Article | Intelligent Investment

Australia’s evolving rent-a-demic

Low vacancies have fuelled significant rental growth in the industrial and retail sectors. Could a limited supply pipeline do the same for retail property?

April 18, 2023

By Sameer Chopra

The image shows a close-up of the exterior architecture of an office building.

Good (or poor) fundamentals can crush the impact of interest rates on real estate value. 

In November 2022, we turned positive on the residential market in anticipation that vacancy would tighten by a further 0.3% in 2023, off an already low base. Scroll forward and rents are now growing +20% y-o-y in Sydney and Melbourne and capital values have started to recover. 

We saw a similar theme with the industrial sector through early 2022 as rent growth accelerated from mid single digits in late 2021 to high teens by mid-2022.

Our learning was that when vacancy falls below 2%, rents start to increase at an ever accelerating rate, with 10%-type levels easily achievable. 

When vacancy falls below 1%, rent growth can be 10-20%; what we’ve described as a rent-a-demic. This is the situation we now face in the industrial and residential sectors.

Migration will boost the demand-side equation and this has been evident since early 2022. What has surprised is the acceleration in arrivals into Australia.

The more important theme here has been to pick where these new residents are going to live, work and shop.  Inner city locations, typically within 5km-10km of a CBD or university have tended to be early winners and we can see that very clearly in how vacancy rates are evolving on a monthly basis.

Retail real estate is another sector that is set to benefit from the tailwind of immigration, students and tourism. 

What’s more interesting is the investment in new supply. CBRE’s analysis across 20 of the largest real estate institutional investors suggests circa $160bn of future development pipeline across all sectors. That appears to be a large investment envelope but digging below the surface, we estimate that this equates to approximately 1% new development for residential; 4% for retail; 10% for industrial and up to 15% for office. 

Now, if you compare this with the projected 14% growth in population to the end of the decade, a number of opportunities start to emerge. 

Residential has been under-supplied since 2016 but we also like retail where there has been a lack of supply in recent years due to concerns about e-commerce. And looking ahead, it is a sector where there is a sizable gap between investment (4%) and population growth (14%). 

Could retail experience a rent-a-demic similar to industrial and residential? The demand side picture has actually been very healthy – Australians are currently spending 26% more on retail goods and services compared to pre-pandemic levels. 

Retail sales have also been relatively resilient in the face of recent interest rate hikes and cost-of-living pressures. We saw this in the recent ABS data release. The positive surprise in more recent times has been the stickiness evident in physical retail shopping. 

Our recent survey of consumers showed that over half of Australians like to see products in-store before shopping online. Similarly over half prefer to return products in-store even when they bought them online.  With rising cost of acquisition, stores have provided an attractive alternative to boost online sales. Over two-thirds of consumers also prefer offline channels for DIY, groceries, luxury products, homeware and clothing/footwear. Why? Because consumers say they like the immediate availability of products and can see/try before they buy.

A different survey of retailers published by CBRE in February 2023 found 64% want to expand their store footprint compared to 12% looking to downsize. The number of retailers who want to increase the size of their stores is double the number that want to reduce size. 

We also see good evidence of retailers looking to open large customer experience flagship stores, particularly in prime locations. 

The main push-back we hear from retailers is the increased cost of fit-out due to elevated construction costs. 

A third survey by CBRE of CBD retail vacancy in December 2022 found that vacancy for this asset class had tightened by 1.96% over the preceding six months. This survey of 5345 CBD outlets nation-wide found that Melbourne, in particular, had seen the sharpest decline in vacancy.  Hospitality leasing has been a positive contributor to the favourable vacancy trends in Melbourne. 

You can also see this positive theme evident in the financial results of retail landlords, which saw occupancy levels trend up in the six months to December 2022 and currently sit at around 98%. 

With low vacancy, very limited future supply and encouraging demand conditions, the scope for retail landlords in prime locations to re-grow rents might well be on the cards. While rent growth rates may not match the levels recently achieved by residential, there is scope for it to pick-up from the current mid-single digit levels.

The icing on the cake of retail property investment may be the growing recognition of the opportunity to redevelop some retail shopping centre space for BTR/multi-family apartments. Shopping centres have the advantage of typically being located in space which is well-serviced by public transport and close to amenities such as gyms and child care – the ideal BTR scenario.


Development Pipeline by Sector V2

* This article was originally produced for The Australian.