Ron Mackersy Comments on a Robust Recessionary Proof Industry

These are extraordinary times, with Covid lingering and an increasing likelihood of a third world war, we are seeing rapid inflation and interest rates rising, labour shortages, logistic transport problems and rising oil prices. This comes after a period of good times for New Zealand which saw massive movements in our real estate prices, plenty of work, strong commodity prices, low interest rates and large influxes of tourists and immigrants gracing our shores.

With our area of the economy being commercial property – the biggest change we have seen over the last ten years has been led by technology. A reduction in traditional office functions and paper processes has meant a reduction in staff in banks and insurance companies and office expansion only in national and local government.

Retail has seen a massive change, while industrial buildings have increased in size and location as online selling and the supporting systems of transport and processing grow. We now see industrial property as the darling of commercial portfolios, with these types of properties now being a hot commodity in the market.

Amongst the change in the commercial property environment, we are seeing the emergence of unlikely star performers for long-term investors. Big box stores, supermarkets, and transport hubs have not only survived, but flourished.

The Mackersy Property portfolio comprises a number of these, including Bunnings and Mitre 10 stores, a number of supermarkets and suppliers to the construction and transport industries. The Tauranga portfolio in particular is focused on these property types and lately this trend has spread to Hawke’s Bay, Palmerston North and Christchurch (particularly in the Halswell and Izone areas).

In addition to the changes that are happening in commercial property, there are a number of wider factors that are playing on our minds: interest rates, inflation and supply chain issues. While these factors should be given consideration, they need to be kept in context and investors who are seeking strong, long term strategic investments need to look past the noise and focus on the bigger picture, asking themselves questions like:

What is my risk in the short term?

Do my investments need to keep up with inflation in the short term when history shows us that they will balance out in the longer term?

What is the context around rising interest rates and how realistic is it that they will keep rising with the amount of debt in the market?

This brings me to Mackersy Property’s latest offering, a distribution centre for Progressive Enterprises in Christchurch. This $75 million facility is designed to supplement the supply of product to the Progressive chain of Supervalue, FreshChoice and Countdown in the South Island.

The property has a build period of 18 months to two years, followed by a 15-year initial term lease. During the build period, a guaranteed 5.50% gross return is paid on equity until the rent starts after completion. Mackersy Property guarantees any interest rate increase during construction, so there is no risk to investors during this period. The 15-year lease commences with 2.00% fixed annual rent increases, commencing in Year four following completion. The build price and land has a maximum price of $75 million with Progressive’s agreeing to either top up any overrun in costs or increase rent.

With uncertainty in today’s environment the proposed purchase yield may appear too low, particularly with interest rates on the move. Of course, a better yield would be desirable but that is not something that is available in the short term. In the current market, supermarket-type leases now have an initial 10-year term with many 5-year rights of renewal and in most cases have no rental growth apart from increases related to turnover.

Mackersy Property’s experience of this formula is that turnover rent increases take between 10 to 15 years to achieve. Also, in most cases, any ‘online’ sales are not counted towards the formula, so in my view, supermarkets provide a lower return – safe but without much ability to see rental growth. In New Zealand, the Foodstuffs brands, particularly the New World and Pak’n’Save facilities, are predominantly owned by Foodstuffs themselves which leaves only the Progressive brands available to commercial investors. This makes a facility like a South Island distribution centre for the Progressive group a particularly favourable investment with long term rental growth built into the lease. Consequently, in the short term, it may not appear particularly attractive due to the current inflationary pressures, but over time the rental growth should make this a strong long term strategic investment.

Naturally, as the population increases there will be more supermarkets. We are already seeing new players such as Costco and Aldi moving to enter the New Zealand market. As such we may see more supermarkets, and more players, but not so many distribution centres available to investors.

Good long-term investments with solid tenant covenants and built-in growth are hard to find. These investments, which in our view are at the quality end of the market, will always be a solid rather than spectacular return. Furthermore, food supply and sales are at a pretty secure point in the investment market.

My final comment is based on observation of what is happening in our nearest market – Australia. Interest rates have not moved there as much as in New Zealand and yields are still low with good investment interest both from Australian and overseas buyers.

If this commentary has raised questions for you and you’d like more information, please don’t hesitate to contact one of the team directly or through invest@mackersyproperty.co.nz.