At a time when global stock markets are rediscovering the appeal of value over growth, it makes sense to ask whether the neglected Asia Pacific (APAC) retail real estate sector now looks attractive. In particular, we see operating strengths and modest valuations in neighbourhood retail centres in general and in Australia.
The retail real estate sector has fallen out of favour with investors over the past several years, both globally and in APAC. The causes of this loss of popularity are well-known and structural, not cyclical. They include overbuilding of retail space in many markets, excessive reliance by shopping centres on fashion and other discretionary categories, and rapid growth in e-commerce. Lockdowns during the Covid-19 pandemic dealt an additional blow to the sector.
The deterioration in APAC retail markets has been reflected in falling rents for retail real estate. In the most extreme case, Hong Kong, average prime retail rents were broadly stable between 2014 and mid-2019, but then fell 40% to a trough in Q4 2022. Average high street retail rents peaked as early as mid-2014, and since then have fallen 75%. In Singapore, average prime retail rents fell about 23% between the peak level of 2014-2015 and a trough in late 2021 before stabilising. Imputed capital values for retail real estate assets have fallen by similar levels to rents.1
There are signs that the retail market may be near the bottom. Retail sales picked up in APAC in H2 2022 as Covid-19 restrictions were dropped and as tourist travel resumed. In Singapore, retail sales rose 13% y-o-y in Q3 2022, although growth slipped to 8% y-o-y for October and November combined. Australia and South Korea have also seen firm sales growth, though Japan has been more moderate. Mainland China and Hong Kong SAR have posted the weakest figures. However, after a 6% y-o-y fall in November 2022, retail sales in mainland China fell less than 2% in December, and both markets ought to improve following China’s move away from its zero-Covid policy and the reopening of the mainland China/Hong Kong border.
While sales are rebounding in many markets, it is not yet certain that real estate rents have reached a floor. Retail rents appear to have been stable or to have fallen slightly in most of the leading APAC cities in Q3 2022. Even in Singapore, one of APAC’s stronger retail markets with a citywide retail vacancy rate of just 3.5%, average net effective rent grew only 3% y-o-y and 2% q-o-q in Q3 2022 to mark the first increase in four years.2
More significantly, retail property yields have reached the highest levels in the APAC real estate sector, and are rising. This suggests that overall confidence in the sector remains fragile. As of end-Q3 2022, according to one broker, indicative cap rates for shopping malls in core locations in developed APAC cities ranged between 2.30%-3.75% for Taipei at the low end (with Hong Kong slightly higher), and 5.00%-7.50% for Australian cities at the high end. For decentralised malls, the corresponding cap rates were mostly 0.25-0.5pp higher. In all cases except Tokyo and Osaka, the broker expects cap rates to rise further over the next six months.
Beneath the headline sales figures, various trends are worth highlighting. Firstly, online sales are now falling as a proportion of total retail sales. With hindsight, Covid-19 appears to have given an unsustainable boost to the growth trajectory of e-commerce, and online sales are now dropping to the pre-pandemic growth trendline. For example, in Singapore, online sales made up 14% of total retail sales in Q3 2022, down from 18% in Q4 2021 and the peak of 22% in Q2 2020. Even in mainland China, where e-commerce is very popular and lockdowns lasted longest, online sales slipped as a proportion of total retail sales from 29% in Q2 2022 to 25% in Q3 in the same year.3 This ratio spiked to 35% in November 2022 as many Chinese cities reimposed restrictions, but looks set to fall back again as consumer-facing sectors in Mainland China rebound.
Secondly, several markets have seen increased spending on luxury items. The resilience of the luxury goods market is a global phenomenon that defies rising interest rates and weakening economic conditions; it has been evident in the results of global luxury companies such as LVMH, which posted organic sales growth of 17% over 2022 and cited strong growth in Japan among other markets.4 Demand for luxury goods has helped drive a rebound in sales in department stores, previously one of the weakest segments of the retail market, in both Japan and Australia.
Thirdly, the trend towards “experiential” shopping continues unabated. A good definition of “experiential” is something that cannot be substituted by an online transaction. This covers the “semi-retail” services which make up a growing proportion of shopping centre space, notably in suburban and neighbourhood malls. In Hong Kong, doctors’ surgeries and medical clinics may be found in retail malls as well as office and mixed-use buildings, while education providers have also become noticeable as occupiers. In Tokyo, beauty clinics and coworking sites are helping stabilise demand for space on upper retail floors which have been vacated by struggling F&B and other tenants.5 In the Singapore secondary retail market in Q3 2022, the cinema operator Golden Village Multiplex took up 30,000 square feet of space in the Bugis+ mall, while new lessees in the Funan mall included a digital art institute and a skin spa.6
China offers certain novel examples of experiential shopping which may suggest ways forward for the retail sector in other markets too. Large shopping malls in Shanghai have experimented with urban campsites as an attraction for customers, complementing them with “lifestyle exhibitions” or “camping coffee festivals”. Chinese malls have also led the way in pet-friendly shopping, adding one-stop pet shops offering beauty and medical services besides pet food and other necessities. According to one estimate, the total pet economy in mainland China was worth RMB400 billion (USD59 billion) in 2022, up 14% from 2021, with similar growth likely in 2023.7
At first sight, central business districts (CBD) and high street retailing stand to benefit from the recovery in tourism that is already supporting the APAC hospitality sector, as well as favourable trends in the luxury goods market. We expect firm near-term sales growth in prime retailing in cities such as Singapore and Tokyo. Hong Kong may see a similar rebound now that the border with Mainland China has been reopened and tourists are returning.
There remain good reasons for scepticism about CBD and high street retailing. In general, prime retailing is still over-exposed to discretionary categories such as fashion and cosmetics; asset management requirements for large CBD malls or individual shops are also onerous. In general, we prefer neighbourhood retail malls. Often anchored by a supermarket, such malls have high exposure to necessity retail categories, especially food, for which demand is inelastic and predictable. As noted, they also have increasing exposure to semi-retail services which likewise have relatively low elasticity of demand. Other strengths of neighbourhood malls include high frequency of customer visits and, from a Value Add standpoint, typically higher potential for tenant repositioning to increase total rental income and less arduous asset management needs.
In Australia, regional and sub regional shopping centres also look appealing. One of the key reasons for optimism about Australia in general is that its population continues to grow. The country is attracting large inflows of skilled immigrants, while the birth rate is falling but still high by the standards of advanced economies. Some forecasts call for total population growth of 14[(-15) was not found] over the next decade. Firm employment growth should drive consumption, benefiting the retail sector.
Given greater availability of land than in most other developed APAC markets, retailing in Australia is best compared with retailing in other western markets. The USA, Canada and Australia all have high shopping centre gross lettable area, but retailing in Australia is the most efficient. Australian shopping centres generate sales per square metre 30-40% higher than for US counterparts.8
In operating terms, Australian regional shopping centres are perhaps the best-performing. Competition is modest but usage is high: the centres often become focal points of shopping and leisure for a wide trading area, with local residents visiting every two to three weeks. An increasing focus on fresh food, speciality stores, services and entertainment drives high efficiency and reasonable rental growth. The centres often also contain sizable plots of undeveloped land, offering potential for redevelopment. However, the ticket size for an investment is large (even if an investment is made with partners), because the total value of a regional shopping centre is between about AUD0.5 billion and AUD2.0 billion.
Smaller sub-regional shopping centres offer many of the attractions of regional shopping centres without requiring such high capital outlay. Sub-regional shopping centres are typically anchored by a discount department store (usually belonging to the Target or Big W chains) and a supermarket.
Neighbourhood shopping centres represent the country’s smallest retail format by area but the largest in number. This is the most liquid part of the market in investment terms, with transaction sizes in the AUD20-100 million range. Neighbourhood shopping centres are usually anchored by a supermarket, and have low exposure to discretionary retail. They performed well during Covid-19 when much of the rest of the market was under severe pressure, attracting investment interest. Looking forward, regional centres and sub-regional centres offer good value.
Elsewhere in APAC, neighbourhood shopping centres generally offer predictable customer demand and rental repositioning opportunities. We have mentioned some of the attractions of neighbourhood retail in Singapore (which is also experiencing population inflows, especially of skilled financial professionals) and Hong Kong. Similar arguments probably also apply in Japan, where some investors have been focusing on neighbourhood retail centres with small trading areas (typically a 3-5 kilometre radius) and high frequency of customer visits.9 If there is any threat to such centres, it may come from convenience stores rather than larger shopping centres. The older segment of the rapidly aging population appears to prefer shops within walking distance, rather than larger supermarkets to which one has to drive.10
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