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In 2007, the golf industry looked strong, with Tiger Woods winning his 13th major championship and thousands of courses dotting the United States.

That year, the Ontario Municipal Employees Retirement System got in on the action when it bought retailer Golf Town Canada Inc. for $240 million. Nine years later, the company and its U.S. parent, Golfsmith International Holdings Inc., filed for creditor protection. As a result of the restructuring, OMERS would no longer own the two golf retailers.

So what happened? Is Golf Town’s plunge due to the sport’s decline in popularity or does it suggest a larger trend in the outlook for retail? Or is the sector still a good investment for pension funds?

Initial optimism

When OMERS, which declined to comment for this story, first acquired Golf Town, the pension fund was quite optimistic about its prospects, with Paul Renaud, president and chief executive officer of OMERS’ private equity arm, telling the Toronto Star the pension fund was “quite comfortable that there is a lot of continued organic growth potential just in the Canadian [golf] market alone.”

For the next four years, Renaud would be right. Golf Town grew to more than 50 stores in Canada and opened seven locations in the Boston area. And in 2012, it reached a $97-million deal to merge with U.S.-based Golfsmith. Soon after, the two companies completed a private placement for $125 million in loans.

But the bubble would soon burst. In September 2016, the retailers filed for creditor protection in Canada and the United States. At the same time, Golfsmith announced it was selling its Canadian operations to Fairfax Financial Holdings Ltd. and CI Investments Inc., which already owned 40 per cent of the company’s secured debt. The purchase price was about $80 million, according to the Nov. 16, 2016, report of the monitor appointed for the Golf Town restructuring in Canada, FTI Consulting Canada Inc.

For Golfsmith, the initial plan was to cancel the company’s secured notes in exchange for new ones and 100 per cent equity in the restructured company, according to FTI Consulting’s Sept. 13, 2016, prefiling report. But in October 2016, Dick’s Sporting Goods Inc. bought Golfsmith for US$70 million and, in early November, it announced plans to close locations across the country.

“So golf itself is in decline,” says Derek Warren, assistant vice-president at Lincluden Investment Management in Mississauga, Ont. He points to younger generations preferring more active sports and the time commitment golf requires as factors in its decline. “So while [golf] won’t disappear, it’s not the best investment for the future.”

Besides the downward trend for golf itself, debt was another factor in the two retailers’ troubles. According to FTI Consulting’s pre-filing report, the company pursued a growth strategy following the 2012 merger that focused on larger store formats with higher occupancy costs. “To finance this growth strategy, the company took on additional debt, resulting in higher interest service costs which further reduced the company’s cash flow,” the report states.

Don’t bet on debt

Taking on a large amount of debt at the time of an acquisition can put companies in precarious positions. “The cynical point of view is you’re using financial leverage to make the returns work out,” says Jonathan Jacob, senior vice-president of portfolio risk solutions at Greystone Managed Investments Inc. “Because if you take a four per cent return investment but you lever it up, then you could easily make it an eight per cent expected return. But sometimes that’s just financial engineering, rather than doing anything significant to the investment itself.”

Debt can be a big weight for a retailer, says Jan Rogers Kniffen, a retail analyst in New York. “As long as you can sell [products] reasonably fast, you can keep paying your bills and you can keep running,” he says, pointing to Sears’ U.S. operations as an example of a struggling retailer that remains afloat by selling its inventory quickly. “And so it takes a long, long time to wreck a retailer. But once you put a lot of debt on it and things start to go wrong, you can wreck them a lot faster.”

Follow the offline money

Golf Town, of course, is by no means alone as a retailer in trouble. From Danier to Aéropostale, retailers in a variety of categories have struggled amid shifting consumer habits and the rise of electronic commerce. Given the challenges, what’s the best approach to investing in the retail sector?

Pension funds interested in retail should invest in gyms, health-care services, restaurants, tutoring centres and other types of companies that can compete with the online world, Warren suggests. While customers can sometimes consult a doctor online and stream yoga classes on YouTube, they must get off their devices for a physiotherapist’s examination, to have a yoga instructor correct their form and to enjoy a nice dinner out.

Retailers more vulnerable to online shopping — such as those in the fashion or cosmetics industries — should sell experiences rather than products, says Rogers Kniffen. Stores like Nordstrom that have installed restaurants, makeup counters and hair salons in their stores are better investments than companies that haven’t embraced experiential selling, he suggests. “If you want to catch the next generation that’s coming through your store, you’re doing that,” he says, noting those that have boosted their experiences tend to attract customers who stay longer because they have a destination to go to.

Mall crawls

Pension funds can also indirectly invest in retail through real estate. “Well-located and wellmerchandized retail properties, either enclosed or unenclosed, have been amongst the best performers in terms of investor returns for many years and we expect that to continue,” says Philip Gillin, executive vice-president and portfolio manager at Bentall Kennedy and Sun Life Investment Management. While large urban malls are “at the top of the pecking order,” high street locations are also attractive, he adds.

In December, Canada Pension Plan Investment Board chief executive officer Mark Machin expressed confidence in retail real estate, telling Business News Network that large destination malls remain a good investment. Business in smaller shopping centres that aren’t in good locations, however, are in trouble, he noted.

The Healthcare of Ontario Pension Plan recently boosted its retail holdings to 25 per cent of its real estate portfolio, up from 15 per cent. It owns six shopping malls across Ontario, several more throughout Canada and some shares in a European discretionary fund. “It’s a diversified income base,” Lisa Lafave, senior portfolio manager for real estate at HOOPP, says of malls. “You have many different tenants, so you’re never at risk of one tenant going bankrupt, shall we say. The income is very resilient, as a result.”

Assets in high-density neighbourhoods near transit, whether urban or regional, are good bets, says Warren. Busy areas will often have established shopping streets, but he urges investors to keep an eye out for tired properties needing cash injections to fit in with their gentrifying neighbours. “Those are excellent opportunities,” he says. “They are expensive to buy, based on what they are, but they’re cheap when you look at what they could be.”

Warren also warns against always choosing tenants based on reliability alone. “For example, there are many fast-food restaurants that are a great credit or a very safe tenant,” he says. “However, a locally known chef, while a riskier tenant, may actually bring in a higher-quality, wealthier consumer to your centre and make that centre part of their weekly routine, which will drive sales throughout the centre. . . . Don’t put in a Kentucky Fried Chicken. Put in a sushi restaurant if you want rich people coming to your centre.”

Food beyond fries is now “an integral part” of Cadillac Fairview Corp. Ltd.’s shopping malls, says Sal Iacono, executive vice-president of operations at the real estate arm of the Ontario Teachers’ Pension Plan.

“We were the first to upgrade traditional food courts to dining halls, starting with the Urban Eatery at CF Toronto Eaton Centre. Now, we’ve incorporated more premium dining offerings at our assets,” including restaurants such as Joey and the Cactus Club and gourmet grocery store Pusateri’s Fine Foods.

Another Toronto mall owned by Cadillac Fairview, Sherway Gardens, reflects many of those suggested best practices for urban malls. It’s 15 kilometres from downtown Toronto but is on several transit routes. In addition to visiting high-end retailers such as Tiffany & Co. and Le Creuset, shoppers can get a pure oxygen facial at a spa and brunch at Beaumont Kitchen, part of the fine-dining Oliver & Bonacini company.

Sticky markets

Retail real estate in smaller centres faces a different set of issues. “It’s needs-based, so it would be focused around a drug store or a grocery store,” says Warren.

While grocery stores and banks will likely be part of a chain, cafés, restaurants and boutiques should have a local connection, says Warren. “People have done very well in secondary, tertiary markets, but not outsiders. You have to have local expertise.”

HOOPP has malls in Vancouver, Calgary and Montreal, but those in Ontario are all in secondary markets such as Peterborough. “It’s hard to get at the major urban centres because it’s so tightly held, to be honest. . . . However, I do believe market-dominant secondary markets, like the ones we’ve gone in, these are very loyal customer bases. The shopping malls are actually part of the community, so there’s a very good stickiness with the brand,” says Lafave.

Like Sherway Gardens, HOOPP’s Peterborough property, Lansdowne Place, adheres to many of the best practices for a mall of its size and location. Its tenants include 11 cellphone providers, a credit union, several opticians and a locally owned Greek restaurant. “The finishes in the mall are almost cottage,” says Lafave of the mall located in one of Ontario’s major cottage destinations. “It’s very warm, there’s a fireplace, there’s lots of wood.”

Single-tenant retail real estate can be a safer investment, says Warren. “When you build a building for Walmart or Costco, you’re less concerned about how to bring traffic to that centre because Costco and Walmart will draw their own people for you,” he says. “Because of that, the rents are much lower.”

However, landlords lose a significant source of cash flow if a tenant chooses not to renew the lease and they may have to invest in structural changes to suit the needs of new occupants, Gillin points out.

Smaller properties also pay more per square foot. Lafave notes a department store might pay $1 to $2 per square foot, but carving that space into several smaller retailers can yield 10 times the rent. But with that income boost comes more responsibility for the landlord.

“A shopping mall is an immersive experience that must lead the consumer to first come to your centre and then stay in your centre longer than what they had planned,” says Warren. “The real landlords understand that their role is to create wants and desires on behalf of those who walk into their mall. Keep them there, keep them spending and really provide what they need and want.”

Sara Tatelman is an associate editor at Benefits Canada.