ALTHOUGH retail property still appears to be holding its own, property pundits expect total returns to drop in the medium term to reflect the more difficult economic environment.

And if interest rates continue to rise, the market could start seeing more tenant failures in shopping centres.

Property economist Francois Viruly, of Viruly Consulting, says that when interest rates moved to 25% in 1998, it had a great effect on retail property. The total returns for retail property in 1997 were 23%, but the following year when interest rates soared, retail returns declined to 9,1%.

Similarly, when interest rates climbed to 17% in 2002, the total returns of retail property declined to 11% from 13,4% in 2001.

“We have precedents in the market that a rise in interest rates does have an impact on the market. It would be reasonable to expect a decline in total returns in the commercial sector, but I believe the retail sector is the most vulnerable,” says Viruly.

He says although all commercial property is affected by interest rate movements, the office and industrial sectors will be hardier than retail in the present circumstances.

Viruly says that in the office sector, vacancy rates are still “very low”, which would provide a cushion for this segment of the market.

The industrial property sector would also continue to see a shortage of space and experience “strong conditions” largely driven by a shortage of industrial land.

According to the Investment Property Databank (IPD), retail property delivered a total return of 26% last year. Viruly says when the 2008 IPD results are released next year, the market will see significantly lower returns.

David Green, MD of Pace Property Group, says that in today’s economic climate, consumer spending tends to be limited to necessities and that luxury and other goods are not required.

Although this would obviously affect retail property, Green says most retail centres in SA are occupied by national tenants who occupy space under fixed-lease agreements.

“As such, the rental income is secured so the only effect retail property owners would see in the short term is a drop in turnover rentals. This would clearly have an effect on the landlord’s rental returns,” he says.

Turnover rental leases refer to retail leases where the landlord shares in the profits made by tenants.

“I do agree that total returns will show a decline, but feel it will take longer before it filters through as there is generally a lag between an economic slowdown and a drop in property returns. Retail property will be the hardest hit,” says Green.

He says that on the “flip side”, the value of retail shopping centres will decline as a result of increasing capitalisation rates, which would be applied in the valuation of these centres.

Green says one of the factors driving this would be increased interest rates.

Ian Anderson, a director of ReConnect and an independent property analyst, says he does not think any of the national retailers are under severe pressure and that most of them are able to grow revenue in line with inflation as is being “seen in the most recent numbers from retail property landlords”.

Anderson says the risk should lie with the smaller-line shops or retailers where tenant failure is “much more likely”.

“As a result, I’m not expecting retail property to perform as well as office and industrial property this year,” he says.

“It’s difficult to put a number on just how bad it’s going to be, but retail is certainly going to be a laggard.”

Anderson says the market has not seen any significant tenant failures yet. But he says if interest rates continue increasing and “stay there for longer” there is no doubt the market will start to see tenant failures.

Retail property landlord Hyprop Investments has noticed that retail property prices, along with other commercial property sectors, are weakening.

But MD Pieter Prinsloo says they have not seen a “significant slowdown in retail in terms of spend at our centres”.

JSE-listed Hyprop owns some of the prime retail centres in SA including, among others, Canal Walk Shopping Centre in Cape Town and The Glen Shopping Centre in Johannesburg.

Prinsloo says that demand for space in Hyprop’s centres is still strong with vacancies sitting at less than 1%.

“The fundamentals are still in place,” he says.

“The fact that there is not much in the way of new retail developments coming onto the market means large shopping centres will remain in demand.”

Source: Business Day