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Retail or Industrial property investment - which is going to produce the best risk-adjusted return?

Snapshot / Markets

Australia

Nov 07 2018

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Each of the primary property investment sectors, residential, commercial office, industrial warehouses, retail shopping centres has an investment cycle and a market cycle. Its useful to have the ability to move across sectors so that when one isn’t performing so well, others which are performing better can be capitalised on. Also, investing across sectors can build up diversification.

Ultimately when looking at an income-producing real estate investment, it’s the property fundamentals and often more significantly, it’s the ability of the tenant or the mix of tenants to trade successfully in that property, in that particular location, so they can afford to pay the rental income and annual increases in accordance with their lease. This then means the investor can afford to hold onto the property and wait for capital growth via improvement in market conditions, or for a value-add strategy to be carried out on the property, or the upside may come as a result of a potential higher and better use via repositioning and planning.

One of the best examples of this was our co-investment with Centennial Property Group, where an almost fully leased 16-level office building in North Sydney was acquired for c.$35million at the end of 2014. Rental payments came in from the tenant quarterly, which we received as distributions on our investment and then as a result of the potential residential redevelopment upside, Aqualand acquired the building for c.$70m and the sale settled in 2017.     

Industrial Real estate

Centennial Property Group is currently raising capital for their latest industrial fund. The fund will initially consist of c. 4 industrial warehouse properties and is forecast to produce double-digit investment returns, annual rental distributions in the order of 6.5% and a 5-7-year investment term. 

The relationship between industrial warehouse and retail property I find really fascinating, warehousing and distribution have experienced growth as a result of the online retailing sector explosion, with groups like Net-A-Porter and the Iconic trading via digital and warehouse rather than traditional retail stores. 

The largest ASX listed own of industrial warehouse property is Goodman Group, with a share price of $10.31 the group has $39.6b under management and a development pipeline of $3.6b. Their portfolio of 373 properties has 98% occupancy and 3.5m sqm of their portfolio has been leased in FY 18. The group has performed exceptionally as a result of a number of major holdings achieving a higher and better use and being repositioned as residential. Goodman has also been able to capitalise on their global logistics and business-tenant relationships, building a global portfolio of industrial warehouse and commercial business property.    

Retail property 

We really love retail property at the moment at MP Funds Management because we see opportunity in the disruption. Australia’s population is growing, our living is getting denser and whilst the advent of online shopping is creating change in the sector, human behaviour causes us to gravitate towards food and entertainment. Whilst some of the retail tenants may be outmoded or a centre underperforming as a result of this evolution, its fair to say that well-located and underperforming centres, which have a strong demographical catchment area can be turned around with some TLC and well thought out repositioning.

Successful retailers understand this fundamental need to improve engagement and are evolving at pace. There is a requirement for creativity and capex spend, and as a result a lot of the larger listed retail property trusts, like Vicinity, are discounting and selling off parts of their portfolio, which is creating opportunity to acquire well-priced assets with repositioning value.

Fairy tales of retail property investment success

The perfect example of a successful retail real estate investment would be the acquisition of Birkin Head Point by the late Frank Woolf’s Abacus group, in 50/50 joint venture partnership with Swazi billionaire-backed Kirsh Group. The JV acquired the asset, which had a gross lettable area of 32,483sqm, for $175 million in 2010, which was reflective of a rate of $5,400 per sqm and an 8% initial yield.

The vendor had commenced a partial $50m refurbishment of the waterfront, open-air centre and Abacus and Kirsh group completed the refurbish, redevelop and upgrade the centre and marina. Improvements were made to the convenience-based tenancy offering while remixing the wider outlet tenancy offering to cater for high-end brands. The Moving Annual Turn Over (MAT) was improved during the period from $125m to $180m, overall improving the asset to institutional grade. 

Midway through 2014 ASX- listed Mirvac acquired Birkenhead point for $310m, producing a 78% capital uplift and an equity internal rate of return (IRR) of 24%.

Mirvac also acquired Broadway Shopping Centre just before the global financial crisis from Walker, with 154 retailers across a gross lettable area of 52,724sqm, a trade population area of 351,930, annual customer visits of 15.1 million and an annual MAT of $610.4 million. Broadway is one of the better performing centres in Sydney, it performs better (measured by MAT) than Westfield in the CBD as well as Westfield Bondi Junction. 

A focus on ‘destinational’ day out; dining and entertainment.

Updating their tagline to a ‘Dining and Entertainment near you’, global retail property holder and the largest NYSE listed REIT and shopping centre operator in America, Simon Property Group’s share price sits at $187.27 USD. Simon reported retailer sales per square foot for the trailing 12-months ended September 30, 2018, of $650, an increase of 4.5% and the highest sales result, according to Simon CEO David Simon, in four years.

The group owns c. 22.4m sqm of retail space and produced a consolidated revenue of $5.4b in NY 2017. Since October, JPMorgan Chase & Co. Bank of America and several other investment banks have upgraded their rating on Simon to a “buy” with an average target price per share of $195.42.

DJ’s Elizabeth Street reinvigorates its magic.

After selling its five-level Market Street store for $360m in 2016, David Jones Elizabeth Street is undergoing a c. $400m upgrade, bringing experiential magic to the 12-floor building.  

The overhaul will increase the retail space in the building by 40% by converting four floors used for storage and administration into retail space including bars and cafes, two floors of beauty and luxury accessories, two floors of menswear, three floors of womenswear, a larger food hall, homewares and, perched on the top floor, a "Disney World".

The concept store focuses on entertainment, dining and a 'destinational' day out.

Level 7 of the Elizabeth street concept store has been the first to complete, opening its doors in October, its been modeled on New York’s Sacks Fifth Avenue and LVMH's Parisian department store Le Bon Marche. The entire floor shoe boutique offers a host of global brands together with a footwear concierge and 50 internationally trained footwear specialists. 80-90 new brands have been added to the brands available including names like Roger Vivier, Sigerson Morrison, and Loeffler Randal.

South African group Woolworths acquired David Jones in 2014 for $2.1 bn and with profits down by 50% last year and book value reduced by a third as a result, the retailer is focused on innovation, experiential marketing and customer service. Whilst Woolworths has committed $200m to the store upgrades, an additional $200 million in contributions have been secured from dozens of concession partners including Louis Vuitton, Chanel and Walt Disney Co. have contributed to fit outs.

In a comment to the AFR, Woolworths CEO Mr Moir said consumer sentiment was expected to slowly improve in Australia, underpinned by supportive economic conditions and a stronger labour market, but heightened levels of competition and promotional activity were expected to continue.  

MP Funds Management

MP Funds Management has funded over $1.1b of real estate across c. 21 transactions producing an average investor return of 21%. Our fees are largely performance-based after investors have received their principal and interest.

MP Funds Management is focused on the retail property sector. The shift in dynamics is creating an opportunity to acquire well-located real estate with repositioning value.  

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