Why historically high yield spreads signal now may be the time to buy retail

The spread between yields for sub-regional retail shopping centres and the 10-year bond yield is at or close to multi-decade highs. The spread has not been near the current levels since the late 1990s.

With the yield spread at such levels, it is our view that now is an opportunistic time to capitalise on certain strongly trading retail assets with sustainable rentals.

Yield spreads (2010-2021)

^{Source: Colliers International, Reserve Bank of Australia}

Yields a signal of dislocation, not true value

We believe current yields reflect dislocation in pricing rather than a signal of the true value and quality that exists in the sector.

The high yields in retail to some extent reflect (understandable) concerns about the sector including:

• The impacts of COVID-19 and consequent lockdowns and closures of many retail stores for periods of time

• Concerns surrounding online retail penetration as a result of increased demand for online shopping

• Reduction in rentals to affordable and sustainable levels for retailers in the current trading environment.

The reality is that many retail assets have recovered strongly and continue to trade well with low occupancy costs and solid prospects for future rental growth.

Price dislocation has also likely been exacerbated by the inability of some institutional investors to buy in the current market. This may be due to various factors including share prices trading at discounts to net asset values, a build-up of fund redemption requests, and foreign buyers largely being ruled out due to current international travel restrictions.

Investor sentiment and demand is on the up

Recent market evidence has indicated that investment sentiment for retail property is already starting to turn, and as such current price dislocation, and therefore investment opportunity, may not be prolonged.

Recent on-market campaigns for sub-regional assets have seen strong demand and firming yields. Casey Central, a strongly performing sub-regional asset in Melbourne, is a good example transacting last month on a capitalisation rate in the range of 5.25% to 5.5%.

Elevated demand for retail assets has been observed in the first half of calendar year 2021 with circa $3 billion of retail real estate transacting. This represents a notable increase of 63% over the first half of 2019 and 142% over the first half of 2020 when only $1.9 billion and $1.2 billion transacted respectively¹.

Factors such as historically strong house price growth, high consumer confidence and high levels of excess household savings all bode well for a future surge in retail spending, which would be highly positive for shopping centres.

Strong migration to regional areas and recent increases in domestic tourism spend in regional locations is also expected to drive demand for regionally-located retail shopping centres, which we believe should be more sheltered from the impacts of COVID-19 and online shopping.

Additionally, it is anticipated offshore demand for retail real estate will increase substantially when Australia’s international borders open, further underpinning yield consolidation in the sector.

What does this mean for investors?

It is our belief that well-located and managed retail real estate will deliver superior investment returns over the next decade.

We particularly like convenience-based assets which have higher exposure to non-discretionary spend, high sales productivity and low occupancy costs reflecting rental affordability and sustainability.

Intensive management and knowledge of Australian shopping centres are increasing in importance as the rate of change in the market and consumer behaviour accelerates.

Richard Germain

Managing Director

MA Financial Group

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MA Financial Group Limited, formerly Moelis Australia, is an ASX-listed financial services firm specialising in asset management, lending, corporate advisory and equities. For more of our insights, be sure to click the 'FOLLOW' button below.