Relative value in the Australian retail sector is emerging compared to other mainstream commercial property sectors (office and industrial). Cap rates for non-core retail assets, most notably within the sub-regional sub-sector, have decompressed over 2019, whilst yields for office and industrial assets have tightened to new low benchmarks. Retail is now the highest yielding sector on average.

Figure 1: Average yields by sector

Source: JLL Research

Both the sub-regional and neighbourhood sub-sectors have recorded softening by approximately 20 basis points (bps) in the last 12 months (national weighted basis), and are forecast to record further decompression in the short to medium term. Investors are clearly pricing in a greater level of risk to retail acquisitions as concerns around negative rental reversions continue to weigh on sentiment. Higher yielding investments are particularly attractive to income-driven investors with active management expertise to manage idiosyncratic risks. Elanor Investors and Primewest are two investors who have increased their allocation to the sector over the last 12 months.

Retail assets offer an attractive yield spread over the inflation-indexed 10-year government bond yield (real risk-free rate). The spread has widened over the last year as retail yields have moved higher and the real risk-free rate has declined to historic lows (0.24% in October 2019). The spread has widened from 498 bps (average of sub-sectors) in September 2018 to 592 bps in September 2019 – well above the 15-year average of 536 bps.

There are pockets of liquidity in the retail sector, with strong demand for assets up to $100m-$150m from both private investors and syndicates. As A-REITs and unlisted funds reweight to other sectors and down-weight exposure to non-core retail assets, private investors and syndicates have new opportunities to acquire assets that were previously tightly held in the institutional market. In the nine months to September 2019, private investors and syndicates accounted for 65% of retail acquisitions. Meanwhile, A-REITs and unlisted funds were net sellers of retail in the first three quarters of 2019, accounting for 55% of sales transaction volumes.

The proportion of offshore capital entering Australia through retail acquisitions has increased over 2019, accounting for 26% of transaction volumes, up from the average of 16% in 2017 and 2018.

Joint ventures and capital partnering have become increasingly common. Local managers have partnered with offshore capital such as SPH REIT (Singapore), Heitman (USA) and SC Capital Partners (Singapore) over the last 12 months. The transparency of the Australian commercial property market combined with the attractive yields and professional local management partners support the investment case for multiple offshore groups. Of the 12 largest transactions recorded in the last two years, six of the buyers have been overseas groups, including three joint ventures.

Retail transaction volume was low in the first half of the year. However, Lendlease APPFR’s recent sale of Westfield Marion to SPH REIT, along with the increase in transaction volumes in the latter half of the year to date, has demonstrated that there is still liquidity in the retail sector. A specialist pool of buyers are seeking to take advantage of more attractive pricing and the opportunity to capture a cyclical upswing over the medium-term.

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