Australian retail commercial property showing interesting dynamics

The retail sector is showing interesting dynamics in Australia’s commercial real estate sector, with a growing investment appetite for the asset class, according to Benjamin Martin-Henry, Head of Private Asset Research Pacific at MSCI.

Martin-Henry discussed retail property with Gregory Preston, Chairman & Managing Director at valuations firm, Preston Rowe Paterson, as part of a wider property discussion for the PFA Podcast series.

Even though discretionary spending has been down, it hasn’t fully impacted retail, Martin-Henry said. “We’re seeing a lot more investment appetite for retail. Retail transaction volumes are well up on last year.

“Returns are quite positive for retail on a quarterly and also an annual basis. Yes, it is coming off a low base, but total return for the retail sector last year was 5.25 per cent. Capital growth was flat, if you look on a quarterly basis capital growth was +1 per cent, so we’re seeing an increase in those retail values from a very low base.” 

“I’m seeing a lot more larger shopping centres transact, and saw a lot more last year.”

Preston agreed there had been some evidence of retail values improving. “Retail got hammered as we know during Covid, but it’s well back on a solid footing now and positioned for growth. I think most significant centres have very little vacancy.

“I do think retail is to a point tied to economic strength as well. If people are earning more they should spend more, and if interest rates come off a little bit it should aid a bit of a kick back for retail as well”, Preston said.

Both Martin-Henry and Preston discussed the fact overseas investors are still relatively hesitant about Australian retail compared with other property asset classes. Martin-Henry said: “If you look at our numbers over 25 years you will see that only seven per cent of overseas acquisitions have been in that retail space.

“I’ve always found that a little bit strange, given the type of quality retail we do have in terms of large format retail, big box and Bunnings. Neighbourhood shopping centres are absolutely killing it down here, some years even outperforming industrial.”

Greg Preston said while retail had been suffering in the USA for some time, in Australia retail shopping centres have retained their status as a destination place.  “A lot of them are looking at putting residential above them, which will only enhance that logic. 

“That is a huge opportunity with retail generally, because retail centres may only be two or three levels at best with a lot of air rights above them, and sometimes they might be very near rail or metro stations, which permit greater development.

“I think it’s a sector where the cash flow risk is not there in the same way that it is with others, so therefore having to weight discount rates and cap rates above the cost of capital of the entity is not as material. I think there could well be a bit of a resurgence with retail”, Preston said.

Martin-Henry said various factors including construction costs and planning hold-ups create a different supply/demand dynamic for Australian retail. “We have half the retail per square metre than the US has, and people just don’t want to build retail. 

“We see a very limited pipeline, and there always seems to be a supply and demand imbalance for retail.”

He said retail is a more differentiated asset class than other property sectors. “It’s a sector I always bemoan having to talk about as ‘retail’, because it’s too differentiated. Whereas office you can break it down by grades … but they more or less perform in a similar type of way. 

“But with retail the difference between a super-regional shopping centre, or Pitt Street Mall, compared to a neighbourhood shopping centre on the northern beaches, is huge. Just totally different asset classes. 

“That’s probably a big reason why overseas investors haven’t grasped it, because they view it as the US, with big department stores, big shopping centres struggling.”

Preston said super-regional and regional shopping centres are good examples of sectors within retail to have shown resilience. “If you look at the smaller centres and the sales of them over the last five years, that market where it’s non-discretionary spending … where there might be a Woolies or a Coles and 20 or 30 specialties, has just rolled on and hasn’t been as impacted.”

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