Convenience is king: The strengths of neighbourhood retail
Colin Mackay, Research & Investment Strategy Manager, Cromwell Property Group
According to the Property Council of Australia, the typical classification of a Neighbourhood is a local shopping centre comprising a supermarket and approximately 35 specialty shops, with total lettable retail area of less than 10,000 square metres. These assets cater for basic day-to-day retail needs and service the more immediate residential area.
The retail property landscape has faced a number of challenges over the past five years, from e-commerce to pandemic lockdowns, squeezed household wallets, and weak consumer sentiment. But one centre type has stood tall through it all – Neighbourhoods. These convenience-oriented centres are the cornerstones of local communities and offer a compelling investment proposition underpinned by several advantageous characteristics.
Income security
Neighbourhood shopping centres are supermarket-based and heavily weighted to blue chip tenants such as Woolworths, Coles and Aldi. These brands are strong, providing exceptional credit quality and security of income. Their leases are also long, typically 20 years with multiple options to extend, further reducing the variability of income received.
Demand stability
A selection of specialty tenants complements the grocery offer. These smaller shops often span essential categories such as food, services and healthcare, rather than non-essential items such as fashion. This tenant mix means Neighbourhoods are largely focused on meeting basic, long-term human needs rather than fleeting style or brand preferences. As a result, these assets benefit from steady demand and foot traffic, regardless of the business cycle or economic conditions, evident in the lower volatility of grocery sales.
Positively, the lower volatility of grocery spending doesn’t come at the expense of growth. The category has recorded growth of 4.9% p.a. over the last 20 years, behind only Dining and Other (which includes online-only retailers)1. One of the factors underpinning headline grocery trading performance is inflation. Since groceries are essential and demand is inelastic, price increases can be more readily passed on to consumers compared to non-essential items. Deflationary effects from technology advancement or cheaper offshore sourcing also apply to a lesser extent than in the case of categories such as electronics or clothing. Stronger headline sales growth supports sustainable rent increases, which escalate on a nominal basis.
Growth through physical stores, rather than online, is most relevant for the performance of shopping centres. Over the last ten years, for every extra dollar spent on food (like groceries and dining), 16 cents went to online purchases. Meanwhile, non-food items lost 43 cents to online sales1. In this regard, Neighbourhood centres have a favourable retail mix which is heavily weighted to food spending through supermarket and specialty grocery exposure. They also have a healthy weighting to categories which consumers must shop in-person, such as personal services (e.g. hairdressing). We also believe the shopping experience small local centres provide, underpinned by convenient carparking and wayfinding, further defends against loss of market share to e-commerce.
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Larger forms of retail investment, such as Regional shopping centres, can only be sustained in catchments with sizable populations (i.e. major metropolitan hubs). In contrast, Neighbourhood centres are found in cities and towns all across the country. This provides investors with a less constrained and more diverse investment universe which is around 30 times bigger (by number of assets). It allows exposure to a wider range of regions/catchments and their associated drivers of economic performance.
Investment liquidity
The Neighbourhood investment market is broader than other retail centre types, offering increased liquidity and supporting a competitive bidding process (and outcome) regardless of position within the economic or real estate cycle. Over the last decade, an average of 51 Neighbourhood centres transacted each year compared to 15 Sub-Regionals and 4 Regionals. Trading was most constrained in 2020, at the height of the pandemic. In that year, there was still 38 Neighbourhoods sold, while only 5 Sub-Regionals and no Regionals changed hands.
Fragmented sector
Ownership of Neighbourhoods is more fragmented than other retail centre types. While Regional shopping centres are typically owned by a small number of institutional investors, private investors are the dominant holders of Neighbourhoods. These private investors have different skills, goals, and priorities, which can affect how well the centres are maintained and managed. In our opinion, this presents opportunities for experienced managers to “add value” to assets through capital projects, leasing and operations, and increases the likelihood that an asset can be acquired and sold at favourable pricing.
Bringing home the bacon
Retail conditions are expected to improve over 2025, with consumer sentiment becoming more optimistic and real disposable household incomes increasing as inflation moderates and rate cuts materialise. Stronger retail conditions are a positive for Neighbourhoods, but these shopping centres will also benefit from their unique characteristics and advantages. The combination of strong, long-term leases to blue-chip tenants, consistent bricks and mortar demand for essential goods and services, and resilience to changing economic and capital market conditions has positioned Neighbourhood centres as a robust and attractive asset class.
Footnotes
Cromwell analysis of ABS data (Jan-25)
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Colin Mackay, Research & Investment Strategy Manager, Cromwell Property Group
Santa has come and gone, prawn-induced food comas have ended, and workplaces and schools have started to hum again after the summer break. As the festive cheer starts to dissipate, now is a good time to look ahead at what the balance of the year has in store for us. This article touches on five key macro developments expected to influence commercial property performance and investment over 2025.
1. Rate cuts
After hopes of a late-2024 rate cut were dashed in October by resilient labour data, attention turned to 2025 for the turning of the economic cycle and a return of looser monetary policy supportive of stronger growth. Financial markets were pricing a 90% probability of a rate cut prior to the RBA’s decision on 18th February, an expectation shared by most economists. The central bank didn’t disappoint, reducing the cash rate for the first time in over four years.
Governor Bullock’s post-meeting comments struck a hawkish tone, drawing attention to the upside risk to inflation that a tight labour market still poses and appearing to reflect a preference for a relatively measured and cautious cutting cycle. The market now expects two additional cuts this year, with economists generally forecasting a further 1-3 cuts. Because these cuts are expected by the market, instruments like Australian Government 10-year bonds have likely already ‘priced in’ most of the change – and so long-term bond yields may not see significant movement from their current level of around 4.5%1 even as further cuts occur.
Regardless, rate cuts should be a net positive for commercial property by supporting a stabilisation of asset pricing, increasing transaction activity, and easing cost of debt pressures. An ‘easier’ monetary policy environment should also stimulate the economy, which is a benefit for a growth asset class like commercial property where tenants’ demand for space is linked to economic activity such as jobs growth, retail consumption, and trade volumes.
In downturns, nimble private investors tend to trade commercial property more actively than institutional holders. This cycle has been no different, with private buyers making up 45% of acquisitions (by dollar volume) from 2022-23, up from 32% in the five years prior. As 2024 progressed, offshore institutional capital thawed and allocated to the Australian market, becoming the dominant buyer type. Such investors have been involved in some of the headline transactions of the year, including Sydney office towers 55 Pitt Street, 255 George Street and 10-20 Bond Street.
Over the course of 2025, we expect domestic institutional capital to join the party and step up acquisition activity. This expectation reflects the turning of the cycle which appears to be occurring, and the stabilisation of prices that should continue as the cycle enters its next phase.
Deepening of the capital pool and increased activity from institutional buyers will be important precursors to price recovery – with more competition comes more aggressive bidding for assets. This competitive shift will likely be felt in specific asset segments (e.g. premium office) before others, and to differing degrees. While markets and segments that follow the cycle (rather than lead it) may face a slower price recovery, acquirers can benefit from a longer ‘buying window’ where sentiment (and pricing) is yet to align with property fundamentals.
3. Stronger consumers
Consumers have been buffeted since 2022 by various cost-of-living pressures, spearheaded by surging inflation, higher interest rates, and bracket creep. These contributed to a stark fall in consumer confidence, subdued retail sales growth, and tough trading conditions for businesses that cater to households more broadly.
In good news for 2025, many of these headwinds are abating.
Headline inflation has slowed from a peak of 7.8% in December 2022 to 2.4% as at December 20242. Lower inflation is benefitting the real (inflation-adjusted) spending power of households.
The arrival of rate cuts will lead to a decrease in what is the biggest expense for many Australian households.
The Stage 3 tax cuts went live from July and are improving households’ disposable (post-tax) incomes.
With a federal election approaching, we may also see additional assistance for households announced in the first half of the year as politicians try to shore up support before voters head to the polls.
An improved outlook is starting to become evident in stronger consumer confidence measures, setting the stage for stronger retail sales growth. While rising disposable incomes will be welcomed by retailers across all categories, we believe long-term consumption trends will continue to provide outsized benefits to shopping centre assets which are resilient to e-commerce competition and more heavily weighted towards ‘essentials’.
4. Improved market sector
The labour market has been remarkably resilient considering the broader economic slowdown – jobs growth of 2.5% was recorded over the year to September 2024, in stark contrast to GDP growth of only 0.8%3. However, the robust outcome was largely driven by the non-market sector, comprised of industries such as education, healthcare, and public administration, where demand is not determined by typical market forces or the business cycle. During this period, the non-market sector accounted for 94% of the jobs created and market sector jobs growth was a meagre 0.2%.
Demand for office space is correlated with white collar jobs growth, which is largely represented by the market sector. Although headline jobs growth may slow in 2025, market sector jobs growth should accelerate from its low base due to the anticipated rate cuts, which benefit industries exposed to the business cycle. This is expected to contribute to stronger jobs growth in the typical ‘office-using’ industries, positively impacting office space demand, reducing vacancy rates, and enhancing rental growth conditions.
While the outlook for office market conditions appears more favourable over the next twelve months, the risk of asset obsolescence remains elevated due to shifting ways of working and amenity preferences. Property selection will be a key driver of outperformance for investors.
5. Geopolitical uncertainty
Geopolitical uncertainty was a key feature of 2024. It was the biggest election year in history globally, with 80 countries heading to the polls and incumbents’ power diminishing in over 80% of the elections held4. At the same time, conflict in the Middle East escalated and the Russia-Ukraine war continued unabated.
It looks set to be much of the same in 2025. While most of the election outcomes are now known, implications for the global and domestic economies are yet to become evident. Trade policy is top of mind following Trump’s campaign trail promise of 60% tariffs on Chinese goods, 25% on Mexican and Canadian imports, and 10% on imports from all other countries. While negotiations are underway and such extreme tariffs are unlikely, increased protectionism of some degree is anticipated and could lead to retaliatory measures including counter-tariffs. Similarly, tariffs are typically viewed by economists as inflationary and may stoke cost-of-living pressures once again, particularly if combined with fiscal stimulus. But it’s also possible that disrupted global trade has a deflationary effect if confidence and growth take a significant hit. It is a time of known unknowns.
Whatever occurs, times of volatility and uncertainty often reward quality and security. Assets with strong tenant covenants and stable cashflow are well placed, as are those with enduring location advantages. Shifting trade dynamics are of particular relevance to industrial property and assets which can cater to manufacturing occupiers may benefit from an increased focus on domestic industry.
5b. A Broncos premiership
The author is unable to provide supporting data for this prediction.
A year with something for everyone
Economic growth should improve in 2025 as the RBA lifts its foot off the interest rate brake pedal, easing pressures on household wallets and business investment. A stronger economy is a positive for commercial property as increased consumption, jobs growth, and trade volumes underpin leasing demand.
Lower interest rates should also support the continued stabilisation of asset pricing, as capital markets normalise after several years of constrained liquidity and elevated debt costs. A stable price environment will be more conducive to improved transaction activity and subsequently valuation recovery.
There are some potential speed bumps which could sap momentum, not least of which is the geopolitical landscape. Given the environment of uncertainty, flight to quality is a theme which will likely continue to play out over 2025, rewarding assets that can provide investors with stable and secure income.
RBA (as at 12th February 2025)
December 2024 Quarterly CPI, ABS (29 January 2025)
ABS September Labour Account and National Accounts (Dec-24)
Market Outlook, Westpac (Dec-24)
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