RETAIL PARKS: SUSTAINABLE INVESTMENT OR HYPE?

RETAIL PARKS: SUSTAINABLE INVESTMENT OR HYPE? White paper from Manuel Jahn, GfK retail real estate expert Contact: manuel.jahn@gfk.com T +49 40 5701 325 35 Responsible for publication: GfK GeoMarketing GmbH Werner-von-Siemens-Str. 9 Gebäude 6508 76646 Bruchsal Germany Date: October 2014

Contents 1 Excess demand for retail real estate... 4 1.1 Sustainable investment or cyclical overvaluation? 4 1.2 Success formula for retail parks 5 1.3 Definition of retail park 6 2 GfK Retail Park Performance Report... 7 2.2 Retail parks a billion-dollar market 8 2.3 Performance assessment of Germany s 20 best retail parks 10 4 Summary retail parks as a stand-alone asset class... 12 Retail centers: Sustainable investment or hype? (October 2014) 2

Retail parks targeted by retail and investors Retail parks are currently a hot topic of conversation: This retail format is increasingly the first choice among retailers and consumers, and investors are now following suit. This is already apparent in the retail real estate transaction statistics, which were led by retail parks in the first half of 2014. In response to the high demand for impartial information and data on this real estate format, GfK published its first-ever "GfK Retail Park Performance Report" this year. This report evaluates the performance of all of Germany's retail parks on the basis of data and on-site inspections carried out by GfK. The report shows that numerous retail parks are attractive investments thanks to a strong market position, respectable turnover performance and sustainable rental income potential. In this white paper, we shed further light on the characteristics of this retail real estate format and also offer advice on advantageous opportunities associated with investments beyond the mainstream. Retail centers: Sustainable investment or hype? (October 2014) 3

1 Excess demand for retail real estate 1.1 Sustainable investment or cyclical overvaluation? A glance back at the Lehman legacy: The Lehman bankruptcy led to a genuine real estate and valuation crisis in almost all Western nations. Within a short space of time, a real estate cycle ended in every corner of Europe, resulting in losses in the billions. Whereas appraisals and lending associated with even questionable retail concepts had previously been enthusiastically embraced, the mood suddenly veered in the opposite direction. This development also affected retail real estate in Germany, particularly those in nontransparent securitization structures that were bundled into extensive portfolios that prevented the evaluation of their constituent objects. Retail park real estate was at that time regarded suspiciously, as appraisers believed there was very little substance associated with this asset class in the market climate of that period. What is the current situation? As we've seen in recent years, reservations vis-à-vis retail real estate have largely diminished. Irrespective of whether this is a consequence of the growing professionalism in this branch, there is no other choice than to get into retail. An ongoing windfall for the branch has been the ECB's low interest rate policies, which already position retail real estate with rental returns of 6% as high-interest investments. Even so, the Lehman crisis marked the beginning of a new era for retail real estate investments, which is characterized by a strong need for security. This led to the development of fanciful prices in the core segment, which make it nearly impossible for the majority of distribution-oriented investment funds to find suitable objects that fulfill the prevailing investment criteria. The consequence of this development is that so-called "trophy buildings" i.e., usually large, longestablished retail real estate objects with first-class rental contracts are for the most part no longer fungible. These "zero percenters" (after deducting management and maintenance costs) are usually large, established shopping centers or commercial buildings at prime sites in large metropolises with saturated core real estate markets. What is the way forward? Previous real estate cycles have shown that investment criteria are relaxed in periods of excess demand. The definition of "core investment" is either changed or the investment focus is broadened to "core plus assets" i.e., assets that only partly fulfill the traditional requirements for core investments. The current resurgence of demand for products that would not even have been considered just a few years ago is a clear indication of a pork cycle. This especially applies to retail parks. The yield compression that is now also apparent in this retail format is reason enough to address the characteristics of the asset class in greater detail. The risks associated with retail parks are not simply a matter of location, year of construction and rental contracts. It's entirely possible to establish successful retail parks that are in greenfield areas and constructed out of inexpensive sheet metal. Retail centers: Sustainable investment or hype? (October 2014) 4

1.2 Success formula for retail parks The following proven formula can be used to reliably evaluate the qualities and potential of retail parks: Success = location x concept x offering x management. Unfortunately, often not enough effort is invested in assessing this formula in detail. Investors typically rely on a rough benchmark founded on the assumption that retail parks are a standardized commodity. Unfortunately there's a scarcity of reliable data that investors or financiers can use to compare and evaluate the soundness of retail park investments. Location- or asset-typical rental figures or tenant turnover figures are not available in a quantity sufficient to deduce meaningful insights. A crucial point worth stressing is that retail real estate is not a homogenous commodity. Even nearly structurally identical retail warehouses differ substantially. Consider two identically built discount stores that offer the same number, size and layout of parking places. Despite being mirror images of one another, these two real estate objects will differ significantly, because they are in two different locations. It is simply negligent to disregard location-related risks when performing a risk assessment. In order to accurately gauge the risks associated with non-standardized commodities, it's essential to evaluate the single greatest risk factor with the utmost care: the product-related risk. The bad news is that these risks also frequently come into play in the case of retail parks. The question is therefore to what extent it's possible to arrive at reliable and well supported insights into the risks and opportunities associated with retail parks. More so than in the case of long-established shopping centers, the prospects for retail parks are more strongly influenced by the current and foreseeable turnover potential than by current rental contracts or the general building and site quality. The greater the ability to guarantee turnover for a given retail park, the more likely it is to hold on to tenants over the long term as well as draw attractive new tenants and thus extend the life cycle of the site. This means that the ultimate success of a retail park fundamentally depends on the drivers of demand, i.e. the end consumers. With the reflections and data evaluations in this white paper, GfK's retail and real estate experts seek to foster transparency vis-à-vis retail parks and spark a fact-based discussion. The basis for these reflections are the identification, viewing, compilation and evaluation of all retail parks in Germany by our retail real estate experts between March and September 2014. The analysis also emerges out of our ongoing cooperation with important investors and management figures, which is reflected in the annual MEC retail park report. We are continually exchanging insights and information with relevant players in the industry, including MEC, Corpus Sireo and TH Real Estate. And we want to contribute to the knowledge base of all market participants. Retail centers: Sustainable investment or hype? (October 2014) 5

1.3 Definition of retail park It's first necessary to collectively decide what constitutes a retail park in order to be able to carry out statistical compilations and evaluations. We agreed upon the following definition of retail parks: A retail park is a retail real estate object that encompasses at least 10,000 m² of cohesive sales area and has at least one large-scale food tenant and two large-scale non-food tenants. Cohesive sales area Retail parks with cohesive sales area constitute a precondition for consideration as investments. This structural cohesion can be accomplished through a shared parking lot or shop streets. Structural cohesion makes it possible to have centralized management of branch mix, architecture and promotion. Retail warehouse agglomerations that do not offer this spatial cohesion and are spread out over a more or less large area are not considered an asset class. Total sales area of at least 10,000 m² A total sales area of at least 10,000 m² clearly differentiates a retail park from a neighborhood center. This minimum threshold constitutes the critical mass needed for the turnover and rental income measures to gain traction. Beyond this threshold, it's assumed that a proactive management can steer and improve upon factors such as the branch and tenant mix. This combination of a minimal size and management potential also makes retail parks an appealing investment for institutional investors. At least one large-scale food tenant and two large-scale non-food tenants 1 A typical retail park has at least one large-scale food tenant and at least two large-scale non-food tenants. This fulfills a daily-needs function while simultaneously rounding out the shopping experience with large-scale and thus usually price-oriented, specialized offerings. These minimal requirements differentiate retail parks from retail warehouse real estate that offer both a cohesive retail space as well as a minimal sales area of 10,000 m², but not the required diversification in terms of the number and type of tenants that makes it possible to proactively manage the site as a real estate object. Particularly relevant along these lines are hypermarkets without foyer shopping areas as well as home improvement and furniture stores without supplementary daily-needs offerings. 1 Note on the high-volume sales area associated with retail centers: In contrast to how high-volume sales area is defined in the Federal Building Code (BauGB), we regard sales area equal to or greater than 500 m² as constituting large volume. Retail centers: Sustainable investment or hype? (October 2014) 6

2 GfK Retail Park Performance Report On the basis of these criteria, we carried out on-site inspections of more than 350 locations in Germany, around 250 of which were subsequently identified by our experts as retail parks. We systematically assessed the total sales area of the retail parks, sales area per tenant and additional qualitative and location-specific criteria (e.g., accessibility or the site surroundings). In order to avoid purely descriptive commentary, an evaluation was carried out of the current performance as well as the turnover and development potential of each retail park. After filtering for the discussed criteria, we were able to reduce the much larger number of assessed sites to 250 objects that can be regarded as genuine retail parks as per the articulated definition. 2 Thanks to our knowledge of all retail parks and their quantitative and qualitative characteristics, we were able to carry out extensive analyses to approximate the size and structure of this market. This allowed us to answer the most pressing questions asked by interested investors: 1. How large is the market for retail parks? 2. Which indicators can be provided on this market? 3. To what extent can these figures and values deviate from average values? 4. Where are the locations with the greatest turnover and rental potential? 5. Which retail parks have the greatest value-enhancement potential? 6. Which real estate objects require revitalization to realize their full value? To answer these questions, we developed an evaluation method on whose basis a report was created for each object under consideration. 3 Using a scoring model, we were then able to rank the locations according to their quality as investments. This model included quantitative data such as sales area, number of inhabitants and purchasing power, as well as qualitative information such as catchment area size, turnover estimate, rental space layout and need for refurbishment. 2 The most common reason why suspect sites could not be deemed retail centers following the on-site inspection was that they could not meet the requirement for a minimal sales space of 10,000 m². 3 The "GfK Retail Center Performance Report" is available from GfK GeoMarketing in extracts and in its entirety. More information at http://www.gfkgeomarketing.de/en/consultancy/real_estate_consulting/gfk_retail_center_performance_report.html Retail centers: Sustainable investment or hype? (October 2014) 7

2.2 Retail parks a billion-dollar market Our analyses allowed us to determine the sales area as well as the turnover and associated rental income potential for every retail park under review. We were able to determine a rough, but plausible portrait of the total market size by extrapolating values derived from a multiplier based on the annual net rent. We estimate Germany's retail park market at around 12 billion on the basis of the object-specific sales area productivity and feasible rent-to-sales ratios. Currently making up around 20% of the retail real estate transaction volume, retail parks can rightly be regarded as constituting their own asset class. 250 retail parks: 12 bil. real estate value, of which 10-15% was traded in 2014 In the first half of this year alone, 900 mil. has been spent on this asset class according to an evaluation of the transaction statistics of the large real estate brokers. This is a clear indication that this market is already actively developing and drawing significant interest from investors. These half-year figures show that around 7.5% of the entire market volume has been traded a figure that should rise to 10-15% by the end of the year. Assuming this market dynamic holds steady, retail parks would change ownership every 7-10 years on average. Retail parks can already be regarded as a sustainable investment alternative thanks to the increasing professionalization in this asset class, which is marked by higher-quality new buildings, a larger number of successful refurbishments, better targeted tenant concepts and a growing management quota. These numbers outshine the previously favored shopping center investments and awaken the interest of investors, particularly institutional investors. Our object analyses revealed that the average German retail park has around 19,600 m² of sales area apportioned into 20 rental spaces that generate around 3,200 of gross turnover/m 2 per year. On the basis of retail format- and tenant-specific rent-to-sales ratios, we calculated an average rental income potential of 12 per month per m 2. As such, the average sales area productivity is, as expected, still far removed from the average performance of a German shopping center, which according to the GfK shopping center database is around 4,000/m 2 ; but retail park performance is not far from the average performance of German retail, which is currently around 3,500 gross turnover/m² of sales space. Here's the good news, along with a qualification: The sales area productivity spread is disproportionately higher among retail parks compared to other managed retail real estate. We calculated sales area productivities that ranged from 1,110 at the weak end of the spectrum to 6,900 (gross) per m 2 at the strong end of the spectrum. Comparison of sales area turnover in shopping centers retail parks Ger. retail avg. 4,000 3,200 3,500 These differences are a result not just of the retail park quality, but also of the product-line mix. Retail parks dominated by established hypermarkets or large supermarkets can achieve high to very high sales area productivities. Retail centers: Sustainable investment or hype? (October 2014) 8

Even though we set the minimal threshold for retail parks at 10,000 m² of sales area and as such chose to concentrate on "large" objects, the differences in size and turnover among the evaluated retail parks can be enormous: For retail parks between 10,000 m² and 76,000 m² of sales area, the turnover spread is even wider, from 15 million to just under 300 million p.a. The branch mix of retail parks is dominated by grocery offerings. Depending on the retail park concept, the turnover share for groceries ranges from 2 million to 90 million. Fashion offerings generate turnover from 0.5 to 30 million p.a. Average retail park: 19,600 m 2 sales area 20 rental units 3,200/m² (gross turnover) rent: 13/m 2 p.m. Retail centers: Sustainable investment or hype? (October 2014) 9

2.3 Performance assessment of Germany's 20 best retail parks Our top 20 list includes retail parks with the quality that investors care about the most during this market phase: stable rental income. The shops are leased to well-known tenants who generate above-average turnover and who, as such, can sustainably pay high rents. The vacancy quota is on average 0.2 %. The locations are easily accessible and generally very visible. More inhabitants live in the catchment areas of retail parks compared to the usual locations. This means retail parks have an above-average population potential on which to draw. On the whole, one would assume that none of the top retail parks are in need of revitalization. These retail parks are long established, tend to generate higher frequencies than newer retail parks and offer a robust range of offerings. A large portion of these retail parks have already been revitalized. Even so, in some cases it is foreseeable that wide-reaching adjustments will have to be made; these will need to go well beyond merely cosmetic alterations in order to avoid losing market share to the competition. Location?...not as straightforward a concept as conventionally believed! The best retail parks are not always located in central metropolitan areas. One of the top retail parks is located in a greenfield area. Established and successful retail parks that have been around a while were often erected in out-of-the-way commercial areas that are not well integrated into the city infrastructure and also often not visible from the main street axes. The fact that these locations have nevertheless established themselves in consumers minds during their decades of existence shows that typical place-related factors don't always play the decisive role. Retail centers: Sustainable investment or hype? (October 2014) 10

Examples An example of a relatively robust location is the A2 Center in Isernhagen in Lower Saxony, which is currently undergoing a two-year construction process involving numerous new additions and reconstruction measures. The location was established years ago as part of a larger retail warehouse agglomeration. A long-standing vacancy at the center will soon be occupied by a large furniture store, which could boost the regional drawing power of the entire location. The InduPark in Dortmund also belongs to our list of favorites. This retail park has already been refurbished and can therefore already profit from the reconstruction measures. These measures involved reducing the size of the anchor tenant real,- and creating a mall for additional shop offerings. This easily accessible location is a modern site within an attractive retail warehouse agglomeration. The Ostsee-Center in Lüssow near Stralsund is representative of all retail parks currently facing significant challenges (in this case, the loss of an anchor tenant due to the bankruptcy of Praktiker/Max Bahr), but which nonetheless have good conditions with respect to potential and competitors. Assuming suitable measures are carried out, notable growth potential should be achievable. A2 Center in Isernhagen; source: GfK Ostsee-Center Stralsund; source: GfK A similar situation characterizes the Multimarkt-Center in Hameln, which has already been partially revitalized and has attracted a range of well-known chain stores, although the full available market potential has not yet been tapped. Additional value should be possible through further revitalization efforts. Multimarkt-Center in Hameln; source: GfK Retail centers: Sustainable investment or hype? (October 2014) 11

4 Summary retail parks as a stand-alone asset class With a total real estate value of around 12 billion and currently a 20% share of the transaction volume of retail real estate, retail parks have now assumed the status of a stand-alone asset class. Retail parks must be regarded as a sustainable investment alternative thanks to the increasing professionalization in this asset class, which is marked by higher-quality new buildings, a larger number of successful refurbishments, better targeted tenant concepts and a growing management quota. Even though many current real estate deals show signs of hype, retail parks and related investment activities have genuinely assumed greater importance in recent years. While there is increasing hybridization among retail parks (i.e., the integration of elements typical of shopping centers), this should not be interpreted as meaning that an important portion of this asset class is to be repositioned under the rubric of shopping center investments over the short or long term. This is because retail parks have too many special characteristics and challenges that are entirely unique to this retail format and that require a specific mode of engagement. Viewing retail parks as a stand-along asset class with its own indicators as well as analysis and evaluative tools is a step toward greater transparency. The GfK Retail Park Performance Report offers an impartial evaluation of Germany's 250 retail parks along with a clear definition of this asset class and first-ever benchmarks on size, structure, performance and earning potential. Retail centers: Sustainable investment or hype? (October 2014) 12

About Manuel Jahn Manuel Jahn heads GfK's geomarketing consulting division. He has 15 years of experience in the analysis and development of retail real estate. He has been with GfK since 2004 and has extensive knowledge of retail and retail real estate thanks to carrying out location and real estate object appraisals throughout Europe. Previously he worked on the development and conception of retail real estate in association with a German retail estate and investment bank, following the completion of his education in banking and courses of study in architecture and urban planning. Manuel Jahn contributes his expertise to the real estate branch through his experience as well as numerous advising roles and publications. He is a member of the real estate advisory board of the Germany-based Immobilien Zeitung. As part of his role at GfK, Jahn provides consultancy to retail companies, banks and investors in the conception and optimization of retail real estate, evaluation of locations and distribution networks and appraisal of the economic sustainability of retail investments. About GfK Real Estate Consulting GfK's geomarketing real estate consulting division is one of the leading independent providers of consultancy services in the area of real estate and location research. The consulting division produces studies and appraisals for clients from the retail, investment, banking and project development sectors. More information at http://www.gfkgeomarketing.de/beratung/real_estate_consulting.html. Retail centers: Sustainable investment or hype? (October 2014) 13