The retail sector continues to perform well, despite recent gloomy headlines. Data shows that, to December 2018, retail sales (online and in-store) grew 3.1% year-on-year. Australia has a growing population (up 1.6% year-on-year) and 26 years of uninterrupted economic growth. So why the negativity?

As we see it, the challenge isn’t with retail per se. Rather, it is with traditional retail that hasn’t adapted to the new “omni channel” environment. Online retail sales are growing by over 25% year-on-year but this only represents 5.5% of Australia’s retail spend, suggesting the majority of retail growth is coming from online retail sales, while in-store retail sales stagnate.

The shift to online retail is creating negative sentiment towards owners of retail assets, with these assets struggling to maintain book values – and the stock market discounting owners of retail assets compared with other property asset classes.

What may not be expected is the fillip this is having on industrial property. Goods purchased online are generally shipped via a distribution centre, so the global growth in online retailing is increasing demand for industrial real estate.

Retail on the rise – but not for all types

Australian retail transactions reached $8.1 billion in 2018, the third-highest level on record, with A-REITs and private investors active on both sides of the transactions. However, A-REITs were highly selective in their choices – signalling some investors were more cautious about bricks-and-mortar retail fundamentals. There has also been less activity from overseas buyers (although acquisitions remain high by historical standards). Given the challenges facing traditional retailers, it’s likely that only those shopping centre owners with strong expertise will come out on top.

Recent sales by major players illustrate the challenges. In November 2018, Stockland sold two malls in the regional centres of Bathurst and Caloundra for a total 5.3% discount to book value, which Stockland attributed to a desire to reinvest in its commercial portfolio. And Australia’s second-largest listed mall landlord, Vicinity Centres, devalued its $15.8 billion portfolio by $37 million (0.2%) amid concerns that traditional shopping centres will come under further pressure this year.

E-commerce strides ahead

In the United States, online sales accounted for around 10% of total retail sales last year, while in the UK they accounted for 18%.

Online retail spending is likely to continue to grow in Australia, with growth in the use of mobile devices, and ongoing improvement of the overall online shopping experience. We see consumers’ expectations around convenience, value, and choice, continue to drive a higher proportion of consumers to shop online. They will also expect faster delivery times, streamlined (and free) returns, and ease of payment.

Online retailing across all categories is also rising, even in areas that traditionally relied on in-person shopping. Many consumers now participate in “show-rooming”, where they look in-store and then shop online for cheaper alternatives.

Retailers need to reassess supply chains

Many retailers are recognising the need to reassess their supply chains. Most traditional networks don’t include enough distribution centres to deliver goods cost-effectively and quickly – and this is a challenge as consumers demand ever-shorter delivery times.

Retailers also realise they cannot separate the online from their traditional shop-based business; rather, they need to be viewed as two parts of a whole. Successful retailers now think end-to-end, which means including transport and fulfilment centres in the mix. This is where industrial property, particularly warehouses located close to consumers and transport hubs, is benefitting.

Proximity to the consumer means cheaper transport costs and faster delivery times – both of which play an important role in overall profitability. And as the number of fulfilment centres for online retailing increases, so too does the number of businesses which service these centres, such as packaging companies. And both require industrial property.

Industrial property outlook

Growth in exports, business investment, and infrastructure, are driving demand for industrial property. There has been a strong flow of capital into the Australian industrial sector from a diverse range of investors – including domestic private and institutional groups, and offshore groups.

Supply is constrained however, and as a result, yields have compressed across the board. In Sydney, yields moved from 5.73% (in H2 2017) to 5.26% (in H2 2018); in Melbourne from 6.27% to 6.06%.

At the same time, the digital revolution and advances in technology mean that industrial property is changing from the simple, low-tech warehouses of the past. Today’s industrial property is more sophisticated, efficient, and flexible – ready to service a diversified range of industries.

As a result, prices have risen across the board – but more significantly in locations close to population hubs, where there is greater density and higher competition from alternative uses. 

While online retailing is providing a positive flow-on to industrial property, to regard this as a one-to-one increase in industrial space would be overstating the case. Certain types of industrial space will benefit disproportionately from the rise in online retailing. For online retailers in pursuit of supply chain efficiencies, “strategic proximity” is key: industrial property that is close to transport nodes and consumers will be the winners.

From an investment perspective, the same holds true. Industrial portfolios that align with the changing face of retail – by offering “strategically proximate” warehousing for online retailers – will be well-positioned to offer strong returns to investors.

Ross Lees is the Fund Manager for Centuria Industrial REIT

This article was issued by Centuria Property Funds No 2 Limited (Centuria) (ABN 38 133 363 185, AFSL 340304), a wholly-owned subsidiary of Centuria Capital Group (ASX: CNI), as Responsible Entity for the Centuria Industrial REIT (ASX: CIP). The information in this article is general information only and does not take into account the financial circumstances, needs or objectives of any person. Centuria is the responsible entity of listed and unlisted property funds, each of which are issued under a product disclosure statement (PDS) that is available on Centuria’s website for all funds open for investment. An investment in any of Centuria’s property funds carries risks associated with an investment in direct property including the loss of income and capital invested. The risks relating to an investment are detailed in each Fund’s PDS and Centuria strongly recommends that the PDS be downloaded and read before any investment decision is made.  Centuria receives fees from investments in its property funds. Past performance is not a reliable indicator of future performance.