RESEARCH

Retail Sector:Time for a re-rating?

OVERVIEW

The retail sector is under stress but this is not just the typical demand supply disequilibrium. Rather, the greater risks are structural changes in technology, socio-demography and consumer shopping habits.

Post 2008, sectorial yield has fallen to comparable level to the office market segment. The traditional yield gap to reflect different risk profile has narrowed or disappear altogether. This short paper attempts to re-examine if this current retail yield level is justifiable given emerging trend in the retail industry and the current retail fallout, which is also experienced globally.

Contents

CURRENT SCENARIO 2

INVESTMENT PERSPECTIVE 5

CONCLUSION 7

REFERENCES 8

CONTACTS 9

Authors

Brian KohExecutive DirectorInvestment Advisorybrian.koh@ntl.my

Edmund CheunAssistant ManagerResearch & Consultingedmund.cheun@ntl.my

Retail Sector: Time for a re-rating?November 2017

Nawawi Tie Leung | Page 2

CURRENT SCENARIO

Developers’ enthusiasm remains strong despite weak consumer confidence

Much print space has been recently given to the state of the retail sector in the Klang Valley, with the sector suffering from a combination of various factors, from the typical oversupply of space, and the weaker and fickle sentiment of consumers. The Consumer Sentiments Index reached its lowest level in 2015 Q4 and remains below the 100-point threshold, as consumers were battered by Goods and Services Tax (GST), inflation and low salary growth. Some of these issues are debatable, given that at the least, officially, inflation numbers remain relatively low at 2.1% in 2016, and median household income growth over the period between 2014 and 2016 has been good, at least on paper, at 6.8% per annum.

What is undeniable, and factual is that new supply continues to be strong and expected to remain so in the next three years with no loss of enthusiasm commercially by developers to build more. As of 2017 Q3, total retail stock in Klang Valley stood at 61 million sq ft and estimated pipeline supply for those under construction is currently estimated at 16 million sq ft, comprising 23 projects. This imply an overall growth of 26% to current stock.

One proxy indication of the health of the sector is retail space per capita, which currently stand at 8.1 sq ft in the Klang Valley and at mid-range compared to other global cities or countries, notwithstanding some theoretical challenges on whether these figures can be truly comparable and where a healthy ratio figure lies at.

Average occupancy rate has been falling marginally over the last six years, and is now hovering at a five-year low of 86%. The underlying trend is of more concern as some of the newer malls have been struggling to establish market shares that are getting more fragmentary and diminishing. In recent years, we have witness a mall closure, namely the SSTwo in Petaling Jaya, and increasing occupancy stress, low footfall and retailers’ turnover, in some of the newer (and older) malls, matched by slower or worse, no rental growth and increasing need to provide for tenants’ incentives.

0

20

40

60

80

100

120

140

Source: Malaysian Institute of Economic Research, 2017

Figure 1: Consumer Sentiments Index, 2017 Q3

Source: Nawawi Tie Leung Research, 2017

Figure 2: Retail Space (sq ft) per Capita, 2016

0 5 10 15 20

Klang Valley

Iskandar Malaysia

Penang Island

Singapore

Bangkok

Manila

Jakarta

Hong Kong

Source: Nawawi Tie Leung Research, 2017

Figure 3: Average Occupancy Rate

70%

75%

80%

85%

90%

95%

2010 2011 2012 2013 2014 2015 2016 2017Q3

Kuala Lumpur Outside Kuala Lumpur

Retail Sector: Time for a re-rating?November 2017

Nawawi Tie Leung | Page 3

CURRENT SCENARIO

Rise of e-commerce

Unlike the past, the emergence of e-commerce has aggravated the market disequilibrium. Whilst this is still only a small percentage of the total shopping spend, and arguably, consumers are still wanting to “touch and feel” products, the speed of growth of e-commerce is growing at double digit driven by a combination of demographic trend and convenience.

In 2016, Tesco Malaysia saw online sales contributed 2% of its total turnover (Box 1: Tesco’s Grocery Home Shopping service), while Nestle Malaysia generated RM50 million through its online stores (Box 2: Nestle’s E-Commerce Stores). Amazon is already providing fresh groceries delivery within a two-hour time and is coming soon to a neighbourhood near you (Box 3: Amazon Prime Now arrived in Singapore) virtually!

According to AT Kearney, Malaysia has about 16 million online shoppers, equivalent to 80% of the online users. E-commerce is estimated at 1% of retail spend and its contribution to GDP is expected to grow at a CAGR of 11% to RM114 billion in 2020, from RM68 billion in 2015. The wreak in brick and mortar buildings are already seeing the aftermath of an economic “tsunami” in some estimated 30% of the malls in America which are seen redundancy, according to Green Street Advisors, a US-based real estate research firm.

Source: The Star, 2017

Box 1: Tesco’s Grocery Home Shopping service

Source: The Star, 2017

Box 2: Nestle’s E-Commerce Stores Box 3: Amazon Prime Now arrived in Singapore

• Launched in 2013.• Available in Klang Valley,

Seremban, Johor Bahru and Penang.

• Recorded total sales of RM179 million since 2014.

• Launched in 2016 via collaboration with online retailers Lazada and 11street.

• Contributed less than 1% of Nestle Malaysia’s total turnover.

• Nestle aims to generate RM500 million in annual online sales within the next five years.

• Launched on 26 July 2017 in Singapore, as the test base for the ASEAN market.

• Offers a wide range of products across 36 categories, ranging from groceries, toys, stationery and electronic devices.

• Requires a minimum spend of S$40 for free delivery service.

• Occupies 100,000 sq ft of warehouse space at MapletreeLogistics Hub in Jurong East, Singapore.

Source: Channel NewsAsia, Amazon, 2017

Retail Sector: Time for a re-rating?November 2017

Nawawi Tie Leung | Page 4

CURRENT SCENARIO

Emergence of experiential retail

The other trend is consumers, who are becoming more environmentally conscious, demanding more for less, and going for more experiential than possessing more stuff, unlike previous generations. With the rising digital culture, consumers are shifting from conspicuous consumption to digital experiences, giving rise to online mass customisation space, allowing you to design your own shirts online and get it delivered to your doorstep.

Towards an ageing population

The national demographic shift is also moving toward a matured population, meaning 20% above 60 years old, which will happen by 2040. This may not be what is commonly touted as a young Malaysian population, but this not too glacial movement may creep on us not too soon and the implication on retail spending will be significant. The shift toward services, experiences and retirees’ goods will be pronounce. The Japanese experience, and its impact on retail is a strong case study.

Driverless mobile stores could soon be a reality

With self-drive technology, you can hail a mobile store to your doorstep for your convenience, all can be done via mobile apps. When the store arrives at designated spots, you board the vehicle, shop and leave. This is currently being developed in Shanghai by Wheelys in collaboration with Hefei University of Technology. Nevertheless, its practicality remains questionable, given the urban landscape in major cities across the globe.

Source: Department of Statistics, 2016

Figure 4: Age Distribution

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2017 2020 2030 2040

0 - 14 15 - 29 30 - 44 45 - 59 60+

Retail Sector: Time for a re-rating?November 2017

Nawawi Tie Leung | Page 5

INVESTMENT PERSPECTIVE

Are retail assets still risker than offices?

Real estate investors in the retail sector have traditionally view the retail sector with both awe and trepidation, being the risker asset class. Historically located on highstreets, and by implication represent very scare real estate, yet continue to be influenced by the vagaries of the economic weather. Turnover rates of retailers may be higher than that of office tenants, but there is always a new taker for every exit in the past. Overall, the retail asset is deemed a higher risk than commercial office, and thus their yields traditionally reflect a premium of 2% to 3% over office’s yield.

Some of these risks arise from the need for more specialist management, cyclical repositioning and refurbishment, and the need to jump start success from the word, go, unlike office asset that can build up occupancy even leisurely to try to nap the ideal tenants without the stigma of opening a half-occupied mall.

Trends such as urban sprawl, looser planning control and the rise of the automobile has affected retail assets. No longer physically constraint to a high street location, although still preferred, the 1990s have seen the rise of the neighbourhood and regional suburban malls supported by the growth of urban sprawl, car ownership, toll roads and highways, and major new townships. Construction of Mass Rapid Transit (MRT) network has spurred a wave of Transit Oriented Developments (TODs), and more retail space supply can be expected along the train ride, resulting in overlapping catchments and intensified competition.

Source: Nawawi Tie Leung Research, 2017

Figure 5: Return and Risk Profile

High

Low

Low High

Stocks

Private Equity

Risk

Return

Industrial

Bonds

Office

Retail

Real Estate

Retail Sector: Time for a re-rating?November 2017

Nawawi Tie Leung | Page 6

INVESTMENT PERSPECTIVE

Ample liquidity gave rise to asset inflation and chases yield downward

More recently, post 2008, and the introduction of various Quantitative Easing (QE) programmes by The Federal Reserve and European Central Bank, ample liquidity and the low interest environment have influenced the direction of investment yield since. Competitive demand from real estate investors have continued to drive yield downward as a result, to a current state whereby yield for prime retail and commercial assets are at parity. The question arises is: what have change from a risk return profile?

In typical leasing terms, both sectors are comparable, in duration and payment terms locally. Is there more diversity of tenants to choose from, especially anchor tenants that historically make or break the success of a mall? The answer is probably not, given that the market share is controlled by limited key players in several sub-segments such as hypermarket, supermarket, and cinemas, and there have been constant mergers and consolidations.

Source: Nawawi Tie Leung Research, 2017

Figure 6: Major Retail Transactions Figure 7: Major Office Transactions

Year Mall

Indicative

Initial Yield

2011 Pavilion KL 6.4%

2012 Mid Valley Megamall 5.3%

2012 The Gardens Mall 5.9%

2015 Tropicana City Mall & Office 5.6%

2015 Intermark Mall 6.1%

2015 Da:Men Mall 6.9%

2017 Empire Shopping Gallery 6.5%

Year Office

Indicative

Initial Yield

2011 Wisma Goldhill 6.3%

2011 Menara Multipurpose 6.7%

2011 Pavilion Tower 6.5%

2012 Portfolio comprises of Petronas

Twin Towers, Menara 3 Petronas,

and Menara ExxonMobil

5.6%

(overall)

2014 Tower 1, Avenue 3,

Bangsar South

6.0%

2014 Menara PJD 6.7%

2014 KL Platinum Sentral 6.2%

2014 Integra Tower 6.0%

2016 Menara AIA Cap Square 6.4%

Source: Nawawi Tie Leung Research, 2017

Retail Sector: Time for a re-rating?November 2017

Nawawi Tie Leung | Page 7

CONCLUSION

Structural shifts pose challenges to return expectation

As is well known, the retail sector is fast and changing, as epitomise by the fashion segment, is wane to! And it is Uniglo and H&M that have introduced us to fast fashion, driven by just-on-time logistics and impatient consumers. This all implied a much heighten leasing risk, and quicker structural economic obsolescence. With e-commerce an existential threat, a substantial number of malls can be expected to fall casualty, and the prospect of successfully changing usages is not likely to be easy nor cheap.

Whilst the stores of the future will be a likely a hybrid, an “augmented retail” that bridge the world of online with offline, the physical store is not going to vanish anytime soon.

Bain & Company, a global consultancy reckons that 75% of sales will still be via physical locations in 2025 but this is still a future to be fought over between virtual and physical realities.

Thus, the argument of this paper is that real estate investors will need to re-examine their implicit assumptions on what should and would be a reasonable entry return on this segment which is and will continue to be very much impacted by the ongoing structural changes in the market, and not a normal supply-demand disequilibrium, that in the past can be resolved through the passage of time, rising affluence and population.

Retail Sector: Time for a re-rating?November 2017

Nawawi Tie Leung | Page 8

REFERENCES

AFP. (2017). Change or die: American malls confront Amazon era. Retrieved from https://sg.news.yahoo.com/change-die-american-malls-confront-amazon-era-011932663.html

Amazon. (n.d.). Prime Now. Retrieved from https://www.amazon.com.sg/primenow

AT Kearney. (2015). Lifting the Barriers to E-Commerce in ASEAN.

Bain & Company. (2017). The Millennial State of Mind. Retrieved from http://www.bain.de/Images/BAIN%20MEDIA%20PACK_The_Millennial_State_of_Mind.pdf

BBC. (2017). The Disruptors - How may I help you? The changing face of retail. Retrieved from http://www.bbc.co.uk/news/resources/idt-sh/disruptors_how_may_I_help_you

Channel NewsAsia. (2017). In pictures: How Amazon Prime Now plans to deliver on its 2-hour promise. Mediacorp. Retrieved from http://www.channelnewsasia.com/news/singapore/in-pictures-how-amazon-prime-now-plans-to-deliver-on-its-2-hour-9069252

Department of Statistics. (2016). Population Projections (Revised), Malaysia, 2010-2040. Putrajaya: Department of Statistics.

Department of Statistics. (2017). Current Population Estimates, Malaysia, 2017. Putrajaya: Department of Statistics.

Malaysia Digital Economy Corporation. (2016). Malaysia's National eCommerce Strategic Roadmap. Cyberjaya: Malaysia Digital Economy Corporation. Retrieved from https://www.mdec.my/assets/migrated/pdf/Malaysias-National-eCommerce-Strategic-Roadmap-Report-V4-20-Oct.pdf

Malaysian Institute of Economic Research. (2017). Consumer Sentiments Index. Retrieved from https://www.mier.org.my/csi/

The Edge Financial Daily. (2016). Nestle targets RM500mil from e-commerce. The Edge Communications Sdn Bhd. Retrieved from http://www.theedgemarkets.com/article/nestle-targets-rm500m-e-commerce

The Star. (2017). CEO: Nestle's growth sustainable. Star Media Group Berhad. Retrieved from https://www.thestar.com.my/business/business-news/2017/09/02/ceo-nestles-growth-sustainable/

The Star. (2017). Nestle eyes RM500mil in e-commerce sales.Star Media Group Berhad. Retrieved from https://www.thestar.com.my/business/business-news/2017/04/28/nestle-eyes-rm500mil-in-ecommerce-sales/

The Star. (2017). Online grocery sales in Malaysia seen growing slowly. Star Media Group Berhad. Retrieved from https://www.thestar.com.my/business/business-news/2017/06/24/online-grocery-sales-in-malaysia-seen-growing-slowly/

Investment AdvisoryBrian KohExecutive Director+60 (0)3 2161 7228 ext 300brian.koh@ntl.my

Research & ConsultingSaleha YusoffDirector+60 (0)3 2161 7228 ext 302saleha.yusoff@ntl.my

DisclaimerThis report should not be relied upon as a basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts havebeen rigorously checked, Nawawi Tie Leung can take no responsibility for any damage or loss suffered as a result of any inadvertent inaccuracy within thisreport. Information contained herein should not, in whole or part, be published, reproduced or referred to without prior approval. Any such reproductionshould be credited to Nawawi Tie Leung.

© 2017 Nawawi Tie Leung

CONTACTS

Nawawi Tie Leung Property Consultants Sdn Bhd(formerly known as DTZ Nawawi Tie Leung Property Consultants Sdn Bhd)

Suite 34.01, Level 34, Menara Citibank, 165 Jalan Ampang, 50450 Kuala Lumpur, Malaysia.Tel: 603 2161 7228 | Fax: +603 2161 1633 | Email: mail@ntl.my | www.ntl.my