Weaker Aussie dollar could have significant impact on retail landlords

It’s no revelation that the retail sector has been doing it tough for the past few years. Every month’s release of retail sales data by the Australian Bureau of Statistics is eagerly awaited. Likewise, the Westpac Melbourne Institute index of consumer sentiment, regarded by many as a pointer towards future retail sales. Has the low interest rate environment caused consumers to loosen their purse strings? What about the impact of rising house prices on consumers’ perceptions of wealth and, hence, willingness to spend? Has the post-election rebound in sentiment been sustained?

These are interesting questions, and the course of retail spending over coming years is critically important to the success of Australian retailers and their landlords.

However, there is another factor of critical importance to both retailers and retail landlords that tends to get overlooked—the impact of a lower Australian dollar on retailer profitability and shopping centre incomes. Of course, there’s plenty of discussion about the fluctuations in the dollar, but it tends to overlook this aspect. It focuses more on the potential upside of a lower dollar—there may be less expenditure leakage overseas (both online and in-store when holidaying overseas) and, conversely, more spending by overseas visitors in Australia as we become a cheaper destination.

However, we believe that these positives are likely to be well and truly offset by a negative impact on retailer profit margins. BIS Shrapnel forecasts that the dollar will fall by around 23% against the trade weighted index from its peak earlier this year. Picking the timing is more difficult, as currency markets are notoriously volatile. Our assessment is that it will happen within around three years.

We have carried out a scenario analysis to estimate the impact of a weaker dollar on retailer profitability and capacity to pay rent. The results aren’t pretty. One of the key issues is that many retailers import a high proportion of the goods that they sell, leaving them exposed to currency fluctuations. Hedging only delays the impact. We estimate that a typical retailer who imports 50% of product sold will see their profitability fall to zero if they continue paying current rents. Clearly, this is not sustainable. In reality, the pain will be spread between the wholesaler (where there is one), retailer and landlord. In this example, downward pressure on rents will be in the order of 10%, albeit spread over several years. In fact, we’re already seeing downwards pressure on rents, but this is not yet reflecting the lower dollar impact.

It will be hard for landlords to absorb the impact and many will be looking to replace tenants with others who are less exposed to the vagaries of the dollar. Service industries are the obvious choice—but how many nail bars do we really need?