Where is retail real estate thriving?

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The past few years have been tough on many types of retail real estate — but not the open-air strips in secondary markets full of stores selling everyday essentials that are the focus of Skyline Retail REIT.

Since its launch in 2013, this REIT has been building a portfolio of resilient properties anchored by grocery and/or pharmacy tenants and filled out with banks, medical offices, dollar stores, and quick-service restaurants. As at March 31, 2023, the portfolio’s value was $1.65 billion spread across 5.46 million square feet with 96.7% occupancy.

Gordon Driedger, President, Skyline Retail REIT, says that secondary markets have the same well-known tenants offering the same financial covenant that you’d find in a primary market, but the assets are available at a significantly lower cost.

“Although the quality of the income is the same, there’s a greater potential for return on investment in the secondary markets because of the differential in the cap rate — the value that’s paid,” he explains.

The portfolio’s emphasis on long-term (as long as seven- or 10-year) fixed-rate mortgages — some renewed early to sidestep the recent rise in interest rates — has reinforced that financial strength and demonstrated stability. Meanwhile, being a private REIT means the unit price correlates directly to the value of the real estate in the portfolio — rather than to market sentiment, which can cause public REIT unit prices to experience wild fluctuations.

“Our focus is to provide stable returns to our investors,” says Driedger. “Our unit prices have remained consistent and have shown a historical upward trend, [and] our tenants are stable and doing well.”

“Our shopping centres are full of tenants that are relevant and vibrant and successful.”

Markets waiting for consumer spending to slow

A PwC Canada survey published in March 2023 found that 47% of Canadian consumers were very or extremely concerned about their personal finances, and 70% were responding to that by cutting back on non-essential purchases. That hasn’t yet been reflected in retail sales numbers, which remained robust in Statistics Canada’s latest report, rising 1.1% in April 2023 and increasing in eight out of nine subsectors.

However, if and when the anticipated spending slowdown comes, Driedger is confident it will have far less impact on everyday essentials. He believes Skyline Retail REIT is well positioned to thrive as long as people continue to buy food and medications, do their banking, and attend medical appointments. Business may even pick up for quick-service restaurants as people scale back on fine dining.

While over 80% of the portfolio comprises everyday essentials, even the more discretionary retail tenants of the REIT’s properties tend to be relatively resistant to the impact of e-commerce. As Driedger points out, it’s pretty hard to get a haircut or work out at a fitness centre online. Meanwhile, grocery stores in secondary markets tend to fulfill from a retail store, offering online ordering with in-store pickup.

“In the industrial distribution sector, they talk about the last mile … that is often the most expensive,” he says. “What’s interesting about these food-anchored shopping centres is that they become a very efficient last-mile solution … Goods can be brought to the location in a relatively profitable way.”

Building strong relationships with tenants

Driedger sees relationships with the tenants who rent space in Skyline Retail REIT’s properties as partnerships. He says it’s very important to be a good landlord, reinvesting to make locations the best possible place to operate a successful business so tenants don’t even think about leaving when their lease comes up for renewal.

Those reinvestments pay off in more than tenant stability. They also allow the REIT to grow top-line rent faster because it’s delivering to tenants the most desirable opportunity in any given market. Higher income will be an important hedge against potentially higher interest costs when the REIT’s long-term mortgages eventually come due.

Meanwhile, tenant quality ultimately drives up the value of the REIT’s underlying assets.

“Our shopping centres are full of tenants that are relevant and vibrant and successful,” Driedger says. “If you have relevant, full, highly occupied, stable, and growing income from really successful companies, that’s what people want to buy … and our advancement has showcased all of these attributes, positioning us to surpass our predefined objectives even in times of increasing interest rates and a somewhat uncertain [economic] future.”

Gordon Driedger President, Skyline Retail REIT