Constrained Retail Supply Gives RioCan a Competitive Advantage
Leaning against the wall in the Toronto offices of RioCan Real Estate Investment Trust REI-UN-T is a golden shovel – the kind of ornamental hardware typically used in groundbreaking ceremonies.
But for more than a decade, at least when it comes to commercial properties in Canada, there hasn’t been much use for a shovel like this. With relatively few exceptions, very little new space for retail is being built – a market dynamic that is pushing up rents for retailers and giving landlords such as RioCan an edge.
“The supply-demand dynamics, which are huge, that really adds to our ability to drive rents,” president and chief executive officer Jonathan Gitlin said in an interview with The Globe and Mail.
In its first quarter, which RioCan reported in early May, the REIT saw a record-high blended leasing spread, a measure of how much it has been able to raise rents. Existing tenants who renewed their leases did so at roughly 20 per cent higher rents, on average, while new tenants are paying 58.5 per cent more on average for their spaces than prior occupants.
As one of the country’s largest commercial landlords, RioCan sees these market dynamics as a clear positive. But is it good for the Canadian retail landscape? A dearth of high-quality space can restrict retailers’ options if they seek to expand, and could also deter international banners that might otherwise bring more variety to the industry.
“I think real estate is the toughest challenge for anyone,” Mr. Gitlin acknowledged, particularly for new entrants that want to be able to scale up to justify their investment in expanding to Canada. RioCan’s properties are roughly 98.5-per-cent occupied, he added, and despite vacancies in lower-quality properties, availability remains constrained.
“So if you want to proliferate the market, and you need real estate to do that, I would have to think that that creates a bit of a barrier, a daunting barrier,” he said.
In its first-quarter investor presentation, RioCan noted that new retail spaces are at “historic lows,” accounting for less than one per cent of total inventory in Canada last year, excluding streetfront properties and spaces under 10,000 square feet.
There are a few reasons for the lack of commercial development in Canada, Mr. Gitlin explained. Most importantly, the economics are difficult. While RioCan is building some new retail space, it is largely redevelopment of existing sites.
The cost of building an entirely new shopping mall is high – even if it is possible to find a large enough tract of land, which is exceedingly difficult in major urban markets where customers are concentrated. To recoup that investment would mean charging rents that may be out of reach, even against a backdrop of “negligible” supply, Mr. Gitlin said.
Another issue is funding for new developments. “I love Canada, but the one thing it’s not is capital-intensive, or at least capital-available,” he said. While RioCan benefits from strong banking relationships, entrepreneurial developers looking to build new retail space will have a difficult time securing the capital to do so.
Canada’s banking regulator, the Office of the Superintendent of Financial Institutions, recently reduced the levels of capital it requires the biggest banks to hold as an economic buffer. The move was intended to provide more flexibility in lending for projects to boost the country’s economy. It remains to be seen whether that will make a significant difference in this area, Mr. Gitlin said, but is unlikely to be a magic bullet for entrepreneurial developers that do not have the access to capital that RioCan does.
Of course, the lack of new construction doesn’t mean that retail space never frees up in Canada. Over the past year, most prominently (and painfully, for RioCan) the bankruptcy of Canada’s oldest retailer, Hudson’s Bay Co., flooded the market with millions of square feet of empty space that landlords have been working to redevelop or fill with new tenants. RioCan’s joint venture with Hudson’s Bay, which owned 12 properties, was placed in receivership.
“It wasn’t very pleasurable, but it is part of running a business,” Mr. Gitlin said.
The three properties owned by RioCan that used to house HBC stores have found new tenants at higher rents. The space at Oakville Place in Oakville, Ont. will be home to a Nations Fresh Foods starting this fall; the former Saks Off 5th store in Tanger Outlets Ottawa was backfilled by an Urban Planet; and the space in Georgian Mall in Barrie, Ont. is being broken up to accommodate a Longo’s grocery store, a GoodLife-owned GYMVMT Fitness Club and a Mark’s, slated to open next year.
“Was it sad to see Hudson’s Bay stores go? As a nostalgic Canadian, sure. But as a business leader who’s focused on doing what’s right for our unitholders and our other stakeholders, it was the right evolution,” Mr. Gitlin said. He believes shoppers will be better served by those new tenants than they were, in the end, by the department stores.
That a grocery retailer and a gym are helping to fill that space is not surprising, because those are two of the categories where RioCan sees growth and strong tenant demand, he said, along with medical services moving into shopping centres. Discount stores such as Dollarama are also expanding, and grocers are investing in building more discount banners.
Even as consumers are stretched, Mr. Gitlin sees continuing strength in Canadian retail, which gives him confidence in his strategy to refocus on shopping malls. Last year, RioCan announced that it would begin selling its residential portfolio of apartments and condos, a business it launched nearly a decade ago to diversify while retail real estate faced challenges. The REIT has now sold roughly 80 per cent of that business for a total of $1.04-billion, which it has committed to reinvesting in the retail business.
“I think there’s excellence in retail,” Mr. Gitlin said, adding that the notion that e-commerce would obviate the need for brick-and-mortar space has proven overblown. “We’ve got some exceptionally smart retailers in Canada – and the world, but in Canada in particular – that have evolved the way they use these stores,” he said.
This article was first reported by The Globe and Mail
