After a robust 2020-2022 period where sales volumes peaked for investment grade stock, the rising interest rates have put a dampener on ongoing investment across all property types. Retail has been no exception, with transaction activity falling considerably from mid-2022 as investors once again consider the longevity of retail as an asset class during a time of rising online trade and tightened retail spending.  

Despite the uncertainty there are still some good news stories for retail. Recent research completed across sub-$5million commercial sales highlighted retail shops as the number one investment choice, with the affordable price point attractive to the smaller investor market. Recent data from the PCA/MSCI Australia All Property Digest indicates income returns remain high across all states for retail assets, highlighting the growing rents achieved, heavily impacted by the high inflationary environment. Owners of retail assets with quality lease covenants continue to enjoy ongoing, growing income streams despite greater uncertainty in regards to capital appreciation.

Both NSW and Victoria continue to show positive capital growth averaging 0.6 per cent and 1.6 per cent respectively in the year to March 2023, while the markets which have enjoyed robust population growth, Queensland and Western Australia, have fallen into negative territory of -1.5 per cent and -3.4 per cent respectively. These markets are more likely to be affected by shifts in market sentiment, with investors historically favouring NSW and Victoria despite the robust income returns which have been on offer in Western Australia and Queensland, at 6.0 per cent and 5.4 per cent respectively.

Total returns by state, however, do demonstrate the reduced confidence across the asset class in recent years. The five year average indicates a negative annual result for Western Australia at -0.5 per cent and 0.8 per cent in Queensland, compared to 2.9 per cent and 2.3 per cent respectively for NSW and Victoria. Looking over the longer term (10 years),  however, taking into account the various market fluctuations, we see retail returns showing robust results growing as much as 7.0 per cent per annum for NSW, while Western Australia and Queensland sit just shy of 5.0 per cent annual returns.

While returns may vary by location, they also fluctuate depending on asset class which indicates changes in the way consumers interact with retail centres. This longer term chart highlights the cyclical nature of retail assets and their performance during periods of economic shocks including the GFC and COVID-19. More recently we can see the deep negative movement for super and regional centres, with more recent upticks below that of smaller centre types. Pressure on occupancy and the closure of various retail types, from department stores to clothing and soft goods, has seen super and major regional centres pivot in their retail offerings with entertainment and food filling spaces to draw customers back into these larger centres.

Conversely, neighbourhood centres recorded a lesser decline this last cycle and peaked higher than other centre types given consumer preference to local, supermarket anchored, and food dominated centres. Similarly, growing retail spend in discount department stores such as K-mart has fuelled demand to purchase sub-regional centres in recent years, aiding in growing their returns.These centres have recorded strong total annual returns over the past ten years, up 8.6 per cent for neighbourhood centres and 7.4 per cent across sub-regional, ahead of super and major regionals (4.8%) and regional centres (5.9%).  

Looking ahead, income growth is expected to remain a feature of all retail types as inflationary pressures are expected to maintain above the target average through to 2025. Many leases and new tenancies anticipate ongoing increases of circa five per cent across most types while capital returns will remain low. Retail trends are always changing, however, consumer desire for local and convenient retailing will see neighbourhood and sub-regional centres flourish given their high food reliance. While larger centres will continue to evolve their retail offering away from traditional retailers which historically have dominated, to provide greater experience led tenancies to grow average custom time in centre and draw in new visitors.

Insights by Vanessa Rader, Head of research, Ray White Commercial.

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