Cap Rates Continue to Decline in Subdued Commercial Retail Market

A year ago, as the first wave of the pandemic hit, Australia embarked on a lockdown which was to last until the middle of May. Additionally, many states and territories have closed their borders at varying times, while there has been extended periods of social distancing. Although some essential retail spending benefitted from panic buying other, non-essential, spending in shops was crimped by a combination of temporary/permanent shop closures and a sharp uptake in on-line spending.

With uncertainty surrounding the length, duration and impact of the pandemic, shopping centre transactions started to taper away, reaching a low around the middle of 2020.

Whilst the number of shopping centre transactions has subsequently recovered from this trough, they remain modest. In the three months to March, the number of shopping centre transactions are 16% lower than a year earlier, while the value and volume of square metres transacted are down by a similar magnitude. So, while transactions have picked up, they remain modest, at best.

Just as consumer spending behaviour has changed, so has the demand for commercial retail space. The appetite for convenience, neighbourhood and large format centres has remained solid, while transactions of large shopping centres has been more subdued. This change in shopping centre demand has been reflected in the valuation parameters.

In the three months to March, the price per square metre is around 12% higher than a year earlier, while cap rates have also tightened. However, reflecting the changing patterns of demand for commercial retail property, the cap rate for sub-regional shopping centres has increased over the past 12 months.

As a number of Government subsidies come to an end, it will become clearer the extent by which some businesses have been kept afloat. Even so, it would seem those most vulnerable to closure are likely to be those where shopping can be done on-line; primarily fashion and food. See for a more detailed exposition. If so, large shopping centres will remain the most vulnerable to weaker demand in the future, suggesting the cap rate differential between large shopping centres compared to neighbourhood/convenience and large format centres will persist meaning transactions will continue to be dominated by non-discretionary high quality, low risk assets.