This article is from the Australian Property Journal archive
LENDER now consider retail as the riskiest sector among core commercial real estate sectors, which has resulted in the cost of debt for retail skyrocketing, to more than double that of industrial.
According to the MSCI/Mercer Australia Core Wholesale Monthly Property Fund Index from MSCI Real Assets, costs of debt has risen sharply following 10 consecutive interest rate hikes, which has slowed transaction activity and commercial property performance in Australia last year, with transaction volumes falling to $63.3 billion, a 25% decline compared to 2021.
New data reveal lenders perceive retail as the riskiest and priced accordingly to reflect their assessment.
According to MSCI, the average cost of debt for retail specialist funds surged to 8.3% in Q4 2022 from 2.6% in Q4 2021 – the highest level since the series began in 2015, an analysis of the data showed.
This compares with 5.8% for office specialist funds and 4.0% for industrial specialist funds in the same period.
Benjamin Martin-Henry, head of Pacific real assets research at MSCI, said given the economic issues pervading the economy, it is understandable why there is concern over the retail sector’s performance in the short term.
“After all, the main aim of the central bank’s tightening is to reduce consumer spending to bring inflation down from levels not seen since the late 1980s. A decrease in disposable income will impact retail sales across all property subtypes. But the hardest hit asset types are likely to be those with a higher proportion of sales generated by discretionary spending,” he added.
This month the market has seen department store Myer abandon its iconic store in Brisbane after 35 years. Myer CEO John King said that “like all retailers, we remain cautious about the macro-economic environment”. The rising cost of living and the impact of growing interest rates are expected to hit Myer and its rival David Jones, and as the $260 billion savings buffer accumulated during the pandemic becomes depleted.
Last week Myer threatened to walk from Adelaide’s Rundle Mall location. Myer pays over $15 million in rent at the Myer Centre Adelaide, owned by Singaporean Starhill Global REIT.
Office and industrial funds also experienced significant increases in the cost of capital.
The average cost of debt for office specialist funds has more than doubled to 5.8% from just 2.7% a year prior, taking it to the highest level since mid-2019. Further uncertainty about the office sector remains, as office occupancy levels across Australia have yet to recover to pre-pandemic levels.
For industrial specialist funds, the average cost of capital increased to 4.0% from 1.9% in Q4 2021, mainly due to the symbiotic relationship with retail caused by the rise of e-commerce. Despite this, lenders are still pricing debt well below that of the other core sectors and only marginally above risk-free rates.
Martin-Henry said some well-capitalised investors who are not reliant on debt may turn their attention to retail assets due to the significant downturn in performance at the onset of Covid-19 and the sector’s failure to recoup these losses.
“The retail sector suffered a significant downturn in performance at the onset of Covid-19, due chiefly to write-downs in values, and so far the sector has not recouped these losses.
“In light of these declines in value, it would not be a surprise to see well-capitalized investors who aren’t reliant on debt turn their attention to retail assets as some current owners face the pressure of refinancing at higher rates,” he continued.
Yields have also expanded for almost all retail subtypes in Q4 2022 as pricing adjusted to the increase in debt costs.
In a recent podcast episode of Talking Property, Martin-Henry said some investors will return to core because they are starting to get better yield spread.
MSCI’s Price Expectations Gap Indicator shows office remains overpriced and industrial is under-priced, which implies office property assets need to be trading at a discount to get investors back into the market.