Shopping for returns: An investor’s guide to the retail property sector
Retail property is a key sector of the commercial real estate market and consists of properties used for selling goods and services directly to consumers. It’s a sector that touches people’s everyday lives but few people think about it as a potential investment opportunity.
There are many compelling reasons to consider investing in retail property. Well located retail properties with high foot traffic and the right tenant mix have the potential to deliver steady income and capital appreciation. In fact, retail properties have generated the least volatile rental returns of the traditional commercial property (retail, office and industrial) sectors in recent years, avoiding the significant peaks and troughs seen in other sectors since 2016.1
With that in mind, let’s explore the retail sector in more detail, including the key characteristics of retail properties, what drives their returns and why they can be an attractive investment.
Retail properties come in many shapes and sizes
There are a variety of different property types in the retail sector ranging from local convenience stores to large shopping centres and out-of-town warehouse outlets. Each type of retail property plays a crucial role in meeting different consumer needs and can make compelling investment opportunities when all the right factors are in place.
For simplicity, retail properties can be grouped into three main categories based on the type of shopping they support: daily needs retail, shopping centres and large format retail.
Daily needs retail
Daily needs retail, often referred to neighbourhood or local shopping centres, includes properties that cater to everyday shopping and essential services. These are the places people go for quick access to items they need of a regular basis like groceries, pharmacy items or bakeries.
Shopping centres
Medium to large shopping centres include a wide variety of goods and services under one roof. Depending on its size, a shopping centre will be anchored by at least one supermarket, a major department store and/or multiple discount department stores and a large number of specialty stores offering both discretionary and non-discretionary goods and services.
Large format retail
Large format retail properties are characterised by their tenant’s substantial size, typically occupying significant square meterage and located within suburban commercial areas with ample parking space. Also known as big-box stores, because the properties often resemble large, box-like structures, large format retail properties often specialise in non-perishable goods like furniture, hardware, electronics or homewares and attract major national or international retailers as tenants.
What drives returns in the retail property market?
The key to a successful retail property is the right tenants, the right location and quality management. While retail property is closely aligned to economic conditions, there are several other factors that can influence the returns from retail property investments. These include consumer spending, tenant mix, occupancy rates and characteristics of the property itself.
Rent and occupancy rates
Retail properties generally have long-term leases of 10-years plus with major tenants and around five years for smaller tenancies. Maintaining high occupancy rates and growing rents are the bread and butter of a successful retail property. The key is finding the right mix of tenants and keeping vacancy rates low.
Consumer confidence and spending
Retail property performance is influenced by economic conditions and initiatives. Strong economic growth and high consumer confidence typically support higher rents and lower vacancy rates which is why demographic and economic data is a key retail property monitor.
Location
The success of a retail property often depends on its location. Properties in areas with growing populations or high foot traffic, such as city centres or tourist areas, tend to attract more customers and have higher demand from tenants. Proximity to public transport or major roads can also increase the appeal of a retail property.
Consumer shopping patterns
The rise of e-commerce has changed the way people shop, but retailers are adopting an omnichannel approach, using both physical stores and online platforms to serve customers. This trend is also driving demand for retail spaces that offer experiences, such as click-and-collect services or in-store events.
While retail is evolving, people will always need quick, convenient access to everyday essentials such as grocery stores, pharmacies and local service providers. By investing in properties that serve local communities with essential goods, investors have the potential to create a buffer against market shifts.
Lease structures
The length and terms of leases can significantly affect returns. Long leases with established tenants provide more security, while turnover clauses (where rent is tied to a tenant’s sales) can offer additional upside in strong retail environments.
Asset management and property enhancement
Active management of retail properties can boost returns. This might involve adjusting the tenant mix, upgrading facilities or introducing new services to attract more customers. Well-managed properties are more likely to retain tenants and command higher rents.
Economic sensitivity
The cost of borrowing and the availability of finance can influence the returns on retail property investments. Lower interest rates make it cheaper to finance property purchases, while favourable credit conditions can increase demand and push up property prices.
Why retail property can be an attractive investment
There are several reasons why investing in retail property can be a good opportunity. Let’s look at some of the key factors that make retail property attractive for investors.
Income potential
Retail properties can potentially provide a steady income stream from rental payments. Tenants that sign long-term leases provide consistent rental income. This makes retail property an attractive investment for those seeking steady cash flow.
Tenant diversification
Many retail properties, especially shopping centres, house multiple tenants, which helps reduce risk. If one tenant moves out or goes out of business, other tenants are still providing rental income. This diversification helps mitigate the impact of vacancies or defaults.
Capital growth opportunities
Retail properties in prime locations, or popular centres that attract lots of shoppers, tend to increase in value over time. Value can also be added by redeveloping or refurbishing the property, improving its attractiveness to tenants and customers and potentially increasing rental income.
Inflation hedge
Many retail leases include rent escalation clauses, where the rent increases over time, often in line with inflation. This means that the income from these retail properties can rise with inflation, helping to preserve the real value of returns over time
Retail property – a vital part of the commercial property market and diversified portfolios
The retail property sector can be an attractive investment due to its steady income potential, diversification of tenants, capital growth opportunities and potential to hedge against inflation. The key to success is understanding the dynamics of the retail sector and proactively managing properties to maximise value.
Well-positioned retail properties, especially those focused on daily needs or offering unique shopping experiences continue to provide solid investment opportunities.
Retail property assets can also play a valuable role in a diversified investment portfolio, potentially contributing to both income stability and long-term capital appreciation.
- Source: CBRE, Australian Cap Rate Outlook report, December 2024.
