Could retail be 2022’s surprise story?

The economy has shown strong momentum into 2022

The economy’s strength is highlighted in a strong labour market and retail spending also continuing to grow well above pre-Covid rates, with January and February this year being above last year by 13% and 16% respectively.

Growth has been spread widely across New Zealand’s core markets and sectors. Employment levels in all regions are now approximately 3% to 4% higher than at the end of 2019, and many industries have seen significant employment growth since 2019. 

Combined, employment in office-based industries has increased by more than 37,000 people. Equally, retail employment has increased by 8,000 people, reflecting the growth in retail spend, which has more than offset the 3,000 person decline in hospitality.

Occupier demand is positive

Economic trends have translated to positive occupier demand. Combined across Auckland, Wellington and Christchurch, net absorption of Prime office space exceeded 50,000sqm in 2021 after contracting by 10,000sqm in 2020. 2021 saw more prime absorption than the years leading up to the pandemic.

Already-strong industrial absorption has become even stronger, and retail centre absorption has also remained positive through the last two years.

Vacancy is below 5% in most sectors and outside of Secondary office there is no real area of concern. This provides a solid platform for the future and, looking forward, demand indicators are positive.

New Zealand is an expansion target for many Australian retailers planning bigger store networks

Retail is looking healthy across Australia and New Zealand relative to what many may be expecting.

More than 60% of Australian retailers in CBRE’s survey last October are expecting to increase store numbers, while also upgrading to better locations.

The same survey also shows that across Asia Pacific, New Zealand is one of the main target markets for cross-border retail expansion. Many Australian chains are looking at New Zealand for their store network expansion plans. 

Therefore, we think that occupier demand in the retail sector could well surprise on the upside.

Hybrid office working models are set to settle into a new normal 

The way office-based work will happen in the post-Covid world is starting to resolve itself. Most occupiers settling into the middle ground of hybrid work, expecting staff to work remotely one to two days per week.

What impact will this have on office space demand? It implies a reduction of required space, but as the emphasis shifts from ‘Me space’ to ‘We space and Amenity’, space requirements don’t necessarily reduce even if the number of desks does.

Inflation pressure is pushing up economic rents and yields

Inflation is directly impacting costs, which are now coming through as rental inflation, especially for new builds. Inflation is directly impacting costs, which are now coming through rental inflation, especially for new builds, and will be putting upward pressure on market rents more generally in the next two years. Face rents are seeing a clear escalation, possibly reaching $1,000 per sqm by 2025. The question is what impact these new benchmark levels will have on existing buildings? We argue that in market sectors where vacancy is kept in check, existing market rents will also benefit sooner rather than later.

Expected interest rate rises will also continue to put upward pressure on yields. While average Prime New Zealand yields have provided a larger margin to interest rates than the period leading up to the GFC, which was the last time we have seen yield corrections, we do expect some upward pressure on cap rates in 2022.

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