Jumped the Synapse: Thoughts without sponsors!

These are my thoughts that don't fit in my other blogs. They'll eventually cover a large range of topics.

Sunday, June 19, 2011

Big Box Vacancy Rate in Canada, 2009-2010

Big Box Vacancy in Canada, 2009-2010. This material is copyright. Not to be reproduced without written permission.

From the effective gross income, a deduction for vacancy allowance and credit loss expense must be made. For a big box store, credit loss is expected to be minimal to virtually non-existent. That’s due to the generally superior credit-worthiness of this tenant-type, compared to almost all other tenants.

However, vacancy loss over a longer period of time might still be expected. Some of that would be due to, potentially, over-supply, changing store formats (meaning the existing size may no longer be viable), and just general economic weakness in an area, format, or sector type.

Home Depot prefer to own their own locations (according to their latest 10K, they own some 89% of their stores, up from 87% a few years previously). According to their 10-K’s (annual report’s) from 2006 to 2010 (five years), Home Depot opened a large number of stores (321) in Canada and the US during that period. They also closed one store outright, and relocated some others. While they don’t provide the store sizes, there are a total of 21 potentially shuttered (closed and relocated) stores during the past five years. Assuming they all remained vacant today and are of average size, this suggests an overall vacancy rate across their combined Canadian and US stores at 1.03%, using the average number of stores open (2043) at year end over those five years.

In Canada, however, only one store has been relocated or closed during that period. Against a 158 average store count, this single relocation (in 2006) implies a possible vacancy rate of just 0.64%, assuming that single store is still vacant today. On the other hand, if only store relocations and vacancies from 2008, 2009, and 2010 (three years) are assumed still vacant, then the combined US/Canadian vacancy rate would be a miniscule 0.32%; the Canadian rate by itself is zero.

Neither Lowe’s nor Rona provide the type of information in their reports that could be used to calculate a big box vacancy rate.

However, there are still some other big box sources available. Statistics from the 2010 Wal-Mart 10-K (annual report) were calculated against their larger-format stores (50,000 sq.ft. and up) listed for sale or lease in the United States. In May 2011, this produced a physical vacancy rate estimate for their big box stores at 1.8%. A similar calculation in March 2009 indicated a 2.1% rate.

However, these statistics must be viewed with some caution. This is because Wal-Mart has been expanding its’ store size as more and more centres move to the much larger supercentre style. This inevitably means that some older stores (e.g. 1980s, early 1990s builds) simply lack the capacity for up-sizing, and Wal-Mart must relocate, producing an empty store. This produces an upward bias in the vacancy number. This phenomenon wouldn’t be expected to affect most other box retailers to any similar extent (except for Target, who is also expanding their number of supercentres too). Home Depot’s average size, for instance, has been stable at 105,000 sq.ft. over the past five years.

In Canada, probably the largest public company housing big box retailers is the Calloway REIT. Calloway focuses almost exclusively on new-format (power centres, big box, etc.) retail development. Over 99% of Calloway’s 24 million sq.ft. is retail, and 30% is rented to big box tenants (Wal-Mart, 25.7%; Canadian Tire/Marks, 4.3%).

That means a large portion of their portfolio resembles the big box economics of the subject. They’ve reported a national occupancy rate exceeding 99% (e.g. less than 1.0% vacancy) in all except one of the past five years (2009, when it was 98.9%, or 1.1% vacancy). However, from information provided in their 2010 report, a separate rate for B.C. could be calculated. The B.C. vacancy rate was only 0.55%, but this covered all their B.C. properties. Of 2.2 million square feet of B.C. space, none of the vacant space was of their big box stores (the largest vacant space was just over 5,000 sq.ft.). Presumably, a similar phenomenon affects the national calculations meaning it’s unlikely they have much, or any, vacant big box space in their portfolio.

Another Canadian REIT generally favouring the retail property sector is Rio-Can. However, Rio-Can has a wider range of retail styles in their portfolio than Calloway, including enclosed centres, urban retail, offices, non-grocery anchored plaza’s, etc., which also elevates their overall vacancy rate. According to their 2010 public filings , Rio-Can’s national vacancy rate over the past two years is 2.8% across their entire Canadian portfolio. The similar number in B.C. is less than half that rate, at just 1.3%. For the new format properties, their vacancy rate across their Canadian portfolio is only 1.1%. New format includes both big box stores, junior boxes, and the surrounding power centre CRU’s. In B.C., there’s no big box vacancy in their portfolio at all.

All of the previous information and breakdown of these statistics illustrate that the B.C. market is stronger than most other Canadian regions, and that the Canadian market is stronger than the US.

Furthermore, it can be concluded that new format retail in general, and big box development in particular, possess superior economics, with limited or rare actual vacancy. Almost all of these sources suggest that any vacancy is more notional than actual. While a reasonable argument could be made for a 0% vacancy and bad debt expense allowance especially in B.C., a more conservative valuation stance has been taken. In this case, an allowance of 1.0% has been made.