Whilst the number of shopping centres changing hands has started to edge higher, they remain down for the three months to February compared to a year earlier, according to The Data App estimates. As in recent months, the volume (sqm) and value of transactions are also lower than a year ago. Clearly, part of the reason for the improvement in transactions is the increase in cap rates, which are close to 150 basis points higher than a year earlier.
The long run implied risk premium* for all commercial retail assets is around 5.75%. So, without taking any view of the future, simple mean reversion and applying the current risk-free rate of interest, would imply shopping centre cap rates of around 7.4%. On this basis, the bias of cap rates still remains skewed on the upside.
However, research with Damian Stone of Y Research, under the PAR group umbrella, highlighted the wide divergence in cap rates between everyday needs shopping outlets, that is, those dominated by a supermarket and those termed destination centres, sub-regional centres or larger, which contain a high level of discretionary spending shops, such as fashion. This PAR Group work showed cap rates for destination centres around 7.4% while, for everyday needs, the reading is closer to 4.5%. The implied risk premium for the two different shopping centre types is similarly different.
The long-run risk premium for destination centres is around 5.85%, only slightly above its current level of close to 5.7%. Whilst consumer spending looks set to moderate as the year progresses, particularly discretionary spending, the current risk premium is not out of kilter with the long-run trend. This is not to say cap rates for destination centres will not rise further, just that the current risk premium is close to “normal”.
The main risk premium disparity is found with everyday needs outlets (the conglomerate of neighbourhood centres, stand-alone supermarkets and convenience centres). Currently, the implied risk premium for these assets is under 3%. This compares to an historical average of close to 5.7%. It may well be consumers forgo eating out to cooking at home, or some other reason to boost the attractiveness of everyday needs centres. Be that as it may, compared to history, investors in these assets are receiving very little compensation for investment risk and, if history is anything to go by, would suggest an upwards lift to everyday needs cap rates, or significantly lower risk-adjusted returns.
*The implied risk premium is the difference between the risk-free rate of interest, as measured by the yield on indexed-linked securities, and the cap rate. While conventional fixed income securities have a tendency to be used for comparative purposes, they are not a risk-free rate, as investors receive compensation for inflation risk, that is, the inflation risk premium priced into a conventional bond yield.
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Further research undertaken by the http://PAR.Group/ on the impact of the pandemic and e-commerce on shopping centres refer to the links below:
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The Data App (TDA) is a member of the PAR Group, an independent research collective offering a comprehensive range of property research and analytical services. The team is experienced in economics, property research, transactional and corporate strategy; all with extensive industry involvement in both the property and finance sectors. Visit: http://par.group/ for more information.