Talking Property | Australia’s 2024 Property Predictions: Episode 1

KH:
Hello and welcome to CBRE's Talking Property podcast series. I'm Kathryn House, CBRE's Australian Communications Director, and I'm your host for this 2024 kick-off episode. To start the year, I'm excited to be sitting down with eight of the country's leading property players to get their thoughts on where they see the best market opportunities this year, as well as the opportunities for industry transformation. We're packaging these up into three episodes, which will roll out weekly between now and the end of January. Today I'll be chatting to Charter Hall, CBRE Investment Management and Lendlease, and make sure to tune in over the next fortnight to also get the good oil from Brookfield, Aliro, ISPT, Investa and Aware Real Estate. So, joining now is David Harrison, Managing Director and Group CEO of Charter Hall. David, you have over 35 years of property market experience and have overseen the growth of the Charter Hall Group from $500 million to $87.4 billion of assets under management since CHC listed on the ASX in 2005. I'd love to get your insights on where you see the best property market opportunities in 2024. 

DH:
Well, it's a complex question because every downcycle we've been through, we've typically taken advantage of pricing the market. And if you look at the history of the group, some of our greatest growth periods have been immediately after a correction cycle. So, I guess the way I look at it is I'm a bit agnostic about any particular sectors. Everyone wants to talk about alternatives at the moment and the living sector and bed, sheds and meds. And I think the way I look at it is, we manage a lot of capital for 40 odd thousand retail investors, high-net-worths through some of the biggest institutions globally and domestically. And we're always looking out for outsized returns for those capital partners. So interestingly, I think there are going to be some fantastic buying opportunities in what are still considered traditional core sectors. 

There's a lot of value you can add selecting assets that have got risk and de-risking them. So that'll be where our focus is. It's a bit like having lots of children, you love them all, they've all got their different challenges and sort of the way I look at our different assets and our different sectors, we're equally focused on them. And as you alluded to, some have been a little more challenged than others. And I guess we'll be looking at opportunities where we can use our deep skills to add value. That might be in the office sector, it could be in industrial, it could be in retail, could be in some of the social infrastructure areas that we've now grown the business into. So, I guess some might say they're looking for stressed sellers. I guess we’re looking for opportunities where we think things are mispriced and we can use our skills to take advantage of that and make money for our partners. That's basically the business model. I would also say that there's going to be perceptions of certain assets and certain sectors that get it wrong. It's a bit like the listed market. Directionally, it's quite often right, but it overshoots on the way up and overshoots on the way down and its sort of never really directly implying what asset values will be in the future. So, we see that as an arbitrage opportunity and we'll take advantage of whatever opportunities emerge. 

KH:
Yes, so probably maybe the most difficult child being the office sector? 

DH:
Yes, well, I think a lot of people are quite negative about office. The whole work from home phenomenon has probably provided a more negative outlook than other sectors. We're pretty big believers in the sort of bifurcation of tenant demand towards modern or modernised assets. You only have to look at our office occupancy across the major office portfolios in the country at sort of 97.5%. We're well above industry averages and, and as you know, average vacancy factors are sitting in the mid-teens and for us to be two and half percent, it tells you a lot. I don't let my team pat themselves on the back. It's not about their skills, although that has added considerable value. It's also about the strategy of having the most modern assets you can either develop or acquire and being prepared to sell older stock that might become obsolete and might have more vacancy challenges. 
So, we're pretty big believers in prime office. One of the things that's happening now with the rise in construction costs and the rise of debt and equity costs is virtually 80% of all mooted development from two years ago is just not going to happen. So that puts a pressure cooker on good quality assets, but there's no doubt that the evidence is there that modern, prime assets are attracting tenants and maintaining higher occupancy than older stock. I think we'll also see a continued divestment of older stock. If you look at most of the major REITs, they've been selling older assets, one commentator called them old boilers. I think that's inappropriate, but.. 

KH:
I did see that in a Financial Review story 

DH:
At the end of the day there's a reason why buildings built in the fifties and sixties and seventies are being sold and the more modern assets are not being divested by most of the major property players. So now that will eventually, like I saw in the early nineties, the last time this country had a real recession, some of that older stock will get to a point where it gets redeveloped, refurbished as residential of some sort, whether it's build-to-sell, build-to-rent, student accommodation. But that's a painful exercise for people that own those assets. We probably prefer to focus our attention on the good quality, modern office assets where I think tenant demand will be stronger. But look, this is just a cycle like any other cycle that  everyone thinks industrial's red hot, and it is, and market rents have grown. 

But we need to be careful in Australia that we don't go down the US route and see a whole lot of speculative development. One of the reasons why Australia's industrial sector has had some of the better risk adjusted returns is that we all learned our lessons from the early nineties. There was a lot of spec development in the late eighties, both in office and industrial, but I saw office values drop 80% in the nineties because there was too much supply. So hopefully there'll be some rational thinking around just how much new supply is actually created without pre-commitments. I think it's one of the features of the Australian industrial sector that is going to sort of hold us in good stead, but there's a whole range of different sectors that also go through oversupply. You know, shopping centre malls went through a massive oversupply creation in the eighties, nineties, 2000’s, and then they've been through a pretty painful 10-year period of market rents coming back because there was too much new supply. 

So, it's not just greenfields, it's also brownfields expansion of assets that is, I think, the biggest risk for most property sectors. So, most of the people that have gone through cycles and delivered for their investors have delivered because they've missed the dud sectors or avoided the dud assets as much as they've added value on the good ones. So I think your job, particularly as a large manager of real estate, is to avoid as many pitfalls as you can and get some winners that creates alpha for your investors, rather than just being a beta player, which, if you look at the history of property returns in this country, both listed and unlisted, there's been a lot of beta players and not that many alpha players. 

KH:
So, moving forward onto the idea of transformation in our industry, I'd be really interested to hear where you see the biggest opportunities are in this regard. 

DH:
Look, I think sometimes you can get a bit carried away with transformation opportunities. If you're a fund manager obviously, the preferred route of growth is organic, however inorganic opportunities do present themselves. We've obviously, through the growth of the business, grown predominantly organically, but we've done a few acquisitions like the Macquarie platform in 2010, three or four other REIT take privates, like Folkstone, ALE pub REIT and more recently the Irongate REIT. So, I think people talk about transformation at a macro level. You've got to be careful. Like, the reality is that industrial has been a big winner with the growth of e-commerce. Now, at the end of the day there's a zero-sum game. There's only 25 million people in Australia, growing at four or 500,000 a year. But there's only so much retail expenditure, whether it's online or bricks and mortar. 

So, for every billion dollars of sales that is being done online, it's got to be taken away from somewhere else. So, e-commerce has obviously been a big tailwind for logistics. It's created some challenges for shopping centres, particularly discretionary retail shopping centres. They're having a bit of a comeback after a really tough time in Covid. Energy transition is pretty topical. We've just seen the big fight over Origin, and people talk up energy transition. We see energy transition in a number of different ways. For example, we are a big believer in our triple net, CPI linked service station portfolios. Now if you think about them, they're just long-term residential development sites where we've got a scarcity of land. You've got federal and state governments now trying to muscle up and get more density in cities. Nimbyism has sort of created this not in my backyard mentality from local government, which is why we've got a real supply issue in terms of housing stock. 

So, our view is a lot of that will eventually move to EV, convenience retail with residential above it. Ironically, in other parts of the world you've got residential 10 to 20 storeys sitting above fossil fuel service stations. But we haven't seen that in Australia and I'm not sure we will. Now, if I think about the modernisation of our office stock, we are moving to net zero. A lot of our buildings are electrified. We're doing a lot of green finance loans. So, I think there's a whole range of different ways that you can be part of the sort of energy transition story without being a direct renewable energy investor. I know it's a diverse answer to your broader question about transformation. So, I think there'll be a whole range of ways to play it. We acquired a large portfolio of Telstra data centres from Telstra in 2019. I think it's fantastic real estate, CPI plus half percent rent reviews triple net and they're basically land value in major markets. And whilst that is critical infrastructure, eventually it'll go through its natural, operational obsolescence and that'll create opportunities to do other things with those assets. 

KH:
Well thank you so much for your time. I really appreciate all your insights David; it was really great to catch up. 

DH:
No problem. Good catching up again. Thanks Kathryn. 

KH:
I'm delighted to now have Alex Crossing join us to provide her views on the 2024 outlook. Alex is the Asia Pacific Regional Head of Indirect Private Real Estate at CBRE Investment Management, one of the world's leading real assets investment managers. The team is responsible for more than US$144.2 billion of assets under management and seeks to deliver sustainable investment solutions across real assets categories, geographies, risk profiles and execution formats. I was lucky enough to have Alex on Talking Property recently to discuss the student accommodation sector. Thanks so much for coming back to share your broader views on where you see the best property market opportunities in 2024. But perhaps before we kick off, maybe you could talk us through, what is indirect private real estate? 

AC:
Well, Kathryn, I know the name could be hard to get, but what we essentially are, is we see direct real estate as what a lot of the fund managers here in Australia do, where they source capital from capital partners and acquire, manage and sell the real estate as fiduciary managers. Essentially what we as indirect are doing is we're like an outsourced investment team for pension funds, sovereign wealth funds, insurance companies, and we are the capital partner. So, we represent them, and we manage their global real estate portfolios. So, for instance, we have one of the largest sovereign wealth funds in the world as a client and we manage all of their allocation to unlisted real estate. So that's where the private real estate part comes in. And the fact that we're working with operating partners or fund managers to do that means that we can then access wherever we want the right real estate strategy, whether it's sector and geography, with the right group to execute that because we really think real estate is a local business. So, we might partner with a particular fund manager in Japan or Singapore or North America or Australia. Specifically, we can tap into their expertise on the ground to execute a strategy that we think we have high conviction on. So essentially, we are the capital partner. I hope that helps describe it. 

KH:
No, that is great and I do understand it more than I did before, which is good. So, it does give you a really, in your role, you've got a really broad view of what's happening globally, and with a really wide range of different partners. So, I would be really interested to hear where you do see the best opportunities. And even I guess where your partners are seeing those opportunities. 

AC:
Well, I suppose my remit is Asia-Pac, so I look at both Australia and New Zealand as well as Asia. Most of our capital is more core, core plus in nature from a risk profile. So, we tend to focus more on developed markets, but we do have some investments in some of the emerging markets. But as a house we've been overweight towards logistics since 2012. We saw that as an opportunity to get access, particularly across APAC, to rising incomes, household consumption, household expenditure, and also tapping into e-commerce as well. So that sort of technological change that we've seen, particularly in the last 15 years. And logistics, well located in consumer demand driven locations, remains a high priority or high conviction strategy for us. We're not alone, everyone's bed sheds and now meds, so we've got to come up with something I suppose a bit more sexy than that. 

But again, it is beds. As we talked about, student accommodation, that's been one area, particularly in Australia that we've looked to get access to the living sector here and found it's the one where the numbers stack up the most given a number of factors, including regulations and taxes. And our other exposure is multifamily in Japan. So that's been something that for us that's been very resilient from both an income growth and capital appreciation perspective. And we've been able to partner there and create a strategy there for our client base who tend to prefer slightly lower leverage than you typically see in Japan where 60 to 80% is quite common. But back to the sheds, beds and meds, we're probably still focused on logistics regionally and in Australia, Sydney and Melbourne's vacancy rate is obviously very compelling. We do anticipate that inflation is going to remain stickier. 

You're just seeing that globally because you've got ageing populations and post Covid, you had a number of people retiring early from the workforce as well. You've had this de-globalisation, with people onshoring and nearshoring to higher cost production countries. And then with all the geopolitical issues, we're seeing that having an impact on commodity prices. So, we're expecting all of that to result in much stickier, higher inflation for some time and therefore higher interest rates. So, we are really looking at where can we get value and I think that's the biggest challenge facing a lot of investors at the moment is how do you price things in the current environment. So I probably varied from the original question there, but taking that macro perspective, I think we are still very much looking at logistics. We're still looking for opportunities in living. Whilst we've gone into life sciences in the US, I think that's challenging here in Australia. We've looked at healthcare in all its forms and we still remain quite positive on the sector, but we’re finding investing in the healthcare sector can be a little challenging here compared to when we've invested in the healthcare sector in the US just to get the returns that we need. 
And I think that is partly driven by the fact that the US is much more of a private health model, whereas Australia is much more of a public health model. But that said, we’re still keeping an eye on that sector. I suppose of those three - beds, sheds and meds - that's probably the main ones and we are continuing to look at all other forms of the living sector as well because the government's policies are very supportive of that becoming, a bigger and bigger part of the institutional investors’ universe. So, we are continuing to watch and monitor, but we can see things are changing quite frequently. So, we are just wanting to make sure we know exactly what we're coming into if we're going to invest. 

KH:
And I guess one of the stronger fundamentals there is the lack of supply at the moment and the opportunities that presents. 

AC:
Yes definitely. And that's been something that's been building up for quite some time. Smarter brains than mine have looked at that and looked to resolve the problems. But we all know it's been a chronic undersupply situation over many years. And we're not alone. I hear that from my US colleagues as well. They're seeing it in many markets that they invest in. So, I think it's something affecting a number of different countries at the moment.  

KH:
So, moving on to my second question and I know this is a really broad one, so it could be answered in many different ways, but what about transformation? So, are you seeing any areas where you think there's real opportunity for transformation in the industry? 

AC:
Well, a couple of different things. I suppose transformation's an interesting word. I would say everybody's net zero carbon targets, countries coming out with them, building owners coming out with it, building occupiers coming out with it. We'll see a lot of work in that direction. But I don't know if that's necessarily transformation because I think a lot of that work has already been done and we already have portfolios where we are fully net zero carbon. I suppose you could say the transformation would be that everyone will be there rather than just a handful. I would say in the short term, I think that market will be, and I don't know if transformation is the right word, but it will be quite a significant shift by having these higher interest rates for longer. It's not something a lot of people working in the industry have ever experienced because we've been in this sort of quantitative easing mode since 2008. And I know people on my team, people I work with weren't even working in the industry during the GFC. 

So, I think it will be quite a fundamental shift. And we have the three independents on our investment committee and one of them has always been asking about inflation and for years we'd say, why does he keep worrying about this? And he knew it would come back. It always does. I think that's why you're seeing this volatility in the fixed income market as bond yields are trying to work out this is a structural shift in the market and how will bond yields settle and therefore how will real estate settle as far as capital markets for instance because everything was driven off that spread to bond yields of being the risk-free rate. What premium do you need from real estate to justify you for the additional risks that you're taking on. So, I think everyone getting their heads around that will be interesting. 

I'm sure there'll be some reluctant people clinging on to the old ways of pricing, not wanting to adjust. There'll probably be some pain and it'll probably take a little bit of time, but we'll re-rate I suppose and get used to what our research team calls the old normal, returning back to the old normal of higher interest rates and higher inflation. And then probably longer term, what I find really exciting is all the different kinds of tech coming in, whether it's in sustainability, whether it's in development, construction, I think some of those things are really quite exciting and could have a really interesting impact. I know probably a lot of them are still very much at the exploratory stage that I read about, but if some of them become commercialised and more widely accepted, I think that would be some really interesting times to see all of those get put in place. 

KH:
Yes, there's some really rapid advancements happening in that area and some really smart minds working on that. So, I'm looking forward to seeing what evolves there as well. Thank you so much for joining me again. I always really appreciated your time and your insights and hope to catch up soon. 

AC:
Great, thanks Kathryn. 

KH:
I'm now pleased to welcome Dale Connor to the program. Dale, you've enjoyed a 30-year career at Lendlease and took on the role as CEO of Lendlease Australia in 2021 to oversee all aspects of the group's development, construction and investments business in this region. The Australian business has over $30 billion in funds under management, $5.7 billion assets under management and a $29.2 billion development pipeline. So that's no small role. I'm really looking forward to hearing your insights on where you see the best property market opportunities in 2024. 

DC:
Thanks Kathryn. Good to have the conversation. 

KH:
So, what are you seeing for 2024. Where I guess are the best opportunities in the market and for Lendlease? 

DC:
First off, I would say one of the strongest themes that's coming through to the market is sustainability in property and in construction. And that will only get stronger as the pressure comes from climate change and comes directly through legislation into how we not only build but operate our assets and our buildings. And so, I think that theme is going to continue to be stronger. If I look at sustainability for us, I think of it in a couple of boxes. One is how we build. We are strongly pushing for renewable diesel, reducing fossil fuel construction. We are looking at electric concrete pumps, electric driven cranes, and it's all about trying to reduce Scope 1 and 2 in construction. Then we think about the building itself and its design. We've shifted to all electrification in our commercial developments going forward. 

DC:
So, our Victoria Cross development coming out of, literally out of the ground in North Sydney and above the metro station, is an all-electric building. And we are thinking of removing gas from all of our kitchens in our residential construction. So driving electrification through residential. And then you start to think about Scope 3, you start to think about the building products - concrete, steel, glass and aluminum. We've just written recently a Scope 3 protocol about how we think about boundaries and measurement and working with industry to help drive embodied carbon out of the basic building blocks of construction. So, I do think sustainability will continue to be something that drives a differentiator between those providing highly sustainable products in property versus perhaps the past. 

KH:
It's interesting because I think a lot of people are looking at Scope 1 and Scope 2, but Scope 3 is something that's a lot more difficult to crack, so it's great to see that that's such a focus for Lendlease. I was looking at a profile piece that was written about you and you were talking about the intersection between transport and property, which I thought was really interesting. We just did a report we called the Metrofication of Sydney and the opportunities that opens. So, what are your thoughts on, if you could maybe share those with me, about how you see that intersection playing out? 

DC:
I like that Metrofication, and we see that intersection of transport and density and growth and development happening right across the eastern seaboard. It's driven the Cross River Rail in Brisbane, the Sydney Metro, Melbourne Metro, Suburban Rail Loop, these types of projects, big transport projects, transport outcomes for the states. But what they really provide is not just a value capture of property, but a real problem solver to the housing affordability and housing availability crisis that's in Australia. So, these are ready-made zones where government has stepped in, put a big station in the ground, so you've got available land and you've got air above those intersectional nodes that is ripe and ready for density and development. So, we've fully backed that notion of high-density development around transport, but not just for the top end of town. 

We see it as, as absolutely a solution to providing social and affordable housing outcomes, especially key worker housing outcomes. You know, at our One Sydney Harbour Barangaroo development in the last tower that we've put in, our residential development, we've got 60 key worker apartments that'll be managed by a community housing provider, St George Community Housing. And that's a good model. We've seen that model work in London, we've seen that model work overseas. So, we see that drive to density and development, housing mixed use and making sure that it sort of suits all parts of the residential spectrum. 

KH:
Yes, it's such an issue at the moment. So, it's great to see that there are some of these opportunities to really provide that much needed housing and you know, a lot happening in that BTR space, people looking at purpose-built student accommodation, but I think that social and affordable housing is just so important as well. We did a recent podcast with a couple of the social and affordable housing providers, so there seems to be a lot of opportunity in that space. 

DC:
That's correct. And you also look at now that the HAFF has passed at a Federal level, the Federal Government was looking to send funds through the HAFF, and the easiest way for the government to do that is through the community housing providers. And when they tee up with placemakers, creators like ourselves, it's a good complementary approach to a mixed-use development that gets all aspects of what you would want out of residential. Also mixed-use, tied with retail, tied with new workplace outcomes. I think that this is certainly the future for our major capital cities. 

KH:
Yes. So, I know we've talked about sustainability already and I know Lendlease is really focused on creating that social value in the communities where you operate, but do you have any other thoughts on opportunities for transformation in our industry? 

DC:
Yes, look, we are always thinking about, you have to think about, community and place and about the country that we work on. We were a strong supporter of The Voice as well. We have an Elevate Reconciliation Action Plan. We’re proud of that status, but you have to work hard at that every day. So, we feel that in everything that we do, we are working on First Nations country and so we need to make sure that there's a connection back to country and that the place connects to the past and the present and the future. And we're always thinking about, well, what are the social ventures that can also take place in those locations? We've got a company called Native Food Wastes in one of our Sydney O'Connell Place development assets that we own and it's bringing those sorts of enterprises into the CBD of Sydney and demonstrating what native food, looks like and tastes like and promote it. So, I feel that you do always need to make sure that there's a sense of community, a sense of heritage, a sense of country in everything that we do. You don't want that stale environment, that corporate environment. That's not the legacy to leave. 

KH:
Yes, no, I love that. And I really appreciate you joining Talking Property today, Dale, and all the best for 2024.  

DC:
Kathryn. Thanks for the opportunity. Talk again soon. 

KH:
So that's part one of our Outlook series to kick off 2024. If you like the show and want to check out more, visit cbre.com au/talking-property or subscribe through Spotify, Apple podcasts or your favourite podcast hosting platform. And make sure to tune in next week to hear from ISPT, Investa and Brookfield. Until next time.