Online retail, overseas competitors and weaker consumer demand are accelerating the decline of easy earnings and capital growth from retail property, according to Grant MacKenzie, a portfolio manager for Freehold Investment Management, which has about $500 million under management.
Mr MacKenzie blames structural, not cyclical or market, changes for sluggish performance, rising costs and growing disenchantment among retail and wholesale investors, particularly for second-tier quality assets.
He said: "Risk has not been priced correctly and the performance differential between second tier and flagship retail assets will continue to widen. Due to this mis-pricing, we will stick to investing into the highest quality and most productive retail assets, which will be best placed to respond to the structural changes facing today's retail environment."
Retail property is facing structural, not cyclical, issues. David Paul Morris
Retail assets ranging from neighbourhood shops to major shopping centres account for about 40 per cent of the S&P/ASX A-REIT Listed Index because of their record for being highly defensive and providing predictable cashflows. "But this is changing," Mr MacKenzie said.
Freehold Australian Property Fund and Freehold A-REIT and Listed Infrastructure Fund are also underweight retail.
Mr MacKenzie said it targets assets that are "irreplaceable and dominate their catchment", such as Scentre Group, which is trading at a discount to net asset value of about 10 per cent.
"We remain underweight with everything else," he said. "For years retail landlords have had it easy with steady sales growth underpinning fixed escalations in retail rents. If a tenant wanted to leave there was always a replacement. This is no longer the case. Owners now have to work much harder and are increasingly offering inducements or incentives to get tenants to commit to their assets."
Retail tenants 'evolving'
Offshore retailers, particularly for apparel, and online retailing continue to flourish as wages stagnate, encouraging shoppers to search for value, regardless of its source, he added.
"Savvy retail shopping centre owners are constantly altering tenancy mixes to cater for changing consumer preferences with an increasing presence of service industries, leisure and al-fresco dining," he said.
"Retail tenants are also evolving as their margins have come under pressure and occupancy costs are increasing. Supply chain management is improving, store sizes are increasing to allow for reduced staff per square metre and hard decisions are being made on non-profitable stores."
But there are increasing signs that retailers are under pressure.
Vicinity Centres sold more than $630 million of mainly neighbourhood centres at a discount of more than 5 per cent to book value, while Stockland sold Brisbane's Cleveland Shopping Centre in Brisbane at a 12 per cent discount to book value.
"This is not a capitalisation rate story, rather it is about the sustainability of income these assets can generate over time," Mr MacKenzie said.
"Effective rents are currently 'resetting' as tenants are unable to afford 'in place' terms given their sales growth has failed to keep pace with their fixed growth obligations outlined in their leases."
Source: Originally published by Duncan Hughes in the Australian Financial Review on March 20, 2019.