SINGAPORE (Dec 11): The size of the e-commerce market in Singapore was about $1.5 billion in 2016, nearly three times what it was in 2011. According to a report by Temasek and Google, it is expected to exceed $7 billion by 2025, making up 6.7% of retail sales in the country.

As consumers change the way they shop and engage with brands they like in evermore immersive ways, all players in the retail sector have to adapt or face extinction. This isn’t just about offering shoppers bargains online. As marketing pundits have repeatedly explained, retailing in the digital era is not about price but experience.

In hindsight, since the 1990s, when the first wave of disruptive online retailers appeared in the form of Amazon.com and eBay, it has never been a good idea to resist change stemming from radical innovation in the retail sector. Everything that has happened is a textbook illustration of what 20th century Austrian-born American economist Joseph Schumpeter called “the gale of creative destruction”.

Now, the leading real estate investment trusts (REITs) in Singapore that own shopping malls could be prime candidates for potentially deadly disruption. As incumbent firms, they have to drastically rethink the way they add value to their tenants.

REITs earn revenue by charging retailers rental. In fact, according to guidelines from the Monetary Authority of Singapore, REITs should not derive more than 10% of their revenue from sources other than rental payments from tenants of their properties or from the interest, dividends or other similar payments from special purpose vehicles that are sometimes used to hold the properties.

However, the space provided by REITs is becoming less a cornerstone of value creation for their tenants and more of a commoditised component of their value chain. With consumers increasingly turning to online shopping platforms, expensively rented space in a shopping mall is no longer a competitive advantage for brands. Instead, some brands are experimenting with “pop-up stores” to engage consumers with a physical presence only when necessary.

REITs, investors must change To remain relevant, owners of shopping malls need to rethink the purpose of these properties. Retail space has to become a platform offering a bundle of services supported by digital technologies that enable tenants to provide their customers with seamless off-line-and-online experiences while fostering closer engagement. In the end, shopping malls might not be primarily places to shop but to experience a range of other services.

A good analogy to this is how mobile phones have evolved in the internet age. Early mobile phones were primarily used to make voice calls, but the current generation of smartphones has become a device on which to play games, consume media content and shop online. In similar fashion, REIT managers must realise that shopping malls need to evolve and change their business model if they are to continue drawing traffic. Other-wise, they will be left managing commoditised structures while other players create the value-added services.

From investors’ point of view, this trend would logically result in a REIT’s net asset value no longer reflecting its underlying value. Investors may come to see value in terms of a REIT being able to support its tenants and “delight customers” (Amazon’s motto from day one) with the use of smart technologies that encompass not only hardware and software but also data.

Furthermore, the current belief that REITs should only acquire “stabilised” and mature properties could change as a result of digital disruption. In the digital era, commercial properties that deliver sustainable income are likely to be run by managers that are agile and adept at using state-of-the-art technologies. This has little to do with the maturity of a property. In this context, REITs that are able to leverage the digital strategy of their sponsors and managers should have an advantage.

This will make ownership of the intellectual property behind a REIT’s success an important issue for investors. How would a REIT’s manager or sponsor be compensated for its investment in new technologies? Would the existing management fee cover it? Or, would the REIT be charged a “smart retailing” licence fee for use of the technology? Clearly, the valuation models for REITs would have to account for their expertise in “smart retailing” and where in the ecosystem the ownership of the expertise is located.

Local REITs making headway abroad Are the local retail property REITs ready to compete in the digital era? What action do they need to take in the face of massive disruption around the corner? A review of public information shared by the leading retail REITs since their latest annual reports suggests that most of them are indeed concerned about what digital technologies mean to their business model. Yet, only a few are proactively implementing solutions to turn disruption into opportunity.

CapitaLand is clearly leading the pack. Among an array of digital initiatives, the developer has implemented a very forward-looking, omni-channel approach in China with the launch of its first smart mall, CapitaMall Xinduxin (Qingdao), in 2016. It recently forged partnerships with Alibaba Group Holding in Shanghai and Lazada Group in Singapore. It has also set up C31 Ventures, a dedicated venture capital fund with $100 million under management, to invest in new economy start-ups around the world with a view to acquiring new strategic capabilities.

By comparison, the REITs within the CapitaLand stable have been less active in pursuing initiatives directly, with the exception of the last-mile-delivery initiative implemented by CapitaLand Mall Trust in cooperation with the Info-communications Development Authority last year. This could indicate that for CapitaLand, digital innovation has to be located at the sponsor level.

Indeed, one stumbling block that REITs face when it comes to making investments directly is that they are required to pay out at least 90% of their distributable income to benefit from tax transparency. They also carry a certain amount of debt to lift their yields. So, big investments in technology may have to be done by their sponsors.

But what about REITs that aren’t backed by a major corporate group like CapitaLand or Mapletree Investments? Would they be better off structured as business trusts, which have more flexibility in how much they pay out? Should the structure of REITs be revisited as they morph from being just owners of physical assets to being service providers?

It could be some time before we know enough to answer these questions. In any case, if the local REITs want to remain the income-producing investment vehicles they were designed to be, they should be ready to totally reinvent themselves, starting by “delighting” shoppers even more.

Dr Patrick Lecomte is an associate professor in real estate at the Henley Business School, University of Reading Malaysia

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