Retail properties going “cheap” and showing strong yields – but take extreme care

Veteran retail property and business professional Duncan Johnston is taking a truly counter-intuitive approach to investment opportunities in shopping strips. There are “marvellous buying opportunities” for cashed-up investors such as self-managed super funds, he says.

Johnston and his associates manage many retail and commercial properties on behalf of more than 150 self-managed super funds (SMSFs) administered by Accounting Solutions Victoria and its financial planning arm, Financial Solutions Victoria.

In another role, Johnston is co-owner of a handful of Collins franchises including the Hill of Content bookshops in Melbourne and Sydney.

As a tenant, he is making the most of the difficult retail market by negotiating cut-price rents for Collins franchisees. And as an investor, he is buying strip shops on the cheap for his SMSF clients.

When Johnston heard that 38 shops on Oxford and William streets in Sydney’s Paddington were reportedly vacant, his reaction was blunt: “It’s a real opportunity for investors.”

Often a number of his SMSF clients join together to buy more expensive properties. “We are looking at properties costing $1 million to $5 million.”

Johnston says the keys to successful buying in this market include paying the right price for quality property, carefully choosing tenants that will draw in customers, and then looking after those tenants in such ways as offering rent holidays if trading gets tough.

The selection of tenants is all-important. Johnston favours what he calls lifestyle tenants that include home furnishings, food supply, entertainment, books and restaurants.

A series of interviews by Property Observer confirm that property analysts and investors have a mixed and somewhat cautious outlook for retail property as an investment.

Some analysts are convinced that the doom and gloom commentary directed at retail is overstated, pointing to some better-performing retail sectors and shopping areas as well as the expectations that retail spending will eventually recover.

And some property specialists believe that investors who select their properties and tenants with extreme care can pick up bargains in this market – provided the purchase price allows for the possibility of more bad news.

Here’s what five retail experts are saying:

Property hunt

Johnston recently bid $2.6 million for a strip shop in Victoria’s Werribee on behalf of eight SMSFs who would have each put in $325,000. Although he decided not to match the winning bid of $2.85 million, the shop typifies the property that SMSFs are hunting for.

The Werribee shop, which is located on the city’s main thoroughfare, is occupied by an IGA franchisee on a 10-year lease. And Johnston knows the shopping strip well because SMSF clients own a Centrelink shop a block away.

IGA-type grocery businesses really appeal to Johnston as tenants for his SMSF landlords. He believes that the “IGAs of this world have really come into their own” as shopping habits change.

“The average spend in a supermarket has gone from $70 or $80 down to $20 or $30 because more people are shopping once a day or every two days. And they like to buy near where they live or work.”

For instance, Johnston describes the inner-Sydney suburb of Balmain – where he co-owns the Hill of Content bookshop – as a “classic” example of a suburb that could accommodate a small IGA supermarket in addition to the existing Woolworths.

Although Johnston says that despite retail’s current woes, “it will be always there for the long-term”.

Johnston adds that while retail landlords might have received low yields in the past and relied on capital growth, yields have now reached 7% or 8%. “And while landlords may not be getting capital growth in the short-term, we can see it expanding in the long-term.”

Pessimism “overstated”

Leigh Warner, director for research and consulting with Jones Lang LaSalle, says that while retailers and landlords face challenges, the pessimism in some circumstances is overstated.

“Retail turnover will recover,” Warner emphasises. While he believes that the aggressive credit growth experienced between 1997 and 2007 will not return, growth in population and real wages will justify an annual increase of about 5% in turnover over the next decade.

“Spending growth is also likely to get a slight boost at some stage over the next few years as a cyclical recover in confidence sees the household savings rate fall from around 10% of household incomes to settle around 7%,” he adds.

Although Jones Lang LaSalle’s research doesn’t include shopping strips – it tracks sales costing $5 million plus – Warner says his comments on the outlook for retail cover retail in general, not solely shopping centres.

Warner believes that the retail yield spread – the difference between the retail yields and the 10-year bond rate – appears to suggest there is “pretty attractive buying” for investors.

He says the yield spread for neighbourhood centres, for instance, is the biggest he has seen since the downturn of the early 90s. Jones Lang LaSalle calculates that the yield gap for neighbour centres stood at 685 basis points in March 2012 compared to 412 basis points at the market peak in late 2007.

“It is very hard to finance a property that is regarded as secondary,” Warner points out. But for investors that could get finance, “we think in some instances, there will be some good returns made”.

Warner says risk-averse investors have largely focused on dominant regional centres and quality CBD properties, leaving a potential opening for investors in secondary properties including neighbourhood centres.

Interestingly, Warner says that astute buyers may find value in shops that have had little spent on their maintenance and improvement. “There is a very shallow buyer pool for these investments.”

Warner adds that active investors and those taking professional advice may do well by bringing the shops up to a satisfactory standard. He emphasises, however, that investors should be confident about the property’s potential value and the suitability of an area’s demographics.

High risk in hard-hit areas

Managing director of SQM Research Louis Christopher warns that any investor buying a strip shop in, say, Oxford Street, Paddington or in nearby Double Bay would be taking a big bet. “There is considerable downside risk.”

Christopher believes there are safer options in retail areas that aren’t as devastated.

“But it’s all about price,” he says. “If you are going to buy into market right now, make sure the price you pay reflects what’s happening in the markets and the potential for further bad news and downgrades.”

“Tenants in Oxford Street, Paddington, are demanding substantial cuts. I am hearing demands for 30-40% cuts. The price needs to reflect that.”

Christopher argues that Oxford Street can no longer blame its woes on Westfield Bondi Junction. He points to retail in another inner-eastern suburb, Potts Point which is potentially affected by Westfield yet is doing well.

“Oxford Street is a physical mess; it’s difficult to park and hard for pedestrians to cross.” Further, many of the shops were upmarket and discretionary. “And rents are too high.”

Nevertheless, Christopher says a “contrarian view” would be to buy a shop in Oxford Street. “It could be the point to re-enter retail. Do your homework. Understand the demographics, understand where rents are, and what turnovers are really like. And snoop on the ground, speaking to shopkeepers.”

Well-located shops

Ross Horsley, research analyst for LandMark White, says that although retail spending is down, well-located properties will still earn satisfactory returns for landlords.

And with yields rising as values fall, Horsley says there could be good buying opportunities including along shopping strips.

Horsley suspects that a large number of for-rent and for-sale signs in a shopping strip may point to a chance for an investor to make an offer that may just be accepted.

While Horsley doesn’t envisage that Oxford Street in Paddington will return to its peak from a retail perspective, he agrees the area is likely to improve when shoppers begin to spend again.

Horsley says that despite weak consumer spending and high savings rates, well-located small shops, particularly in central business districts, remain popular with SMSFs.

Strong sectors

Tony Sherlock, senior property analyst for investment researcher Morningstar Australia, says there are few signs of an improving outlook for retail property.

However, Sherlock writes in a new report – Retail – What’s in store? – that weak sales are not being experienced across all retail. He says the better-performing categories are consumer staples, pharmaceuticals, cosmetics, cafes, restaurants and supermarkets.

“This is shown in recent sales statistics for supermarkets, up 3.7% on a 12-month moving average basis; liquor, up 7.1%; pharmaceutical, up 7.3%; and cafe/restaurants, up 4.2%.”

Sherlock says this “bodes well” for owners of smaller neighbourhood and sub-regional malls.

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This article first appeared on Property Observer.