Retail Therapy for Private Credit

With its income resilience and market liquidity, the retail property market presents a strong contender for additional capital allocation in 2024. Despite the uncertainties in consumer spending and cash rates, retail assets have demonstrated through-the-cycle strength, which is fundamental to senior asset lending. With our anticipation that transaction volumes will remain elevated compared to ten-year averages in the sector, we look at the outlook for private credit opportunities.

• Based on supply/demand for 2024-25, only 285,700 sqm of new retail space is currently under construction, just 21% of the annual 10-year average (JLL). Existing retail assets are expected to reap the benefits of this undersupply, potentially amounting to a supply/demand dislocation of 2.2m sqm of floorspace nationally by 2032 (Colliers).
• Landlords have been managing rent increases to maintain occupancy, which is supporting elevated transaction volumes. HomeCo Daily Needs REIT reaffirmed its support for essential and national retailers by acquiring two new Woolworths-anchored centres in high-growth areas in Sydney for $165 million at initial yields of 5.4%. The company reported $77 million in valuation gains for the first half of 2024, a 2% increase driven by strong net operating income growth, partially offset by the minor capitalisation rate easing to 5.64%. According to valuers, shopping center vacancies are generally being kept at 2%–3% (M3 Property).
• Since the first cash rate hike in May 2022, cap rates on retail assets have increased from 5.1% to approximately 6.5% across Australia’s capital cities (KPMG / Colliers), in comparison to US 10-year bond yields, which increased from 84% to 4.24% (Bloomberg) over the same period. Listed retail landowners, such as Scentre Group, also reported 7.5% rent escalations in 2023. Vicinity Centres reported a 3.3% leasing spread in 1H FY24, up from 0.3% in 2023.
• Our conversations with developers indicate this supply imbalance will not be addressed in the next 3-5 years, with high migration numbers driving consumer numbers even as spending softens and project feasibility concerns with any new projects due to high construction costs, in particular, labour which has a 5-7% p.a. expected cost escalation (although this varies across states). Some developers favour mixed-use projects with a combination of residential and high-end or luxury retail to bring amenities and branding to projects. However, we do not see this meaningfully addressing the supply gap, with mixed-use projects tending only to deliver modest new retail floorspace.
• The buyer pool for retail assets has proved resilient, with institutional funds and syndicates managing private and HNW capital, thereby driving asset liquidity. In 2023, retail property transaction volumes reached $6.25bn, surpassing the industrial (34%) and office (30%) sectors for the first time in 20 years (JLL). Based on the narrower bid/ask spread we are observing for retail assets compared to other sectors, we would expect 2023 volumes to be matched or near 2024.

Merricks Capital holds approximately $120 million of senior secured loans backed by retail assets. The sector represents 6% of the Merricks Capital Partners Fund. We currently have two assets nearing repayment, one 30km from Adelaide, which is a large-format retail site and expected to transact by September at a price point higher than 2023 valuations and one loan in New Zealand secured against a diversified retail portfolio which has multiple offers to refinance our position during Q3 2024. As retail loans repay, we will look to redeploy up to $150m into the sector, with $220m in the pipeline across WA, QLD and NSW.

  Source: RLB Construction Tender Index

Source: Colliers