Property Trusts: what could go wrong (Part 2 -Retail meltdown

Macquarie Equities estimate 326,000 square metres of new demand from international retailers exists longer term (June 2016). This equates to 2.5 Warringah Malls or 1.5 Chadstones. International retailers are attracted not only by Australia's growing and wealthy population but also it's lethargic competitive environment. Retailers that haven't responded to the online threat and have grown fat on high margins, or those that compete primarily on price, will struggle, but these failures will be replaced by new expanding chains.

For shopping centres it was ever thus. The Internet has been around for decades, as has Amazon, but online sales still account for only around 7.2% of total retail sales.

Those global and local retailers, plus online retailers like Peter Alexander rolling out store networks understand the limitations of a purely online presence. Going shopping, gathering to meet, eat and play, is an essential human activity that the Internet cannot replicate. How else to explain historically low vacancy rates of between 0.5% and 1.0% in the best mall assets, and the heaving crowds?

3. In grocery, online is a tougher market than the US

What about Coles and Woolworths? Amazon, which has rolled out physical stores in the US to market its Amazon Fresh grocery lines, must look at the margins these retailers make with glee.

But without a store network Amazon may struggle. Our relatively low population densities, even in our biggest cities, will increase Amazon's distribution costs, as will higher wages, which is why we understand the incumbents currently run delivery services at a loss.

With online grocery shopping accounting for just 3% of total visits, unless Amazon can find a new model, the cost of convenience is likely to be beyond most Australians. As Gary Mortimer, Associate Professor at Queensland University of Technology, wrote in The Conversation, 'With no physical stores, Australia represents a very small market for the retail giant.'

Even in the US, where wages are lower, populations are bigger and densities are higher, Amazon's sales growth is slowing. If Amazon hasn't destroyed conventional grocers where market dynamics are on its side, why would it do so here, where they aren't?

4. Retailers have more cards to play

Of course, Amazon's expanded local presence is likely to provoke a response. Retailers are likely to beef up their loyalty programs as they seek to lock in customers. They will also take lessons from leading global retailers, as has Myer, to deliver a more interesting retail environment. And they'll hone their cost structures to be more competitive.

But again, this is what retailers have always done. Those that succeed in transforming themselves will blossom; those that don't will eventually fail, replaced by new retail concepts that cater for new market tastes. In that sense, the Amazon 'threat' seems over-hyped and overstated.

Amazon's expanded Australian presence will affect retailers in price-driven, commodity markets and those that don't adapt. Some will fail. But in the shopping malls across the land this is unlikely to lead to boarded up shops and empty floors. As we have seen, retailers and shopping centres have shown a great capacity to adapt. Amazon's arrival won't change that.

5. Amazon is more likely to cannibalise existing online sales

So, what will it change? Our research indicates that Amazon is more likely to cannibalise existing online sales than take market share from conventional retailers.

Currently, about 7.2% of total sales are conducted online. This figure will grow, albeit at a slowing rate as it has in recent times. Amazon's proportion of that figure, now modest, may well grow to around half. That's unlikely to affect shopping centres and their tenants but it might impact local online retailers like The Iconic and Shoes of Prey.

6. Amazon is shifting to a third-party model

But even here the issue is more complex than it appears. Media commentary seems to neglect the fact that Amazon Marketplace, a platform for other online retailers, accounts for half of all packages the company delivers. Amazon may compete with the likes of The Iconic but it's also a potential customer.

In fact, Amazon is undergoing a shift to being a third party marketplace rather than a primary retailer. That means providing services to online retailers is gaining more importance than competing directly with them for sales. This reduces the threat to local retailers and may actually help existing retailers improve their online offer.

For these reasons, we think the media coverage of Amazon's arrival far outweighs its actual threat. Investors in Australia's best shopping malls have less to fear than the excitable commentaries would imply, APN AREIT Fund investors should sit back and enjoy the current yield of 5.99%. The Amazon threat is overdone.