SA Property – The Retail Property Landscape
It has been believed for some time that retail property leads the commercial property cycle, and that it should thus be the first to cool, ahead of industrial and office space. Retail property experiences similar drivers to residential property, i.e. household disposable income and interest rates, which drive the rate of growth in consumer spending. In contrast, the drivers of industrial and warehouse space, as well as office space, are less consumer-specific and more related to the broad economy of which the consumer is only part.
In 2005, retail property achieved impressive total returns of around 33% according to the Investment property Databank. (IPD). 2006 statistics are not available yet, but we do know that real retail sales growth last year was impressive, suggesting that last year was another year of great returns on this property class. IPD statistics show retail vacancy rates have steadily declined since a peak reached in 2002, so the sector appears to have moved further away from oversupply of space despite significant addition of new stock to the market. Capitalisation rates have declined dramatically in recent years. From above 12% at the end of 2002, regional shopping centre capitalisation rates were near to 8% as at mid-2006.
While my claims of a lack of general oversupply in retail space may be greeted with scepticism by some who have observed the mushrooming of new shopping centres in many areas, it is perhaps because they do not take into account just how furious the pace of real retail sales growth has been.
Cumulatively, the real (nominal value adjusted for inflation) value of retail sales in 2006 was about 42% higher than in 1999. This implies the creation of a lot of additional space in the market for new retail property.
However, signs of mildly deteriorating fundamentals in this sector are becoming apparent in 2006. A mild rise in interest rates was accompanied by a small increase in capitalisation rates. This rise in cap rates may have been merely the result of a short term rise in long bond yields, but higher levels of consumer indebtedness are a more permanent fixture. The household debt-to-disposable income ratio has risen from around 50% in late 2002 to 73% by the third quarter of last year. This has driven a rise in the overall household debt-service ratio from after the end of the aggressive 2003 interest rate cuts. In addition, significant tax relief for individuals in recent years, along with wage inflation remaining above consumer price inflation and an economy that has begun to create significant employment, has seen real household disposable income exceeding economic growth for the past few years.
Going forward, households are expected to curtail their robust consumption borrowing growth, while real household disposable income growth is expected to move slower into line with economic growth. Given real economic growth of near to 5%, this will imply a healthy consumer situation to come, but somewhat slower than the frantic pace of growth of recent years.
Meanwhile, on the supply side, we saw a significant rise in the number of square metres of retail space completed last year, and further increases are anticipated this year. This increase is the result of the long time lag from the beginning of planning of retail projects until completion, and represents the lagged response to the consumer boom. A higher number of square metres completed along with slower expected retail sales growth this year should imply a deterioration in total returns in this property sector, as the downward trend in vacancy rates is halted.
So should we expect a long downturn? My view is that this is not likely. Retail vacancy rates still seem low, and solid economic growth and thus consumer demand growth will not take long to absorb any surplus retail space that may be created in the near term, especially as I anticipate a lull in new retail completions in 2008 and beyond. As in the case of residential property, therefore, gross oversupplies of space are difficult to create in an economy on an accelerating growth path, and deterioration in retail property returns is expected to be mild and of short duration.
During the near term period of mild weakening in returns, it can be expected that the larger super-regional and regional shopping centres will hold their own better than the community, neighbourhood and street-front shopping space. Therefore, after some years of narrowing the gap, 2007 is expected to see a mild widening of the gap between the larger shopping centres and the smaller categories (whose cap rates are generally higher as it is). In addition, it is possible that the latest wave of crime, and indeed an increased (pre-2010) focus on crime, may affect the performance of street-front space and the neighbourhood centre category, as perceptions of better security in the larger centres increase their relative popularity amongst both retailers and clients.
Many new investors in the commercial property sector begin by buying shops, often located close to home. Alliance Group research reveals that up to 60% of retail property sold is within the buyer’s own geographical location with few buyers purchasing property in other South African cities. The IPD index shows that retail owed its strong performance in 2004 to relatively large falls in yields. Shops and retail warehouses were the best-performing sectors of the commercial market, with total returns of between 22% and 24%. Investors making the transition from residential property often find retail the most accessible route. Simply going shopping provides market research, and a discerning investor can sense if a location trades well. However, it is a very competitive market for private investment.
WHAT TO LOOK FOR
- Apart from location, lease length and tenant strength, you should consider the effect of competing retail centres, population growth, and car parking (which is particularly relevant in the CBDs). “Assess how realistic the rental level set in comparison to other competing buildings is, in your location and others,” says Alliance’s Sean Parsons.
- Look into whether any new residential developments are being built in the area, as this could increase the number of potential shoppers, thus potentially increasing rents.
- Check planning consents: is it zoned commercial or is there mixed zoning.
“Information courtesy of the Alliance Group Property Investor Guide, available at all Alliance Group offices nationwide. To find out more, call 0861 ALLIANCE, or visit www.alliancegroup.co.za to download an electronic version“