Buying Investment-Quality Retail Real Estate
With e-commerce sales rising, a higher cost of capital and lingering effects from the pandemic, many mall developers, property owners and tenants are struggling to stay afloat. But, according to Andrew Lutfy, CEO of Montreal developer Carbonleo, there are still investment opportunities – if you know where to look.
When it comes to malls, Lutfy, who recently hosted a “retail masterclass” webinar with BMO, said the best opportunities are the centres with stores from brands that sell their own products. These stores, which are generally luxury brands such as Chanel, Tiffany & Co., and Hermès, have seen a 12% annual compound growth rate (CAGR) since 2015.1 They’ve done well because they have more control over their products, while the physical store is just one distribution channel for these businesses.
Stores such as Walmart and Target, however, which sell all sorts of items from different companies, have seen a 4% CAGR since 2015, while others, like Macy’s, Nordstrom and Bloomingdale’s, have seen, on average, a negative 10% CAGR over the last nine years.1 The reason for the poorer performance? Amazon also sells an assortment of items from the quiet of your home. He said it has experienced a 27% CAGR since 2015.1
Fine dining wins
While the best opportunities have top luxury brands as tenants, that’s not all they offer. Sit-down restaurants and bars represent another set of prospective mall tenants that have been growing well ahead of the inflation rate.
A generation ago, two-thirds of the total food spend went to groceries and one-third to food services. Now, recovered from the pandemic, restaurants account for 57% of food spending and are on track for two-thirds by 2040.2 “Restaurant dining is no longer a privilege and a luxury,” Lutfy said. “It’s almost become a rite of passage, and everyone should feel entitled to come and connect with others in a restaurant.”
Having subway or bus access inside a shopping centre also increases the value of the mall, he added, while centres with premium brand companies, such as Zara, H&M and Sephora, can also make a mall more attractive, as long as they’re coupled with restaurants, transportation and luxury brand stores.
Top-tier real estate
When considering opportunities, Lutfy divides the 400 or so enclosed shopping centres in Canada into five tiers. Top-tier malls – the best investments – have at least some of those top 10 luxury branded outlets, along with secondary luxury brands. They also have transit hubs that enlarge their trade areas, at least 700 sit-down restaurant seats (not including food courts) and premium domestic brands such as Lululemon, Aritzia, Sephora, Uniqlo, Apple and H&M. Tier-2 malls have all that except the luxury players, while tier-3 malls don’t have transit. Tier-4 can boast only some standard mall brands and no food and beverage, while tier-5 has no amenities that make malls attractive.
By that definition, more than three-quarters of Canadian malls are tier 5, and another 15% are tier 4.3 “I would say your tier-4 and tier-5 are not investment-grade,” Lutfy explained. That means, in his view, just one in 10 shopping centres in this country can grow above the rate of inflation. That includes 16 tier-3 properties, 18 tier-2, and just four tier-1 malls representing 1% of the retail inventory.
Creating social connectivity
With Royalmount, Carbonleo’s soon-to-be-opened mega-mall project near downtown Montreal, Lutfy and his team aim squarely at that rarified tier-1 space and then some. Beyond luxury brands, restaurants and transit, it will have entertainment amenities, including a multiplex cinema, aquarium and ice rink, sustainability credentials, LEED Gold building standard and a residential component where people within the community can live and work. It will also have substantial green space and a 3.5-kilometre linear park. Likewise, with Quartier Dix30, Carbonleo is elevating an old tier-3 mall on Montreal’s South Shore to a tier-2 lifestyle destination with 4,000 residential units.
In a Q&A segment after Lutfy’s presentation, Kate Low, BMO Financial Group’s regional vice-president of real estate finance Quebec, pointed out that Royalmount “was not something that popped out of thin air,” and wondered what the motivation was to create this mall with more than 170 stores and 60 plus restaurants.
“It’s really about bringing people together and making people happy,” he said. “It’s about social connectivity. People should have fun, they should smile, they should celebrate and create real moments.”
That’s part of the appeal of a successful mall – you want to invest in something where people want to be – but, most importantly, the trend of luxury isn’t going away, even in a higher inflationary environment. “These luxury brands control the pipes from beginning to end, and they’re only going to become better marketers; they’ll do a better job of managing the relationship from the factory, right to the consumer, and the consumer is going to be engaged.”
At the same time, inflation may be causing luxury consumers to hit pause when buying a multimillion-dollar home, but they still want the emotional gratification of purchasing an expensive item, he noted. And for those who do buy online? Most still return in-store, which means they could end up buying something else on their way out. “Those returning online merchandise are, 99% of the time, returning it in-store. Then what do you think happens? There’s probably a 30% conversion to go and buy something else.”
“There are some amazing opportunities out there,” Lutfy concluded. “Not many of them, but they do exist.”
1 Capital IQ
3 Number of malls in Canada provided by Oberfeld Snowcap.
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Kate Low:
Good morning, everyone. I'm Kate Low, Regional Vice President for Real Estate Finance at the Bank of Montreal. Thank you all for joining us today for our retail master class hosted by none other than Andrew Lutfi. Andrew is the CEO and of Carbon, Leo and GDI and he's going to help us demystify a little bit the world of retail. I'm honored to be here with you today in your Carbon Leo offices and I'm excited to hear what you have in store for us. So, thank you. And over to you, Andrew.
Andrew Lutfi:
Thank you. Thank you, Kate. Listen. So. Yeah. Good morning, everyone. Nice to be with you. And I think a master class might be maybe we might be expecting a little too much from this but I do share some interesting perspectives you and as know, we're you know in an interesting position understanding what's happening with brands and then of course retail and of course you know my in my bipolar life, I lived the real estate creative dream working on such epic properties and projects such as Royalmount And, of course, Dison even the Four Seasons downtown. So, a lot of people say to me, hey, Andrew, like how do you reconcile both? How do you split your time and the truth is there's far more overlap than you could possibly imagine. And I think going through this presentation you may come to appreciate, and it puts me a unique position to unpack this, you know this asset class which is commercial Enclosed shopping centres. So, with that. Let's get going. these are just some headlines of the past year of course, all kinds of doom and gloom and if you just click bait and you listen to this, you'd say, hey, the world is falling apart Commercial enclosed shopping centres? Definitely not investment grade. Forget it. We're staying. You know, we're staying away from this. Now there is truth in some of this, but this is where we start double clicking. I think it's really, really critical. It's unless you understand the customer, it's really hard to understand the industry and ultimately where the opportunities are. So, no different than you have customers. I would be for example a customer understanding me as a customer really and empathizing with me helps to unpack part of the investment thesis. Well, it's the same thing as you as you look at let's say. This idea, this catch all called retailers put them into two buckets, put a line in the sand and it's either a bunch of retailers right? Whether they're digital or physical, that ultimately are distributing someone else's brand in the other bracket. Put all the brands, if you will. I don't even call them retailers Put all the brands who whereby they're distributing their own product. Now, what has happened to this first bucket, right the ones who whereby they're distributing someone else's brand. Well, what has happened is if you think about it, what are they all they are is a channel of distribution really it's about creating convenience if you will for the consumer and if you think about their heyday, maybe years ago or years ago. Hey, you brought a ton of assortment into one physical place customer came in. Oh, this is great. Throw in some customer service it all made sense. In this day and age, the customer's definition and appreciation of, call it value or service, really has a lot to do with, yes, still assortment but imagine 50Xing the assortment and so far as convenience, imagine just one click checkout like this is and it's at your house same day next day within three days. So, imagine if you will you have to be under you have to talk about the Amazon effect onto that first subset. So, if you look at the last 10 years, we just took the last years as a proxy and you look at the market valuation increase, so publicly traded company market cap and so on and so forth, well Amazon sits at a 27% annual CAGR. If you look at Walmart and Target, right? And I would say that I mean these are these guys are darlings 4 % CAGR, think for a second inflation probably through that period of time ran 3 %. So really, you're left with 1% real growth. If you double click on these two guys and ask yourself, hey, what happened over the last years, well, they turned into grocery stores, so it wasn't through general merchandise that they eak out the 1% real growth. It was through grocery, then you have the bottom subset, right? Your traditional department stores. Take all the department stores throughout North America. Put them all together. And you wind up with a ridiculous -10 % CAGR. Throw in the inflation -13%. They have been selling off physical assets over the last years and they've been taking that money and burning it so despite the fact that they've generated liquidity events they still managed to drive a -13%.
Let's talk about the power of luxury. So, as you think about, remember on the right-hand side those who are really controlling their own brands and those for whom the physical real estate location is just a mere point of distribution as part of a customer relationship or an omni customer relationship. Let's talk about these Lux brands, right. I'll remind you there's our department stores. Once again deluxe brands have managed these would be let's say the 10biggest, the 10 biggest are worth close to 1.5rillion dollars market cap. Their annual CAGR nine percent, real growth nine percent real growth. And I know a lot of people like whatever luxury brands and how important are they or aren't they and what not? Just think that these biggest brands are probably worth 3X more than the value of the five biggest Canadian banks in terms of market cap. Well, another proxy if you will, would be. Another interesting tidbit is, and I’ll answer that one in a moment. But another interesting tidbit is if you go back a generation ago 2/3 of the food spent was basically in grocery, 1/3 in a restaurant, roughly in around was the point of inflection where it became 50/50. We see a crazy spike here through Covid right? Like it became 75/25for a moment because all the restaurants were closed, social distancing and whatnot. But immediately kind of came back to its normal right. And this is where we are today, you know, roughly at 57% prepared food or restaurant and really ultimately the projection is basically 2/3 restaurant, 1/3 prepared food. So, you know what does that mean? It means that we're not really eating at home so much anymore, right? It does kind of make sense that we're creating social connections right? And so consequently, what does that mean restaurant dining and whatnot has become no longer a privilege and a luxury, but it's almost become an absolute right of passage, and everyone should feel pretty entitled to go and connect with others, if you will, in a restaurant. shopping center tiers. We took a very standardized approach, if you will, and I love my standards, basically unpacking the universe of, let's say shopping centers and coming up with very, very clear standardized buckets, right. So. Before we get in the buckets, I'll just say that in the end, we have 5 tiers of assets, 5 tiers of enclosed shopping centers. And we have 5 criteria, the first criteria is super luxury. So those were the same super luxury players that we saw in an earlier slide in this case, you got your, Louis Vuitton, your, Chanel's, your Rolex and Saint Laurent, Tiffany. Long and the short is to make the cut, you need four of these 10. Secondary luxury so they're just smaller luxury or aspirational luxury, you need 10 of a list of 45. Third criteria is subway connectivity or bus terminal connectivity this is really important, right? So, as you're thinking about a limited capital to invest in Capex as the brands are rationalizing this stuff, right, they want to access the greatest trade areas, the largest primary trade areas consequently having access to this becomes really, really important. It increases your reach and obviously your trade areas. Food and beverage dining. So, this is not a food court. This would be restaurants. So, sit down restaurants. You think of an Earl’s, or you think of a Joey’s, or you think of an Outback or whatnot to seasons 52? 700 seats minimum. Sit down dining and then of course the global North American premium brands. There's a bunch of them here. You need a minimum of four. So, when you have this kind of standardization, it makes it a lot easier to assess, if you will, the assets d then kind of rank them. So, in the case of a Tier one, right, So yes, well, Royalmount is a Tier 1 You know you do we have the luxury threshold? Absolutely. Do we have the secondary luxury? Absolutely. Do we have the metro connectivity? And food, beverage, dining? We have about 4000 seats, so above the 700 and of course we have the premium brands you get into the tier 2. They would have everything except the luxury players, the two buckets of luxury. You get into the Tier 3, they're missing the luxury, but they're missing the subway or public transportation connectivity. Tier Fours. You're missing almost everything, but you may have four of the 10 premium brands you might have H&M you might have a legacy Sephora and so on and so forth. And the Tier 5. None of the above. So, if you think about you know, signing a lease, right and you think about the value of committing to a tier one and a tier 2 asset right where the real sales growth above inflation might be four, five, three, four, five percent. That's huge, right, when you think about the flow through on P and L, basically these brands are controlling their brands, their margins are high, their flow through could be 50 percent, 60%. So, you think about all that incremental growth above you know inflation that expansion to EBITDA is huge, it might be as much as 15/20/25%. Growth at the EBITDA line level and that's just on the physical and that does not include the digital Halo. Which is very, very significant, right, when you're in a Tier 5 market, guess what, there's nothing else to do but to go to the shopping center. So, there is no digital halo. Conversely, if you're in a tier one or Tier 2 market, you're busy, right, And there's a greater halo effect on digital sales. So, what's the so what? How many of these assets are there? So, if you think about just Canada, there’s about 400 enclosed shopping centers. There's only four tier ones, right? Less than, let's say we call it 1%. Tier 2 there’s 18%, about another 4% tier 3. So, if you think about Tier 1, 2, 3, it represents just under 10%. of all enclosed assets, right? And your Tier 5 is 75% so if you go back to if you go back to the first slide right of all those headlines and articles and so on and so forth it stands to reason where does that noise come from? I would say you're Tier 4 and Tier 5 is not investment grade, right, and you're basically looking at 90% of assets, so 90% of your assets. Truthfully, are not. They don't keep up with inflation. There is no growth. It's a ticking time bomb. Whereas the 10% that make up the Tier 1, tier 2 and Tier 3 that exceed inflation you know, do really ultimately perform well.
So, on that note, let us do some self-promotion and pivot into why Royal Mount yes of course we took all these boxes. But we have three other amazing boxes that we tick, and I don’t know if anyone else or very few people can actually tick it. Entertainment, right? Everyone's going out restaurants and yes, we kind of covered that off if you will in the F&B component and what not. But beyond eating in a restaurant, you need the social connectivity. Entertainment is an amazing, amazing place. So Royal Mount will certainly between the aquarium, the art program, ice skating, the parks, the linear parks, outdoor spaces, we certainly tick off the box on entertainment our goal is to be the number one tourist destination in Quebec. So that is that's a clear tick. Sustainability, well this is we're you know Royal Mount is the largest lead gold project in Canada and the largest carbon neutral project in all of the Americas including South America, so we most certainly between the wells certification the lead and even the B Corp and LEO. We certainly check the box on sustainability. I think that we can all agree at least those at least on this call, you know this is going to be a bigger and bigger and bigger conversation as time goes by. You know, asset allocation and is going to you know we'll probably see greater asset allocation by the banks and the lending institutions probably into this call it notion of green financing, we're well positioned here. And of course, the live work play. Well, I think we've done an amazing job in so far as now checking that luxury box and that really is the rudder on the sailboat or the keel on the sailboat that gives direction and purpose to the sailboat, we saw that 12% CAGR growth if you will. Know we've done a great job there. Just something else to point out right when we talk about business valuations and whatnot. These guys are trading at roughly 6 times sales. So, if you think about it from a public stock market perspective, they're trading at roughly about 6 times sales, which is really quite fantastic and it's been an expansion if you go back ten years ago go, you know they would have been trading at maybe 4.5 time sales. So, you've seen expansion just in the multiples there, I'll tell you the specialty guys, specialty North American or global retailers are trading at about .3 times sales, department stores also two or three point three times of sales. So, on the luxury on the whole park and sustainability. Just a couple of images, but really Royalmount is centered around an urban park, so it's a two week or urban park. With a linear part called the SHA lib that will ultimately on the second level, which will ultimately be about 3 kilometers long. That kind of like wraps it all up. It's kind of like our New York highline. The whole thing was really designed around green spaces and organic outside, and we managed to bring the outside inside. That was really a challenge, right? How do you kind of reconcile indoors and outdoors? I think we really nailed it. You'll see soon enough. And shifting gears, we can’t forget about Dix30 or other babies. So, Dix30. We are now a Tier 2 shopping center, and I will say about a year ago we were at Tier 3 shopping center What changed the addition of the R.E.M. So, we have a beautiful amazing R.E.M. connection right into the property and it's already like one of the most important stops. And so that certainly helped again to expand market share. It brings us, it brings Dix30 really into the downtown and the city center. So, if you will, accessibility from anywhere downtown is like maybe what 17 minutes away? Which is really an incredible unlock and expands our trade area and of course we have all the other components on the food and beverage. I could tell you where we've e always over indexes in this food and beverage if I'm not mistaken. Well, there we go, we have about 5000 indoor seats, so we're the minimum is 700, we have 5000 indoor and 2000 outdoors. So, we really do nail it on this whole lifestyle. For those who may know it a bit less, it's about 8,000,000 feet of land. 3.1 million feet of rentable density. It's actually the second largest in GLA Shopping centre in Canada. It’s huge. It started as hodgepodge or big box and lifestyle, and it was really awkward and really didn't know which way it was all going to go, this and really ultimately where we've converged is regular price, lifestyle destination and it's really become a fixture and on the South Shore. How is it performed the last four years it has performed at roughly five and a half percent annual CAGR sales growth, which is roughly about 2% better than inflation. So that's real growth and with a recent acceleration as a result of the R.E.M.
So, with all this square footage, what are we planning on doing? Well, there's a million square feet. Carbon Leo's basically taken over the asset about a year and a half ago and with that we've accelerated d everything, including coming up with a vision for that. That vision includes a master plan residential component, so this becomes a true live-work-play. We’ve identified roughly about 1.1 million square feet which is adjacent the R.E.M. connection. So, a nice warm R.E.M. connection into this area and we will be redeveloping it to include four thousand units of differential. How do we want to differentiate ourselves? From our perspective, we are much warmer, much more community. If you think about some of the areas like Point St Charles or Little Burgundy and what not, we have a lot of very, very charming neighborhoods, if you will, in Montreal and I think there's a real opportunity to bring that warmth and to bring that charm and that accessibility, if you will, not to mention the green spaces and whatnot into Dix30, so this is really just an image board that supports our master plan. The whole thing is 100% pedestrian. There are no cars, so that's a basic one. The spaces between the buildings somewhere are between seven and nine meters, so it is close, it is cozy and a nice mix of indoor, outdoor, and super, super livable. We live by the rule of 3-30-300.Three trees visible from each residential unit. 30% of the areas covered by green canopy and A maximum of 300 meters from a green space.
So super excited with that development and with that, I think that ends the presentation per se. And Kate, maybe able to come back.
Kate Low:
I wanted to thank you for your time and your energy and everything that you’ve done today to help me learn more to help the rest of our crew here online learn more. And for anybody you know looking to finance retail, you can pick out all the little tidbits for writing your credit applications
Andrew Lutfi:
Thank you all for your time. That was really great. I really appreciate it. And listen, hopefully there was some. Insight and some different perspectives and yes, as you're writing up your credit applications or you have to go up to your investment committees and you got to make the case for or against. Hopefully some of this data could have been of use and of interest and whatnot. There are amazing opportunities out there. There's just not many of them, but they do exist. So, thank you all for your time. I do appreciate it.
Mike Beg
Head, Real Estate Finance
Mike Beg as Head, Real Estate Finance, Canada is responsible for management of BMO’s Commercial Real Estate Finance group and its client relationships across …(..)
View Full Profile >With e-commerce sales rising, a higher cost of capital and lingering effects from the pandemic, many mall developers, property owners and tenants are struggling to stay afloat. But, according to Andrew Lutfy, CEO of Montreal developer Carbonleo, there are still investment opportunities – if you know where to look.
When it comes to malls, Lutfy, who recently hosted a “retail masterclass” webinar with BMO, said the best opportunities are the centres with stores from brands that sell their own products. These stores, which are generally luxury brands such as Chanel, Tiffany & Co., and Hermès, have seen a 12% annual compound growth rate (CAGR) since 2015.1 They’ve done well because they have more control over their products, while the physical store is just one distribution channel for these businesses.
Stores such as Walmart and Target, however, which sell all sorts of items from different companies, have seen a 4% CAGR since 2015, while others, like Macy’s, Nordstrom and Bloomingdale’s, have seen, on average, a negative 10% CAGR over the last nine years.1 The reason for the poorer performance? Amazon also sells an assortment of items from the quiet of your home. He said it has experienced a 27% CAGR since 2015.1
Fine dining wins
While the best opportunities have top luxury brands as tenants, that’s not all they offer. Sit-down restaurants and bars represent another set of prospective mall tenants that have been growing well ahead of the inflation rate.
A generation ago, two-thirds of the total food spend went to groceries and one-third to food services. Now, recovered from the pandemic, restaurants account for 57% of food spending and are on track for two-thirds by 2040.2 “Restaurant dining is no longer a privilege and a luxury,” Lutfy said. “It’s almost become a rite of passage, and everyone should feel entitled to come and connect with others in a restaurant.”
Having subway or bus access inside a shopping centre also increases the value of the mall, he added, while centres with premium brand companies, such as Zara, H&M and Sephora, can also make a mall more attractive, as long as they’re coupled with restaurants, transportation and luxury brand stores.
Top-tier real estate
When considering opportunities, Lutfy divides the 400 or so enclosed shopping centres in Canada into five tiers. Top-tier malls – the best investments – have at least some of those top 10 luxury branded outlets, along with secondary luxury brands. They also have transit hubs that enlarge their trade areas, at least 700 sit-down restaurant seats (not including food courts) and premium domestic brands such as Lululemon, Aritzia, Sephora, Uniqlo, Apple and H&M. Tier-2 malls have all that except the luxury players, while tier-3 malls don’t have transit. Tier-4 can boast only some standard mall brands and no food and beverage, while tier-5 has no amenities that make malls attractive.
By that definition, more than three-quarters of Canadian malls are tier 5, and another 15% are tier 4.3 “I would say your tier-4 and tier-5 are not investment-grade,” Lutfy explained. That means, in his view, just one in 10 shopping centres in this country can grow above the rate of inflation. That includes 16 tier-3 properties, 18 tier-2, and just four tier-1 malls representing 1% of the retail inventory.
Creating social connectivity
With Royalmount, Carbonleo’s soon-to-be-opened mega-mall project near downtown Montreal, Lutfy and his team aim squarely at that rarified tier-1 space and then some. Beyond luxury brands, restaurants and transit, it will have entertainment amenities, including a multiplex cinema, aquarium and ice rink, sustainability credentials, LEED Gold building standard and a residential component where people within the community can live and work. It will also have substantial green space and a 3.5-kilometre linear park. Likewise, with Quartier Dix30, Carbonleo is elevating an old tier-3 mall on Montreal’s South Shore to a tier-2 lifestyle destination with 4,000 residential units.
In a Q&A segment after Lutfy’s presentation, Kate Low, BMO Financial Group’s regional vice-president of real estate finance Quebec, pointed out that Royalmount “was not something that popped out of thin air,” and wondered what the motivation was to create this mall with more than 170 stores and 60 plus restaurants.
“It’s really about bringing people together and making people happy,” he said. “It’s about social connectivity. People should have fun, they should smile, they should celebrate and create real moments.”
That’s part of the appeal of a successful mall – you want to invest in something where people want to be – but, most importantly, the trend of luxury isn’t going away, even in a higher inflationary environment. “These luxury brands control the pipes from beginning to end, and they’re only going to become better marketers; they’ll do a better job of managing the relationship from the factory, right to the consumer, and the consumer is going to be engaged.”
At the same time, inflation may be causing luxury consumers to hit pause when buying a multimillion-dollar home, but they still want the emotional gratification of purchasing an expensive item, he noted. And for those who do buy online? Most still return in-store, which means they could end up buying something else on their way out. “Those returning online merchandise are, 99% of the time, returning it in-store. Then what do you think happens? There’s probably a 30% conversion to go and buy something else.”
“There are some amazing opportunities out there,” Lutfy concluded. “Not many of them, but they do exist.”
1 Capital IQ
3 Number of malls in Canada provided by Oberfeld Snowcap.
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