In a low interest rate world, retail property looks attractive to both large and small investors. But people are concerned about what happens when interest rates rise.
Retail property has performed well over the last few years. Strong competition for assets amongst investors has resulted in an aggressive firming of investment yields in recent years following the post-GFC blow-out. Shopping centre capital values are now comfortably higher than pre-GFC peak levels. With interest rates likely to remain low for some time, there is scope for further firming of yields and growth of centre values.
Retail property is not overvalued. That’s one of the key findings from BIS Shrapnel’s latest report on the sector, Retail Property Market 2016 to 2026.
Report author, Senior Project Manager Maria Lee, observes that for some centres, investment yields are already at or below pre-GFC levels, while others are not far off.
“Some people are now becoming a bit uncomfortable with the level of retail property yields and are wondering what the future has in store,” she comments.
She continues: “Our analysis shows the importance of bond rates in determining retail yields. In a post-Brexit world, a ‘lower for longer’ scenario looks increasingly likely. We think retail yields will firm further, giving centre values a boost.”
However, BIS Shrapnel cautions that, at some stage, rising bond rates are more or less a certainty. This will put upwards pressure on retail property yields. But even when bond rates rise, the impact on shopping centre values will be limited.
Lee explains: “Bond rates aren’t the only factor determining retail yields. The expectation of capital gain is also important. And centre income growth, in turn, is a key factor in determining investors’ expectations of capital gain. BIS Shrapnel notes that centre income growth is modest at present and facing numerous challenges in the near term”.
“However, the bulk of centre incomes is subject to fixed annual escalations, putting a base under the rate of growth and reducing volatility from year to year. And we expect a period of stronger growth around the turn of the decade and early next decade that will largely or wholly offset the impact of any softening in yields on centre values.”
Lee follows up with a note of caution: “Retail is a tough business and a high level of expertise is required to successfully run a shopping centre. The level of competition between shopping centres is ever more intense, giving rise to considerable capex requirements. Retail property’s not for everyone.”
Even so, BIS Shrapnel forecasts solid long term returns to retail property. Prospective annual total returns over a five year investment horizon are between 8% and 9% for regional and sub-regional shopping centres.
Image by TK Kurikawa