Key points

• Transactions totalled $7.6 billion in FY16
• REITs continue to divest non-core assets
• All buyer groups are pursuing acquisitions at present, but ‘core’ remains the focus
• Yields for major CBD assets have moved firmly into <5% territory

“Transaction activity in the retail investment market was very strong once again in FY16. Capital remains widely available for acquisitions, although a clear preference for core assets has emerged. Investor demand has been strong for major CBD retail assets, driven by the solid fundamentals and income growth potential that many of the CBD markets offer. A series of CBD retail transactions have occurred, cementing yields at a new record low for the Australian market.

“Investors continued to bid retail yields lower through FY16 as the cost of capital continued to decline, and the spread to the risk-free rate remained wide. We see that downward trend in yields starting to slow and are expecting stabilisation in yields to occur through the second half of 2016 and through 2017. The increase in financial market volatility since the start of 2016 has caused some investors to approach transactions more cautiously, especially given the tight pricing levels for core assets.”

Overview

The total volume of transactions reached $7.6 billion in the 2016 financial year, just 7% below the record reached in FY15. Sub-regional shopping centres continued to dominate the activity, accounting for 37% of all transactions. The volume of transactions was high across all shopping centre sub-sectors in FY16 except for regional centres, where no sales occurred. Activity was evenly split between the remaining categories. ‘Other retail’ (non-traditional formats) accounted for $1.3 billion of the acquisitions (17%), while CBD and bulky goods assets similarly each accounted for $1.2 billion or 16% of the transactions, and neighbourhood shopping centres were close at $1.1 billion or 15% of the total.

Offshore purchasers dominated once again, accounting for $2.9 billion (or 38%) of the acquisitions, more than twice as much as the second-most active buyer group, A-REITs, which accumulated approximately $1.3 billion in FY16, or 17% of the total.

The 2016 financial year was a year of two halves. The second half of 2015 was the strongest six-month period for transaction activity ever recorded, with $5.4 billion of transactions, while activity slowed somewhat in the first half of 2016 to $2.2 billion. Lower stock availability has been one of the reasons for the lower level of activity in the first half of 2016. In addition, financial market volatility in early 2016 resulted in some hesitation among investors, not just in the Australian retail market, but globally across all sectors. While some cautiousness remains, that hesitation in terms of engaging in transactions has largely subsided.

The sale of major portfolios was a key feature of the market in FY16 as investors sought transaction scale in order to build their exposure to the retail sector. Eight portfolio transactions occurred, totalling $2.2 billion in FY16. The largest of these transactions was a portfolio of four sub-regional centres sold by Vicinity Centres for $841.4 million to Blackstone and Mirvac in June 2016. Blackstone acquired Forest Hill (Vic), Clifford Gardens (Qld) and Brimbank (Vic) for a total of $613.3 million as part of the transaction, while Mirvac acquired Toombul (Qld) for $228.1 million.

Blackstone was also the purchaser of a major portfolio of sub-regional centres from Scentre Group during FY16. The portfolio comprised of Westfield Strathpine (Qld), Westfield Warrawong (NSW) and Westfield Figtree (NSW) for a total of $655.5 million in August 2015.

In other portfolio transactions, The Insurance Commission of WA sold two assets in Perth for $303 million to Vicinity Centres, One Five One Property sold a $219-million portfolio of bulky goods centres to Aventus Retail Property Fund and SCA sold $60.9 million worth of assets from the REIT into an SCA managed wholesale fund.

Product

Sub-regional shopping centres remained the most actively traded sub-sector in FY16, primarily driven by the assets contained within portfolio trades. 22 sub-regional centres sold in FY16 totalling $2.8 billion, generally in line with the $2.95 billion sold in FY15.

In addition to the assets contained within portfolio transactions, some of the key transactions were: Dandenong Plaza (Vic), sold by GPT to Armada Funds Management for $197 million in December 2015, Stud Park Shopping Centre (Vic) sold by Lendlease to AMP Capital for $154 million in August 2015 and Lakelands Shopping Centre (WA) sold by Peet to ISPT for $98.4 million in July 2015.

Dandenong Plaza, VIC

Investors have been drawn to sub-regional centres for the attractive yield and potential for development and tenant re-mixing opportunities.

CBD retail transactions have been unusually high in the past year, given the number of major CBD assets is relatively small and they typically transact infrequently. Investors are seeking major CBD shopping centres for income growth and capital growth potential. The primary vendor motivation was to recycle capital into development projects.

World Square

In some of the key transactions, Rundle Place and 80 Grenfell Street, Adelaide ($400 million) were acquired by Blackstone, a 75% share in MidCity Centre, Sydney for $320 million was acquired by NGI, a 50% share in World Square, Sydney for $285 million was acquired by ISPT and a 50% share in Metcentre and 60 Margaret Street, Sydney for $279 million was acquired by Pacific Alliance Group.

Rundle Place and 80 Grenfell Street Adelaide

The drivers of CBD retail suggest market fundamentals will remain healthy. The influx of major international retailers has supported leasing demand and revived CBD retail precincts. The growth in inbound tourism has also supported retail spending, especially within CBD markets. Over the longer term, the high level of apartment development will further drive the demand for retail space.

The Jam Factory, VIC

Other retail, which includes non-traditional shopping centre formats, has seen high levels of activity, primarily reflecting the demand for inner-urban areas to capitalise on densification and population growth. Some examples included Jam Factory and Como Centre, both located in South Yarra, Melbourne. Outlet centres were also highly sought after over the year, with four transactions recorded, including the Spencer Outlet Centre in Melbourne, DFO Brisbane, DFO Jindalee and DFO Cairns. Also within this sub-sector of ‘other retail’, private investors were actively pursuing freestanding supermarkets and Dan Murphy’s for the long-term leases and strong lease covenants.

DFO Cairns

Bulky goods investment activity has remained elevated, primarily due to the considerable improvement in the underlying fundamentals and leasing market conditions, driven by a recovery in housing construction activity. The sector has also been gradually evolving and the tenant base has diversified. Investment activity rose to $1.2 billion in FY16 from $765 million in FY15. The breakdown of the different subsets of bulky goods shows that multi-unit centres (predominantly homemaker centres) accounts for 76% of the transactions in FY16, while category-killers (single tenanted retail warehouses) accounted for the remaining 24%. Private investor demand has been very strong for single tenanted retail warehouses such as Bunnings Warehouses, with yields being recorded at close to 5% on certain transactions and below 5% in some instances.

Neighbourhood shopping centres have become more tightly held in the first six months of 2016. In FY16, transactions slowed to $1.1 billion, approximately half the level from the previous financial year. Queensland was the most active market, with $463 million in transactions, followed by New South Wales ($282 million), Victoria ($219 million), Western Australia ($103 million), ACT ($33.7 million) and South Australia ($32.6 million).

Demand has remained solid from institutional and private investors for neighbourhood shopping centres, but given the sharp compression in yields over FY16, some institutional investors will be restricted by cost of capital constraints at the current benchmarks.

Regional shopping centres have become increasingly tightly held. Owners have sought to bolster the low-risk components of their portfolios. Many owners are undertaking redevelopments of key regional centres as a method to defend or increase their market share within their catchment, drive sales growth and attract new retailers. No regional shopping centres transacted in FY16. The last transaction was recorded in October 2014 (a 50% share in Stockland Townsville).

Pricing trends

Yields continued to trend lower in FY16 as investors revised their return expectations for core assets. Financial market volatility in early 2016 highlighted the stability of real estate, retail real estate in particular, and the wide spread to the real Government bond rate meant the risk-premium continued to attract investors to the sector.
There was a greater level of yield compression across neighbourhood, CBD and bulky goods in FY16 of between 50 to 75 basis points, while regional and sub-regional centres recorded tightening of approximately 25 to 50 basis points over the same period.

CBD shopping centre yields have moved beyond historical benchmarks and firmly moved into unprecedented territory, with the latest evidence confirming yields at approximately 4.50% – 4.75% for premium defensive assets, or those with a strong income growth outlook.

Given the recent shift in yields, the rate of yield compression is likely to slow in the near term and we expect yields to stabilise through the second half of 2016.

Investors

Offshore investors have been a dominant force in the Australian market for a number of years. FY16 was no exception. They accounted for 38% of total acquisitions, or $2.9 billion, and have acquired over $5.2 billion worth of retail assets over the last three years.

Blackstone was a key driver of the activity in FY16 as they continued to build their Australian shopping centre portfolio, with the addition of three sub-regional centres acquired from Scentre Group, three sub-regional centres acquired from Vicinity Centres and Rundle Place in Adelaide, acquired from epc.Pacific. This adds to their existing assets including Top Ryde City, Greensborough Plaza and Waverley Gardens Shopping Centre.

Other offshore investor acquisitions in FY16 included a 75% share in MidCity Centre ($320 million) by NGI, a 50% share in the Metcentre & 60 Margaret Street ($279.5 million) by Pacific Alliance Group, Forestway Shopping Centre by Invesco ($112 million) and two purchases by LaSalle Investment Management, King Street Wharf Retail ($90 million) and Morayfield Super Centre ($75 million).

Unlisted funds were active on both sides of the market in FY16, acquiring $1.0 billion worth of property and selling $1.1 billion, making them marginal net sellers over the 12-month period. Unlisted funds still have appetite to grow their portfolios through acquisitions and development. However, some unlisted funds are focused on repositioning their portfolios and disposing of assets while capital markets are accommodative of major asset sales. Some of the unlisted funds that disposed of assets during the year included: Fortius (75% share of MidCity Centre), Lendlease (Stud Park Shopping Centre) and Challenger (The Jam Factory).

A-REITs One of the key themes among A-REITs in FY16 was the sale of assets considered to be non-core to their strategy. In most cases, the proceeds have been redeployed primarily into development pipelines or to repay debt, and to a lesser extent, into selective (and limited) acquisitions. There were a number of examples of non-core assets sales across the REIT names, including the portfolio sales by Scentre and Vicinity, in addition to GPT’s sale of Dandenong Plaza. Dexus, Charter Hall, Mirvac and SCA Property Group also disposed of assets in FY16. We expect this process of selling non-core assets to slow over the next 12 months compared with previous years.

Superannuation funds were relatively active in purchasing assets in FY16 ($709 million). However, the level of acquisitions was below offshore investors, A-REITs, private investors and unlisted funds. Due to the specialised nature of the retail asset class, with regards to asset management in particular, many superannuation funds gain exposure to retail property via unlisted wholesale funds or listed funds. This, in part, explains the level of activity within the unlisted fund category.

ISPT was the key driver of activity in this buyer category in FY16, acquiring assets such as World Square Sydney (50%), 206 Bourke Street in the Melbourne CBD, Lakelands Shopping Centre in Mandurah, The Well Shopping Centre in Camberwell and a portfolio of two neighbourhood centres in Silkstone and Springfield, Queensland.

Private investors were the third largest buyer group in FY16 ($1.1 billion), behind offshore investors and A-REITs. The types of retail assets sought after by private investors remained very similar to previous years.

Neighbourhood and bulky goods shopping centres made up the largest proportion of acquisitions, each accounting for 32%, followed by ‘Other retail’ (freestanding supermarkets) at 25%, followed by sub-regional and CBD at just 8% and 3% respectively. As previously noted, many Bunnings Warehouse sales and Woolworths supermarkets sold to private investors in FY16, as the demand for low-risk, long-lease assets remained high.

Other investors refers to corporates (companies whose primary business is not real estate), syndicates, insurance companies, receivers or government. This category continues to be the biggest source of investment product as it is a consistent and significant net seller of retail property. The major contributors to asset sales in this category comes from Woolworths and Wesfarmers. It reflects their development of new centres and ongoing divestment program from their subsidiaries, Woolworths (Fabcot), Coles and Bunnings. The two groups sold close to $400 million worth of retail property in FY16.

Market fundamentals

Economic indicators are providing a mixed outlook for the retail sector. The housing market, which has been a key driver of the recovery in retail spending, has begun to soften. House price growth has slowed and residential construction is slowing as well. The strong growth in household goods spending is therefore likely to continue to moderate, with implications for the bulky goods sector.

For the broader retail sector, inflation is low, which is weighing on retail turnover, for grocery food sales in particular; within the clothing category, however, volume growth is offsetting the effect of discounting and low inflation. Interest rates remain accommodative but the effect of further cuts in the official cash rate would be relatively minor on retail spending growth given that the effect of house price growth on consumer confidence has now largely past for this cycle. Furthermore, households seem reluctant to take on greater levels of personal credit. In the labour market, employment growth remains healthy but the rate of wages growth is weak in a historical context. So there are many countervailing factors at work, but on balance, the outlook remains reasonably positive.

At a high level, the economy is gradually transitioning from mining investment-led growth to the services sector and to domestic drivers of growth. The implications of that transition continue to be positive for the retail sector. Household balance sheets have strengthened due to asset price inflation and the repayment of debt, which will be supportive of retail spending in the short to medium term.

Leasing market conditions in the retail sector remain relatively stable, consistent with previous years.
International retailers continue to be a major source of leasing demand for CBD and regional shopping centres. Market rental growth is starting to emerge, not just in the CBD and bulky goods sub-sectors, but in regional, sub-regional and neighbourhood in the Sydney and Melbourne markets as well. Rental growth remains constrained in the other markets of South East Queensland, Perth and Adelaide, but the downside risks to rental growth are relatively limited.

While development remains a key focus for many landlords, the overall supply outlook is relatively low in terms of additional floorspace. Completions are expected to be approximately 500,000m2 per annum in 2016 and 2017, which reflects a 22% decrease from the previous construction cycle, in the five-year period leading up to 2009. The lower level of new supply reflects the high proportion of refurbishment and reconfiguration of existing space that is occurring within existing shopping centres.

Investment market outlook

Offshore investors are likely to remain active participants in the Australian retail market given the transparency of the market, stability of returns, solid market fundamentals and attractive yields relative to other countries, but we could also see some offshore investors trade out of some assets acquired earlier on in the cycle to redeploy into other opportunities. Unlisted funds will also be key drivers of activity as they seek to grow portfolios and build scale in the retail sector.

Given the number of assets that have traded over the last four years, stock may become more tightly held in FY17, particularly for core assets which act as a cornerstone to an owners portfolio. Nevertheless, the demand for core assets will remain robust from a range of domestic and international capital sources. Although there will be ongoing competitive pressure in the market, it is unlikely to translate into significant yield compression due to cost of capital constraints, given current benchmarks.

Overall, investment activity is likely to remain above the long-term average in the next financial year, but we expect volumes to be below the exceptionally strong level recorded in each of the last four years. SCN

Property Sales Retail Transactions over $20mill / 2016FY

Click on the following tables to view full screen.

1 No pricing split available (includes mixed-use properties)
2 Core capitalisation rate adopted
3 Approximate pricing
(P) Portfolio
Table above excludes transactions in Tasmania and Northern Territory