RETAIL PROPERTY BOOM FACES NEW RISKS AS GEOPOLITICS CLOUDS OUTLOOK

Australia’s retail property sector entered 2026 as the strongest performing commercial asset class, but rising geopolitical risks and cost pressures are beginning to test its resilience, according to new research from Knight Frank.

The latest Australian Retail Review shows the sector rode a wave of consumer spending and constrained supply through 2025, delivering total returns of 9.2 per cent and driving transaction volumes up 43 per cent year-on-year to $14.4 billion.

That momentum carried into early 2026, with around $3.6 billion in deals recorded in the first quarter alone.

“Retail clearly emerged as the standout commercial property performer in 2025,” said Knight Frank Senior Economist, Research & Consulting Alistair Read.

“Improving household spending, limited new supply and stronger leasing fundamentals combined to drive better income growth and renewed investor confidence in the sector.”

Spending rebound drives retail strength

A lift in household spending has been central to the sector’s performance. Consumer spending rose 4.6 per cent year-on-year to February 2026, supported by easing inflation and improving real incomes.

That shift flowed directly into retailer performance, with average EBIT margins across major retailers rising to 8.9 per cent in the first half of 2026, their strongest level in several years.

“Stronger consumer spending was critical in restoring momentum to the retail sector,” Mr Read said.

“Retailers have generally been better able to absorb costs, rebuild margins and support sustainable rental outcomes, particularly in higher-quality centres.”

Improved trading conditions also pushed leasing spreads up 4.2 per cent in 2025, reinforcing income growth and supporting capital values.

Geopolitical tensions begin to bite

But the outlook has become more complicated. The report warns that escalating conflict in the Middle East and its impact on fuel prices, supply chains and interest rates could weigh heavily on consumer spending.

“Higher fuel prices, flow-on cost pressures across supply chains, and recent interest rate increases are collectively squeezing household budgets, and early consumer sentiment data suggests confidence is already softening,” Mr Read said.

“While household balance sheets remain generally resilient, heightened uncertainty over future costs is likely to weigh on spending — particularly in discretionary categories — in the months ahead.”

The impact is already being felt in investment activity. While the year began strongly, transaction volumes slowed in March as investors paused amid the uncertainty.

“Early indicators suggest elevated uncertainty has already begun to affect the market. While retail investment enjoyed its strongest start to a year in a decade, with nearly $3 billion transacted by the end of February, activity stalled in March, as investors took a pause amid elevated uncertainty,” Mr Read said.

Solid foundations support medium-term outlook

Despite the near-term headwinds, Knight Frank maintains that the sector’s underlying fundamentals remain strong. Limited new supply, high construction costs and population growth are expected to continue supporting rental growth over the medium term.

“Retail has entered this period of uncertainty from a position of strength,” Mr Read said.

“Supply-side constraints, population growth and improving income fundamentals remain powerful structural supports for the sector.”

The report highlights several trends shaping the year ahead, including steady yields as interest rates rise, mounting pressure on tenant margins, continued outperformance of prime centres, the growing need for logistics integration, and risks linked to underinvestment in capital expenditure.

For now, retail remains a sector with momentum, but one increasingly at the mercy of forces far beyond the shopping centre.

Australia’s major CBD office markets are recording some of their strongest rental growth since the pandemic, with businesses increasingly prioritising premium office space despite elevated geopolitical and economic uncertainty.

Knight Frank’s Australian Office Indicators Q1 2026 report found net effective rents in Sydney and Melbourne CBDs rose at their fastest annual pace since COVID-19, increasing 10.2 per cent and 6.8 per cent respectively over the 12 months to March.

Brisbane posted the strongest growth nationally, with net effective rents climbing 11.7 per cent over the same period.

The report points to a widening divide between prime CBD office towers and secondary office stock, as occupiers increasingly focus on quality, location and workplace amenity when making leasing decisions.

Knight Frank Senior Economist, Research & Consulting Alistair Read said demand remained heavily concentrated in premium assets within core CBD precincts, helping drive stronger rental growth in top-tier buildings.

“Occupier demand continues to be heavily concentrated in the most desirable CBD precincts and the highest-quality buildings, accelerating a sharp divergence between core and non-core markets,” Mr Read said.

According to the report, Sydney’s Core precinct and Melbourne’s Eastern Core significantly outperformed broader CBD markets over the past year.

“In Sydney’s Core precinct and Melbourne’s Eastern Core, net effective rents surged 14.3% and 16.1% over the past year, significantly outperforming the rest-of-CBD precincts,” Mr Read said.

The rental gap between prime and non-prime office locations has also continued to widen sharply.

“As a result, core CBD rents are now 54% higher than non-core locations in Sydney and 93% higher in Melbourne, highlighting the growing premium placed on amenity, accessibility and workplace quality,” he said.

Knight Frank said the strong rental growth across the major CBDs was being underpinned by a limited supply pipeline, with few new office developments expected to be delivered in the near term.

Mr Read said subdued construction activity was likely to support ongoing rental growth and tighter vacancy rates over the medium term, particularly for premium office towers.

“The combination of sustained demand and declining levels of new development will aid ongoing prime rental growth and lower vacancy rates over the medium term, particularly for best-in-class assets,” he said.

The report noted that current economic conditions were making new office developments increasingly difficult to justify financially.

“Economic rents remain well above expected market rents, making the construction of new office towers largely unviable, and concentrating tenant demand into existing buildings,” Mr Read said.

While suburban office markets generally remained subdued compared with CBDs, Melbourne’s Southbank precinct was identified as a relative outperformer, recording annual net effective rental growth of 2.7 per cent.

The report comes as broader Asia-Pacific office markets continue to stabilise following several years of disruption linked to hybrid work trends, inflation and rising interest rates.

Knight Frank’s separate Asia-Pacific Q1 2026 Office Highlights report found Sydney and Brisbane were among the strongest-performing office rental markets in the region, behind only Bengaluru and Tokyo for annual prime net face rental growth.

The Asia-Pacific report also found 18 of the 24 cities monitored across the region recorded stable or increasing rents in the first quarter of 2026, even as geopolitical uncertainty intensified following escalating conflict in the Middle East.

RETAIL PROPERTY BOOM FACES NEW RISKS AS GEOPOLITICS CLOUDS OUTLOOK

Strong consumer spending and tight supply have driven retail to the top of commercial property, but signs of pressure are starting to emerge.

Office rents in Sydney, Melbourne and Brisbane are climbing at their fastest pace since the pandemic as tenants compete for premium CBD space amid tightening supply.