How to Gain The Best Returns on Direct Retail Property Investment

Current low levels of retail turnover are driven by low consumer confidence, due to rising unemployment. Emerging behaviours are also having an impact; an aging population is changing spending patterns and technology is providing alternative shopping options for consumers.

In this climate, some retail will be more resilient than others. The key for investors is to tread carefully, seek expert advice and opt for the most secure tenants in order to avoid long potential vacancies.

Do your homework

Approximately 7.25 percent net is the expected average return for retail property, but it varies depending on asset class and risk rating. 

Investment yield ranges reflect a variety of factors, such as size of investment, location and quality. For example, a prime shop in a prime street in Sydney or Melbourne may fetch a yield between three per cent and five per cent. The best shopping centres in the country have yields of five per cent to six percent and supermarkets between six percent and eight per cent. There are some retail properties in secondary locations, such as rural areas, that could have yields of nine to 10 percent.

If you are looking to add some retail therapy to your property portfolio, it’s vital to undertake extensive research before purchasing. Attend commercial auctions, research comparable sales, look at the volume of competition in the local area and be aware of any large development in the planning stages that could increase competition. When you are viewing properties, look at the parking facilities and factors such as average passing foot traffic, natural light and a good internal layout.

Also, consider that lending institutions typically require a larger capital contribution when lending on retail property. Banks are usually only prepared to lend up to around 65 percent of the bank agreed value of retail premises, as against 90 to 95 percent for residential investment property.

Cherry pick tenants

According to a report by Deloitte Access Economics, real (inflation-adjusted) retail sales growth was forecast to show growth of 3.2 percent in 2013-14, and is expected to move up to a cyclical peak of 3.6 percent in 2014-15, before moderating to just 2.4 percent sales growth in 2015-16. So, for secure yield, the most important factor is the tenant’s ongoing ability to pay the rent. 

The more boutique the business is, the more risky the investment. Safe tenants, such as banks, credit unions and government offices will give a lower yield as it is secure, but you will get a better capital rate when you eventually go to sell. Medical facilities are also a good choice. Local dentists, optometrists and general practitioners rely on building loyal clientele and don’t want to move from the area once they have committed to leasing premises. 

Ensure any tenant can shoulder the occupancy costs. If the rent costs more than 20 per cent of the tenant’s turnover, the business is unlikely to be sustainable in the long term.

Negotiate favourable terms

Aim for a five-year lease with no options as this provides the owner/vendor additional power in negotiating new lease terms.

Always engage a specialist commercial lawyer to look over the lease and disclosure documents when buying retail property. The lease will set out the rent and any incentives – such as rent-free periods or assistance with fit-outs – which the landlord should provide. Other details, such as who is to pay for marketing promotions and any outgoings, such as electricity will be included in the disclosure documents. 

With retail sales growth continuing at a low ebb, doing your homework and choosing secure tenants who need a street-front retail presence, but do not rely on retail spending for their income, can ensure a low-risk move into the direct retail property market.