THE trend towards shopping centre showrooms could become more attractive as centres report reducing income growth while warehouse space in some parts of Melbourne and Brisbane have plunged to their lowest levels in 10 years.

Both may affect how dealer groups plan their next property move, especially if considering an expansion program or changing their retail model.

In its report on shopping centre performance for the future, industry research and forecasting service BIS Oxford Economics said Australia’s retail environment remains “challenging” because of the nation’s difficult economic transition away from a resources-driven economy and back to more broadly balanced growth.

BIS Oxford Economics’ author of “Retail Property Market 2017 to 2027” and senior project manager Maria Lee, said: “This is proving to be a long, hard slog. We expect retail expenditure to remain muted for the next three years”.

“Some centres are at risk of losing anchor tenants and/or specialty retailers and will underperform. Even for stronger centres,” she said.

“Even experienced shopping centre managers may have trouble in dealing with what are arguably the toughest conditions yet in retail property investment.”

The report said shopping centres will struggle to match the pace of industry turnover growth because of increased competition from more retail outlets and the continued growth of online sales, aggravated recently by the expansion of Amazon.

Ms Lee said shopping centres also faced other challenges including over-rented shops, high leasing incentives, poorly performing anchor tenants and pressure on retailer profit margins.

“In addition, changing consumer spending patterns mean there’s a requirement to constantly reinvigorate centres and this involves spending money,” she said.

“We forecast shopping centre net income growth to barely keep pace with inflation over the next five years, with probably more downside than upside risks to those forecasts.”

The erosion of shopping centre revenue may play into dealers’ hands. The trend to locating showrooms amongst high-traffic areas continues to grow and is being considered by an increasing numbers of car-makers and franchises.

But the reports said that while the spectre of large scale shop closures, declining retail employment and abandoned shopping centres that are featured in the US are unlikely to be repeated to the same extent in Australia, “the risks associated with retail property investment are arguably higher than at any time in the past”.

“Returns are expected to vary significantly from centre to centre and some will fail,” it warns.

Despite all this, BIS Oxford Economics notes that retail property remains in high demand among investors, with the dollar value of transactions seemingly held back only by a lack of stock for sale.

Meanwhile, existing owners are pumping large sums of money into (often defensive) refurbishment/expansion projects.

Competition for assets is driving yield compression, thereby boosting centre values and total returns.

Average yields for regional, sub-regional and neighbourhood centres are all below pre-GFC levels.

“We can’t see much further yield firming from here. If anything, the main risk is in the opposite direction” suggests Lee.

In its second report, on warehouse space, BIS Oxford Economics said tenants hold the key despite some more high profile leasing deals such as Amazon and other online retailers.

The research house said when incentives – usually in the form of rent-free periods or free fitouts – were factored into pre-leasing deals for new prime-grade warehouses, effective rents in these markets were around their lowest levels in 10 years.

Co-authors of BIS Oxford Economics’ “Melbourne and Brisbane Industrial Property, Market Forecasts and Strategies, 2017 to 2027” Lee Walker and Christian Schilling, said current pre-lease rentals on offer to tenants to lease new warehouses in Melbourne and Brisbane make the decision to upgrade very compelling.

“It makes sense that companies would find the option to upgrade to newer, more efficient facilities at a much lower rent very appealing,” the report said.

They said that since 2007, the average rents in Melbourne’s south-east and Brisbane’s TradeCoast (the 8000 hectare major industrial precinct close to the Brisbane CBD) had fallen by 15 to 18 per cent.

“Compounding the situation, stated rentals for a new lease are substantially below the rent being paid by tenants coming to the end of a long-term lease,” they added.

The reports add that a tenant who signed a lease over a prime property in Melbourne’s south-east in 2007, with annual escalations of three per cent, would be paying 25 per cent above the current market rent for existing space.

In Brisbane’s TradeCoast, the situation is even worse, with the tenant ending their lease paying an estimated 35 per cent above market rents.

The report said that over the past five years, major developers in Brisbane and Melbourne were able to use firming yields and rising capital values, underpinned by the strength of the investment market, to fund leasing incentives, whilst keeping a lid on pre-lease rents. The competition in the pre-lease market kept market rents subdued.

“However, developers’ calculations will change when yields stop firming and start to soften, as forecast over the next five years,” it said.

“Without firming yields, developers will no longer be able to fund such generous leasing incentives and will need higher rents to underwrite project feasibility. Rising pre-lease rents will then filter through to the existing market.”

BIS Oxford Economics said it will be “business as usual” for the next 12 to 18 months until the generous leasing deals will gradually start to evaporate.

“With leases typically involving a long term commitment, tenants looking to upgrade would be advised to take advantage of the generous leasing incentives and rents whilst they are still around,” it said.

By Neil Dowling