Latin America contains an unusually large number of dominate retailers who also hold significant retail real estate holdings. This is a rare practice in the rest of the world, and there are many reasons to believe that the practice may come under pressure in the future. This topic is important for real estate investors as it impacts on current developments and retail in general, and may represent an opportunity in the near future if the large retailers ever decide to, or are forced to, divest themselves of their real estate holdings.
Introduction
Many of Latin America’s retailers have a tendency to own large retail real estate holdings in the markets where they trade. The practice of retailers owning large holdings of shopping centers is quite rare outside of Latin America. It can be found sporadically in Europe and Asia, and virtually never in America or Canada. In Africa rarely. Four examples of major retailers owning shopping malls are Exito (Colombia), Cencosud (Chile), Falabella (Chile) and Liverpool (Mexico).
Exito is the largest retailer in Colombia and had 2022 revenues of $4.1 billion. It operates 619 stores, in three countries, 422 being in Colombia. Exito owns a controlling share of Viva Malls, the largest mall owner in Colombia with 15 malls, comprising 483,997 m² (i.e., 5.2 million ft²).
Cencosud is the largest retailer in Chile, just behind Falabella. It trades in five countries in Latin America, through several brands, in the supermarket, home improvement and department store categories. Most of its 67 shopping malls are in Chile, followed by Argentina where it has 22. It has 4 in Colombia and 6 in Peru.
Falabella has 527 stores in the region concentrated in Chile, Peru and Colombia. It also has stores in Brazil, Mexico, Uruguay and Argentina. Its 46 shopping malls are less spread out with 27 being in Chile, 15 in Peru, and 4 in Colombia.
Liverpool is a leading high-end department store retailer in Mexico and can be fairly compared to Macy’s or Nordstrom in America. Incidentally, Liverpool purchased a 9.9% stake in Nordstrom in 2022.
Retailer Argument for the Practice
On paper, the practice of large retailers diverting excess cash flows into owing retail real estate, has merit. Usually, the retailer-owner of the shopping is an anchor tenant and is responsible for drawing much of the traffic to the mall in the first place. By owning the property, it is able to extract further value from the traffic it generates in the form of rental income from the other tenants who stand between it and the parking lot.
Other benefits which might accrue to the retailer-owner of the shopping mall include: access to other tenant trading data, control of the premises where it trades, more stability in overall cash flows given the relatively predictable nature of real estate returns, and to keep out competitors. There are more potential advantages to the practice, but these are primary.
Risk of the Practice for LATAM Retailers
Some of the risks are discussed and they are:
Antitrust issues,
Competitive tension removed between landlord and tenant, and
Reduction of operational efficiency.
(1) Antitrust. According to White & Case, a large global law firm with a significant presence in Latin America, antitrust regimes in the region are being bolstered and increasing enforced. It labels the three largest REIT markets in South America as “active” enforcers of antitrust laws and those countries are Brazil, Colombia, and Chile. In 2020, Brazil ruled on 17 antitrust proceedings with 11 convictions and fines of approximately $54 million. In the same year, Chile had two cartel antitrust cases, both resulting in fines over $1 million, and the previous year Chile had two convictions with fines over $17 million. In 2020, Colombia imposed 12 antitrust sanctions totally approximately $174 million.
Antitrust issues can manifest themselves in many ways, here are a few with illustrative examples provided:
Local Competitor Disfavored. An example involves a situation that could play out in Colombia between Exito and D1, two grocery chains. D1 is a low-cost grocery retailer that is expanding rapidly and winning market share through pricing. Exito and Olimpica, the dominant supermarket chains, are feeling the pressure and were recently forced to lower their prices even though they should be raising them given the current levels of inflation in Colombia. Potential antitrust issues: 1) what if D1 wishes to occupy a building owned by Exito’s real estate division and is blocked or given different terms than Exito is given? Or if D1 wishes to replace Exito in a property it owns and offers to pay higher rent?
Foreign Entrant Blocked. Walmart’s expansion into South Africa highlights this issue. Malls in South Africa historically signed leases with supermarket anchors containing clauses excluding other grocery tenants from renting space in the mall. When Walmart decided to enter that market with a grocery offering in the Game anchor stores it had purchased, it found that it was blocked from doing so in most of the malls it hoped to trade. Walmart won its appeal to the competition commission, but only after a protracted legal battle. The situation would have been even more obviously anti-competitive had the anchors also owned the shopping malls subject to the litigation.
Local Developer Frustrated. Local developers in Latin America don’t have many anchors to chose from, and where the anchor is also a competitor, it makes approaching the tenant to join the development fraught with risks. An anchor needs to see details of the development in order to decide whether it wishes to join. This sensitive information could be shared with the real estate development division within the retailer. The retailer may choose to delay signing in an area of town it wants to expand with another developer until such time as its in-house real estate team is able to secure land of its own. Anchor commitments are essential to gaining financing, securing land, and attracting other tenants. Anchor commitments should go to the party with the best site and best offering, and this is difficult to ensure where the retailer is also a developer or owner of malls.
(2) Competitive Tensions Removed. Competitive tensions between the landlord and tenant are removed where both parties are the same. This tension creates the necessary conditions for rental price discovery. The negotiations that occur when a rental agreement is up for renewal should be a somewhat contentious process. The give and take is how markets set prices. A retailer should drive down rents as far as it can in order to pass those savings onto customers. This benefits customers and the reduction of fixed costs for the retailer encourages it to open more stores. Conversely, the landlord should do all it can to drive its rents higher. Higher rents lead to more real estate investments which improve economies in a number of ways.
(3) Operational Efficiency. Perhaps the most important reason why retailers should not be mall owners is the two businesses are dramatically different. Retail is a low margin and competitive business. New competitors are always forming, and factors outside of the control of the retailer (e.g., inflation, GDP, government in power, interest rates) have large impacts on the bottom line. Likewise, real estate is a difficult business with its own peculiarities and culture. Companies which spread themselves too thinly will inevitably be defeated, overtime, by their more focused and potent competitors.
Simon Property Group and Brookfield in America
A related practice to LATAM retailers owning malls has recently emerged in American. That is that some REITs are deciding to purchase distressed retailers. Brookfield bought Forever 21 and also JC Penny with Simon Property Group (“SPG”). SPG has purchased other retailers including Brooks Brothers, Aeropostale, and Lucky Brands. One motivation for these purchases is to save the retailer so it can continue to pay rent. Another motivation is using the accumulated tax losses of the distressed retailer to offset gains from real estate operations. Lastly, the purchases often turn out to be phenomenal investments and offer some diversification to the REIT.
The objections and limitations to the practice of REITs purchasing distressed retailers are similar to those already discussed related to LATAM retailers owning malls:
Loss of Focus. Retailing and running real estate companies are very different, and difficult in their own ways. Winning in competitive markets requires focus and specialization.
75% Requirement. REIT legislation requires them to hold 75% real estate and cash to qualify for important tax advantages. SPG is lobbying congress to amend that figure permitting it to invest more outside of real estate.
Antitrust Issues. Legal issues can arise from the practice such as if the REIT grants more favorable terms to retailers it owns, or if a REIT shuts down a retail competitor in another mall it owns.
