Regional mall fundamentals suggest that recent years of lacklustre returns could be reversing for the owners of Canada’s largest enclosed shopping centres. The credit rating service, DBRS Morningstar, has issued a strong endorsement of the sector’s prospects, citing surging population growth, densification trends and minimal new competition for incumbents among the pluses.
Newly released commentary from the agency’s corporate real estate analysts projects there is “significant opportunity for growth” for asset managers reinvesting in and upgrading their properties. It notes the steady improvement in sales volume and occupancy rates since the grips of the COVID-19 pandemic and charts a continuing climb in the rental rates top-tier malls command.
The rising conversion ratio, which measures the correlation of foot traffic to sales volume, offers evidence of what’s seen to be a stabilizing equilibrium of e-commerce and bricks-and-mortar venues. Analysts conclude that physical stores serve as anchor space for the many retailers now operating in both channels, while, in turn, shoppers are going to malls with “greater purpose” and intent to purchase.
Although Canada-wide foot traffic to malls still trailed pre-pandemic levels in 2022, the vast majority of top-earning malls surpassed their 2019 thresholds for sales per square foot (psf). The most productive mall, Yorkdale Shopping Centre in Toronto, posted a 13 per cent gain in 2022 compared to 2019 with sales rising from $1,964 psf pre-pandemic to $2,226 psf last year.
“High sales productivity is more pronounced at top-tier malls, which enjoy a more affluent customer base and are in desirable areas for retailers to build and maintain their brand image. Product mix has an effect on sales psf with a number of the top malls providing an extensive luxury goods offerings,” DBRS Morningstar analysts observe.
Only three of 2022’s top earners recorded a slip in sales per square foot compared to 2019. All three — CF Pacific Centre, CF Toronto Eaton Centre and CF Rideau Centre — are downtown shopping centres that have historically drawn a significant share of business from the nearby office workforce.
The widening gap between the population growth rate and the addition of new retail inventory is seen as another favourable factor for regional malls. Canada lags well behind the retail space per capita in the United States and few new enclosed malls have been constructed in the 21st century. Analysts tally a number of impediments to new supply largely related to the high cost of land, capital and construction, while noting that owners of existing shopping centres are well placed to draw from an expanding pool of consumers.
“Investors seem to be focused more on industrial and multifamily properties in the post-pandemic era, and construction of enclosed malls has taken a backseat,” they observe. “The overall stock of enclosed malls is aging. Most malls are now 50-plus years old, opening possibilities for repurposing of old properties.”
Some of the pension plan real estate entities DBRS Morningstar rates are highlighted for current redevelopment activities or future plans to densify and introduce new land uses at prominent regional malls in prime urban locations. Projects slated for Toronto, Montreal and Vancouver will collectively bring about 87,000 new residential units to mall property footprints along with other new commercial, community and green spaces.
“Some of these top-tier malls have seen millions in investments over the past few years and this commitment is expected to continue while shopping centres become even more entrenched as community activity hubs,” the analysts state. “Top-tier mall owner/operators across Canada are well capitalized and thus have an advantage over their lower-tier Class B/C mall owner/operator peers in their ability to continually reinvest in their properties.”
While high interest rates, slowing economic momentum and a potential pullback in consumer spending are acknowledged downside risks for the sector, the credit outlook is deemed stable in the near to medium term. The analysis notes that regional mall owners/operators generally lean to conservatism with lower leverage on their properties than other asset type REITs.
