With retail capital growth looking fragile, retail yields are firming

There has been much debate recently about the health of the retail sector.

Needing to constantly have everything "on sale" has certainly shrunk everyone's margins. But overall, sales volumes have languished.

Yet, maybe there is some light at the end of the tunnel. The ABS just reported that retail sales increased by 1% during June, following a 0.8% rise in May.

And department store sales jumped by 3.4% during June — the largest increase in more than a year.

However, as you can see from the graph, the most recent surges in retail activity have also followed directly after generous government handouts.

Source: Australian Financial Review

The golden era

Clearly, retail's golden era is somewhere in the past. In fact, the BIS Shrapnel recently forecast retail sales growth of 2.9% per annum over the next five years. And you only need to compare that with around 5% per annum before the GFC.

Add this to the strong incursion being made by online retailing, and you start to realise the retail sector (as a whole) is looking somewhat fragile.

In fact, Moody's rating agency has recently indicated that the credit standing on major Australian shopping centre owners is a risk.

Moody's considers that low vacancy rates and fixed rental increases above the CPI are simply not sustainable given the sudden growth in online retailing.

Online influence

However, it's not just purchasing over the internet that is causing retailers a problem.

Have you noticed how customers conduct instant in-store price checks using their iPhones or iPads? Retailers are now often being forced to further shave already thin margins on the spot to make a sale.

That simply means retailers need to respond more vigourously to this online threat.

Some recent research by Deloitte confirms retailers must change — and quickly — to deliver a seamless online service for their customers.

Bottom line: Historically, retail landlords have been prepared to accept income yields as low as 4% to 5% because they were accompanied by 8% to 9% per annum capital growth. But this is no longer the case.

Leases with fixed rental increases have been growing faster than the CPI, which only creates illusory growth — because those rentals will simply fall back at the next market review.

Therefore, most commercial property owners are now viewing their retail investments as an "income play". And yields have been firming accordingly.

Chris Lang is an advisor to commercial property investors and gives keynote speeches and regular seminars on the best way to invest in commercial property. He maintains a blog, his-best.biz, which he updates regularly about the best way to get the most out of your commercial property investment.