What if all the small shopping centres closed down

the worm has turned - bricks & mortar retail is shrinking

So last year I wrote a lot (probably too much) on the rapidly shifting landscape of Australian retail - a fiery cocktail of intense competition, the arrival of Amazon the gorilla, 3rd world logistics, fickle consumer sentiment and erosion in consumer loyalty.

No, I'm not Nostradamus, just an average guy with a genuine curiosity about cause and effect. 

This month's opinion piece is a collective from a few months of observations and it's certainly been a period of interesting events - Shopping Centre Landlords doing mega global deals, bloodbaths at Myer and the scathing Financial Services inquiry.

In mid-Feb, the new CEO of Vicinity - Australia's largest shopping centre landlord - pointed to a key strategic change of direction for developing the opportunities in land around some of Vicinity's Shopping Centres. Seems they don't want to expand the footprint of leasable retail space and customer parking, they just want apartments.

This is without doubt the first major external signal of the so-called high-tide we have known as traditional bricks and mortar retailing. It's also a pretty dumb and lazy play - falling back to a reliance upon the mythical wealth generation of real estate.

It's not surprising actually as the likes of Chadstone in Melbourne had spent most of the last few years developing hotel concepts and cutting edge experiences for their mega complex. Shopping centre owners are grappling with the most significant change in mix of tenants and services at their properties in history.

They are pushing hard to include more "unique experiences" - stuff you can't easily buy online. Some call it "Amazon proofing". The losers in this pivotal shift are small and medium facilities lacking the capital and leverage to truly transform into diverse, exciting destinations.

An article published in commercialrealestate.com.au during April featured an interview with the Chairman of a large, global Shopping Centre group (we won't mention the name). It seems he was quite chuffed with a scorecard of "churning more than 25% of it's tenants in the last 3 years". Unfortunately, the statements come across with incredible arrogance and as expected there was significant backlash on social media, not to mention the impact upon all those small business owners that had invested in trying to build something. Controversial and particularly insulting statements like "use the space or lose it" smell of bluff and bluster.

Seems this Landlord was only too happy to push out existing tenants if they complain about the "onerous conditions", stuff like forcing expensive renovations every 2 years, etc. Churn is obviously good for their business, tell that to the investors piling money into exorbitant shop fit-outs, watch $500K disappear down the drain in a couple of years.

Apparently, there are long lines of new retailers eager to secure retail spaces - these invisible lines run for miles. I guess that's one way to keep things interesting inside a complex - consumers spot the difference.

It's no secret most shopping centre tenants are keen to exit expensive leases and in particular where the competition inside the complex from similar categories, e.g. food outlets, has gone crazy. Some talk of having 300% more competition inside the complex compared to the time they signed their leases.

Reliance upon apartments a trend that's been evident in retail strips around Melbourne's inner suburbs for years - older shops bulldozed and replaced with multi-story apartments, complete with ridiculous "mock" retail/service offerings in the ground floor. I call them mock because they are basic inclusions and concessions made by the developers in order to pass through highly questionable council planning approvals.

Some of these mock retail facilities spring to life from amazing developer incentives for the first 12 months (think free rent) whilst apartment sales are active to give the false illusion of success and vibrancy. Once the incentive period finishes, it's then a sorry story of struggle.

We have spoken with many cafe owners that have invested their time and money into these "ground floor" utopia's only to end up desperate and frustrated. You only need to look at Melbourne's Docklands as literally two decades of retail wasteland.

It was also ironic the Vicinity CEO's comments came at almost the same moment Myer's CEO had resigned under pressure from the scrutiny of the retailer's lacklustre performance over the last few years. Both announcements on the same day.

David Jones, owned by South Africa's Woolworths Holding Group (not to be confused with our local Australian fresh food people) have been tinkering away for a while with an incredibly ambitious and expensive strategy involving premium foods.

I can sort of see how David Jones's new ideas might have a better chance of success - people need food every day, but they certainly don't need to update their wardrobe or their home wares as frequently (except my darling wife Dianne - she thinks nothing of replacing her entire wardrobe many times a year !). It's fair to say David Jones are doing this foodie gig rather seriously as they partner with the heavy hitters of the culinary world.

Wesfarmers and Woolworths Australia have their own lost dogs in Target, Big W, Best & Less - unable to arrest the declining profitability and growth and unwilling to offload them for well under book value - obviously fearful of triggering write-downs and dent their executive performance bonus - no, not on my watch mate !.

Bernie Brookes, ex-CEO of Myer, put it quite bluntly when he returned from South Africa in February 2018 - department stores in Australia need to take a hit and scale back to the right size - "there are too many Myer, David Jones, Target, Kmart, Big W, Best & Less and Harris Scarfe all offering the same stuff with different labels, locked into expensive leases and online retailers are burning them up with better value".

Brookes went on to hint that the only strategy for Department stores to survive involves drastic surgery to shut down 30% - 40% of smaller, underperforming stores and operating with just a lower number of flagship stores.

Unfortunately, it's not a simple case of closing the doors on the marginal stores whenever it suits and walking away - Department store leases are generally negotiated on long terms, some up to 20 years and the landlords have historically used desperate tactics to leverage the benefit of a Myer or David Jones tenant as drawcard in generating foot traffic - a clever negotiating card held by landlords to justify charging higher rents to the remaining businesses in the facility - unfortunately, it no longer works as these Department stores show signs of weakness.

In April 2018, Myer's chairman (also acting CEO at the moment until his new candidate starts) called in the country's top liquidator - KordaMentha. The game plan here is to have one of the biggest heavy hitters assist in re-negotiating leases with landlords.

This tactic was incredibly canny and kudos to Myer's Chairman for such a demonstrative and combative approach - battling the shopping centres over disparity between lease rates and the special incentives offered to international fashion labels.  Premier Investments (also the largest Myer shareholder) is also in a battle to rationalize rents.

It's interesting when you take away those high profile retailers - what are you left with as the primary drawcard to pull in the foot traffic ? - supermarkets.

Our grocery matriarchs are themselves living through their own transformation and disruption by delivery offers like Uber Eats, Menulog, Foodora, Deliveroo, etc. Apparently, they are slicing into their supermarkets by tapping into the time-poor families. It's easy to see why so many shopping centre tenants are wanting to re-negotiate their leases or exit.

A person we know connected with Shopping Centre management has told us under the radar it's a desperate and even ugly mood inside the realm of centre leases. Many public retail companies reporting under-performance are blaming it on "tough trading conditions" or the "toughest trading conditions we have seen".

Let's call out that "tough trading condition" for what it really is - shopping centre tenants are demanding a discount on their rent or to exit early without being liable for unrealistic penalties. Retail Food Group are the nascent bell-weather of shopping centre leases and we all know that's gone pear-shaped, as have many other franchise business models.

Reliance upon flagship stores is designed to create intense halos in concentrated areas that are both highly populated and  with a visible profile. However, it raises inevitable questions about how smaller, regional areas of Australia will be serviced in the future and what happens when you live outside of the convenience of attending a flagship store - is it worth the hassle - drive, park, congestion, fees, tolls and a lot of personal time.

Imagine towns like Geelong, Newcastle, Gosford and maybe even Gold Coast without department stores - it will only lead to accelerating the shift of focus into the increasingly influential marketplaces of Amazon, eBay, Google and Facebook. Of these four titans, Amazon is the real likely winner.

Of course, none of this will happen overnight, but will arrive sooner than we imagine - the gaps between online and offline spending are closing more aggressively each quarter. Analysts with their clever sound-bites and smart suits don't really know what's going on, they are existing in a clean office of a multi-story building and looks at figures that are likely to be at least 6 months old.

Smart retailers like Aldi might spot a hole in the market to exploit, or Bunnings will keep on expanding their range (if that's at all possible), but it's certainly going to place incredible pressures on logistics and distribution with so many parcels moving throughout the network - you would hope there is a massive improvement in both transit time and service to cope with the spike in demand.

We think focused, niche online players will continue to grow at the expense of traditional retail. Consumer behaviour for shopping online is regarded as "fickle", shifting with their "list" of trusted merchants. When merchants slip-up or drop the ball, they are easily replaced with another similar provider. Loyalty becomes a function of consistency of performance and true value rather than being awarded for longevity, legacy or perceived convenience.