-pop lessees remain, with many becoming franchisees. One positive for leasing is that fresh retail concepts continue to spur new store openings. For example, to increase traffic, malls and shopping centers are renting to a more diversified group of both domestic and international retailers providing non-retail services that are unavailable on the internet, such as restaurants, hair salons, crafts stores, gyms and medical offices.
Development has increased in all sub-sectors, although mostly in the outlet sector, which has become a successful distribution channel for retailers in the U.S., Canada and overseas. Redevelopment is making older malls and shopping centers more modern, service-oriented and internet friendly.
E-commerce growing, but bricks and mortar still king
Omni-channel is the oft-used term to indicate that retailers are accessing all avenues to reach consumers by integrating stores and the Internet. Although e-commerce sales, which comprised 6.6 percent of total sales in the third quarter of 2014, increased by 16.2 percent in in the third quarter of 2014 year over year, compared with a 4.2 percent increase for retail sales, the vast majority of retail sales (93.4 percent or $1.23 trillion in the third quarter of 2014) still take place in bricks and mortar establishments. Both REITs and retailers are integrating digital technology to interact with shoppers and enhance the shopping experience through text and email alerts to consumers about in-store deals and mall events while at the center.
 US Retail Industry: Growth Will Be Moderate Through 2015 Amid Muted Consumer Spending, Nov 10, 2014, www.moodys.com (176945)
 U.S. Census Bureau News, US Dept of Commerce, Quarterly Retail E-Commerce Sales (3rd Quarter 2014), Advance Monthly Sales for Retail and Food Services (October 2014).
REITs go back to basics
Several retail REITs have spun off portfolios in 2014. Simon Property Group spun off Washington Prime Group, Vornado is spinning off its retail portfolio into Urban Edge Properties, and Westfield Group spun off its Australia/New Zealand properties (Scentre Group) and legacy U.S./U.K./European assets (Westfield Corp.).
Most of the retail REITs are managing their balance sheets conservatively. The prevailing theme among retail REITs is simplicity; they are undertaking fewer joint ventures, maximizing property income and values through redevelopment, culling portfolios, and taking advantage of capital markets to finance upcoming maturities or acquisitions. Simon in 3Q14 became the first U.S .REIT to establish a global commercial paper program, which introduced highly-rated REITs to a new source of liquidity. The retail REITs we rate have maintained stable leverage metrics as a result of robust equity and unsecured debt issuance, cost containment and astute balance sheet management — their fixed charge coverage has increased, while their leverage and secured debt have declined (see chart below).