Retailer Data Reveals Why Shopping Centres Should Continue to Outperform

What You Need to Know:

• Canadian shopping centres are benefiting from strong retailer sales productivity, which re-accelerated last year after several years of elevated growth.
• Retail space per capita has fallen 9%, while limited new store openings over the past decade have tightened leasing conditions.
• Retailers are now planning store openings at the fastest pace since the early/mid-2010s.
• Near-peak occupancy and constraints on new development support a longer runway for market rent growth.
• TD Cowen raises average NAV estimates by 4% and target prices by 7% across its Retail REIT coverage universe.
• Strong fundamentals may support further valuation upside, cap rate compression and higher NOI/AFFO growth.

Our deep dive into Canadian retailer sales trends revealed why today's shopping centre leasing is so strong. Sales per square foot (sales/SF) productivity enjoyed several years of unprecedented growth and re-accelerated last year. Key reasons are the 9% decline in retail square-foot per capita and the dearth of new store openings over the past decade. Now, retailers are planning a pace of store openings not seen since the early/mid 2010s.

With near-peak occupancy levels and barriers precluding any meaningful new development, we conclude that the upward trajectory in market rents has a longer runway than previously thought.

The TD Cowen Insight

Following a dearth of new store openings during the pandemic, retailers enjoyed a surge in sales/SF productivity in their Canadian stores. Just last year, this metric re-accelerated, and retailers are opening new stores at a pace not seen in over a decade. With near-peak occupancy levels and muted new development, we see a longer runway of market rent growth, and we raise Net Asset Values (NAVs) and target prices for Retail Estate Investment Trusts (REITs).

Our Thesis

Retailers in Canada have experienced elevated sales productivity in their physical stores in recent years, which has prompted a broad-based acceleration in planned new store openings. Canada's shopping centres are already enjoying peak or near-peak occupancy levels, and new construction – while starting to increase – remains constrained by both land availability and simple economics. The result, we believe, is a longer and potentially steeper runway of market rent growth that will directly support higher retail property valuations. While our focus in this report is on Canada, we are also seeing much the same trends in the U.S.

What You'll Find in Our Full Research Report

As a collaboration across the TD Cowen real estate and retail research teams, this report benefits from our combined analyses and perspectives on 16 years of sales performance and store fleet expansion and contraction over multiple Canadian retail categories. The retailers we assessed represent a material sample, occupying over 230 million square feet or 43% of total relevant Canadian shopping centre space (29% of all retail space in Canada including malls). Our analysis reveals how the strength of today's retail industry supports sustained high occupancy rates and likely further growth in market rents.

Since the Pandemic, Retailer Sales Productivity Growth Has Accelerated While Store Fleet Expansions Have Slowed to a Trickle:

Compound Annual Growth Rate (CAGR)

Cumulative Growth

Financial and Industry Model Implications

Rising retailer sales productivity should drive a near- to medium-term continuation of the current accelerated pace of store fleet expansions. The eventual resumption in Canada's immigration flows – likely by 2027 in our view – should provide further support. In addition to today's historically strong retailer fundamentals, we have also found very limited sensitivity to rising rents. This backdrop provides even clearer visibility on strengthening market rents and leasing spreads.

All of this supports greater potential for cap rate compression in our view, due to the direct impact on Discounted Cash Flow (DCF) models from a higher forecast growth rate. With this report, we increase our NAV/unit estimates on average by +4% and target prices on average by +7% for our Retail REIT coverage universe.

What to Watch For

Retail REITs have been among the top-performing REIT sub-sectors almost every year since 2022. This was partly caused by Retail REITs finishing 2021 at trough relative valuations (vs. Apartment and Industrial REITs). Given how strong fundamentals are today, we see further potential valuation tailwinds ahead.

Our analysis points to greater visibility on both the upward trajectory in market rents and also a lengthened duration of this growth. We therefore have greater confidence that both shopping centre capitalisations (cap) rates can outperform (i.e. compress relative to other property types) and Canadian retail REITs can trade at higher absolute and relative valuations versus historically. The higher and more sustainable rent growth trajectory that we see raises our confidence in further upside to both NAV levels and the pace of Net Operating Income (NOI) and Adjusted Funds From Operations (AFFO) growth for our shopping centre REIT coverage universe.