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 special Outlook series to kick off 2024. 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 biggest opportunities for industry transformation. In the past two weeks I've spoken to Charter Hall's David Harrison, CBRE Investment Management's Alex Crossing, Lendlease's Dale Connor, ISPT’s Chris Chapple, Investa’s Peter Menegazzo and Brookfield’s Leone Wilkinson. Next up we have Aware Real Estate's Michelle McNally, the Chief Executive Officer of Aware Real Estate, which has 2 billion in property under management, a development pipeline valued at over $3 billion, and is responsible for the strategic performance and management of Aware Super's directly owned Australian property portfolio. Aware Real Estate was established in 2022 with Michelle at the helm, bringing her 25 years' experience in the property industry and broad experience across investment and funds management, property and portfolio management, valuations, leasing and occupier management. Michelle, thanks so much for talking to me today. I'm really curious to know where you see the best property opportunities in 2024 as Aware continues to expand its Australian portfolio.
MM:
Thank you, Kathryn. And thank you for having me on the program. Look, I think to look forward, it's actually very helpful to look back at 2023 and informing, I suppose, where we see value in 2024 is literally saying what we saw in 2023 was lots of levels of elevated uncertainty. We have had a period of very sticky inflation. It's proving harder to tame. Interest rates are also elevated and look like they will be for a little bit longer. And I think that has surprised the market throughout the whole year of 2023. And we've had elevated geopolitical risks as well. We have conflicts in two parts of the globe. And resolution's not clear on those. The US banking systems continue to drive some level of concern, particularly with the decline of office values in the US and causing some debt positions to incur heavy losses in the sector.
And the Chinese economy, there’s also been some level of uncertainty there in relation to stabilising the residential development market. And there has been quite clearly an oversupply of industrial in that market as well as, as operators pull out and start manufacturing in other locations. Locally here, construction risk remains elevated as well. Throughout 2023, there were still challenges in terms of insolvencies in the construction sector and shallow pools of subcontractors. And we found that demand fuelled by the government during 2023 in targeting stimulus and infrastructure spend has made it very challenging for the private sector to necessarily get good pricing from any of their projects as well. And the theme of more taxes across states also impacted 2023 and particularly foreign owners as well.
So, with that background, in 2024 and looking ahead, where do we see some of the opportunities? And for us really, we still see with valuations adjusting across the markets, slower in Australia versus say overseas markets, we do see the opportunity for realistic pricing and transactions now. The bid-ask spread that we saw over 2023, I think has narrowed and we should see transactions flowing and matching really the reset cost of capital requirements. Cost of capital has been elevated and we see that the transactions will come through and meet the return requirements that ourselves and other investors have. We're particularly interested in income-generating assets. In the industrial sector, for example, I think you'll be able to access better returns without the development risk.
I think there'll still be some challenges in development in terms of both industrial and the residential market in terms of planning and construction risks. So there particularly across the markets will be quite attractive as well. We still see good tailwinds in residential, in supply challenges, immigration and a growing economy. We are actively looking for opportunities in that market and we see that 2024 will still be able to provide many of those opportunities. And there is a lot of conversation around retail and the fact that pricing sort of held up in parts of that market, we'll see some good buying there too. So really, for us, I think the divestment drivers for parts of the market will still be quite high. People are trying to manage their gearing levels to fund developments to re-rate out of property to other markets and meet redemption requests. And for a new business like ourselves with capital to invest, we look at this as being a really positive time to be in the market in 2024. Looking forward to some good value.
KH:
Yes. I saw you made an interesting acquisition in Canberra recently for your build-to-rent portfolio, so it's interesting that people are looking at these different opportunities.
MM:
Yes, look, that was a great purchase. It was a purpose-built, build-to-rent development that the vendor wanted to recycle some capital into their future development pipeline. It really suited us to take a position in an existing asset that had been well built. It's also underpinned by a long-term Coles lease, and a very large car park, which is a unique feature of the Canberra market. So, we've just launched that asset at the end of 2023 and we're looking forward to some great leasing up and performance across the 140 apartments that we've got there. So, for us, accessing, looking to take advantage of opportunities where there's a lot of divestment drivers across different vendors as such is a really good sign for us and we're very happy with that purchase.
KH:
Another thing I was interested to read about was your focus on essential workers and housing those essential workers. And I think there's been so much discussion about the housing crisis. Can you tell me a little bit about that and the opportunities you see in that space?
MM:
Yes, sure. I think there was a great evolution of conversation around housing and the need for housing, throughout 2023. The government's really made it a significant focal point, both at a Federal and state level. And it is fabulous to see the property industry rising to the challenge and really highlighting the need for improvement in planning, in infrastructure and also in collaboration across the market. Aware Super was very much a pioneer in this space creating its own program to house essential workers. Currently we have about 500 apartments where we provide a discount to market rent for essential workers. We're really hoping that that has provided a catalyst in the market for people to view essential worker housing as really critical, particularly around locations of employment. We know essential workers are traveling a long distance to get to where they need to work, and that's having an impact on employers and also on the community in general.
And so, I feel quite encouraged, looking ahead into 2024, particularly with the HAFF coming into fruition, but also continued conversations around how the property industry and investors can actually collaborate more broadly across the sector and work towards resolving and providing a greater range of housing. I think it shouldn't just be one form of housing we're looking at here. It needs to be a really diverse range of housing across all locations. There's as much need in regional Australia as there is in our cities as well. And so, we've got a big task ahead of us over the next five to 10 years to supply the housing that we need. But it's really great to see, particularly, changes happening at the state government level in planning that should facilitate a greater level investment in residential.
KH:
Yes, that focus on planning is so important. It has been particularly problematic, particularly in some states. So, I'd also be really interested to hear your thoughts on transformation in the industry and where you see that's headed.
MM:
Yes, Kathryn, if I look at big themes in 2023, the one for me is really around AI and the explosion of that onto people's desktops and their phones. And if you think about what happened in 2023 outside of the property industry and where really the rally happened, it was very narrow. It was across AI and tech related AI companies, in the US and elsewhere. And I think for, for the property industry, often we're quite insular and how we look at things. And for me, looking at that, that really is the call out of the change for transformation very broadly for our occupiers. At the end of the day, property is all about the occupier and what's happening to them. And so, AI will absolutely change how we work, how we shop, how we live and where we do those things.
And I don't necessarily know the answers now, but the observation is externally these will be big forces within property over the next five to 10 years, and there'll be winners and losers out of that, both at the sector level and at the asset level. I think location will become an interesting thing in terms of how AI will actually change the force of location. But also really, in terms of transformation, it's not just an external change, it's also an internal change for property companies. The property industry at some times has been slow to necessarily evolve. And I like to call it a little bit of an analogue industry at times. I think AI will really be quite a transformative piece for our internal companies as well. So, looking at how we actually drive change within our organisations and embrace AI will be quite important for property organisations going forward. So, for me, that's probably the big transformation and how it'll evolve in 2024 further, I think we probably didn't see what was going to happen in ‘23, so who knows what's going to happen in the year ahead.
KH:
Yes, it seems like anything is possible and I do like your comment about us being a bit of an analogue industry, so it'll be great to see how we navigate that in ‘24. Thank you so much for your time, Michelle. I really appreciate you joining and all the best for this year. Next up I'm talking to David Southon, executive chairman of Aliro Group, an entrepreneurial property development, investment and funds management group that works with a diverse range of wholesale capital partners. David, you founded Aliro Group in 2017. In the past 12 months you've progressed with some major industrial projects around the country, while Novus, the build-to-rent company that Aliro Group backs, has grown its portfolio to over a billion. I'd love to hear your thoughts on where you see the best opportunities in 2024.
DS:
Thanks Kathryn. And yes, very nice to join you on the podcast. We, as you say, did establish the business back in 2017 and we were fortunate at that stage to focus on those two growth sectors that you mentioned, industrial and build-to-rent. We certainly see the tailwinds for those two sectors continuing. They're obviously very different sectors with industrial being a very well-established sector here in Australia and BTR being an emerging sector. But one thing that is common for those two sectors is just the demand relative to supply. We've got an undersupply in both of those sectors, very tight markets, and that's really driving things like rental growth and ultimately total returns that we see continuing to come out of a focus on those two sectors. We are also interested in what's happening in the office sector. We intend to have a more diversified funds platform going forward, and as we see deep value emerge in the office sector, that's something that we expect to be doing more with as well.
We are a property funds management group and so a lot of what we do reflects what capital's looking for. So coming back to industrial, because of those very strong tailwinds, because of the fact that we've seen very strong rental growth and even though for all sectors the impact of higher interest rates and therefore cap rate decompression has had an impact on valuations, in the case of industrial, and particularly better quality industrial, what we've seen is that the rental growth has more or less offset the cap rate decompression impact on valuations. What's interesting about that sector, I think, and the position that we're currently in is that as we get towards the end of that interest rate hiking cycle and therefore cap rate decompression cycle, we'll see cap rates start to moderate. We feel we are close to that point now, and we think that the tailwinds will ensure that rental growth will continue to come through, maybe a little bit more modestly than it has done to date, but still five year CGAR’s pretty much in all of the gateway markets are 5% on average, which is very high over that next five years.
So, we see that adding to valuations and we see better value in the buying over the next 12 months in that sector. Whilst there's still an opportunity to develop to core, we actually see the opportunity to buy more value where there are particular parties who have got themselves into a position where they just need liquidity. It's very difficult to sell other product at the moment, other sectors. And so, industrial's the one that we've seen a little bit more product come to market with a higher probability of being able to find a buyer for that product. Notwithstanding that we've seen a very challenging year for capital where because of higher interest rates and cap rate decompression and not knowing where asset values are ultimately going to reset, capital has sat on its hands pretty much for the last 12 months and that situation could continue to occur, certainly for the first half of ‘24, but we’re starting to hear more positive signs coming out of capital now that because they too feel that we can see the end of that cap rate decompression cycle, certainly for growth sectors, like industrial, that we'll start to see a bit more transactional activity in 2024.
KH:
It's great to hear that there's some more positive signs in that capital markets space. This has been a pretty challenging 12 months, so, hopefully we will see a bit of a shift, especially if capital does start to really re-look at office again.
DS:
Yes, look, I think at the moment, office is a bit of a dirty word in real estate. Most investors, institutional investors, are overweight office. We've seen the impact on other markets around the world of significant resets in value that we really haven't seen here in a meaningful way in Australia as yet. There is still a very wide spread between buyer and seller in our market, and so not too many transactions are occurring in that space. And if they are, typically they're a structured style transaction where the vendor has to do something to assist the sale. So, look, I think Australia has got some different dynamics in that market to say something like the US, which is a very big and broad market, and there have been some, significant resets over there. And so, when you're talking to global capital, they kind of don't even want to consider it at this point in time and coming into our markets.
And it's difficult to convince them that Australia will be different to what they've seen in other markets. Australia typically is a laggard market, so it does take a little bit longer for things to filter through, but what I think we will see over ‘24 is some deep value emerging in that sector. And what I mean by that is that we will start to see the valuation reset come through in ‘24. There certainly is that flight to quality that everybody's talking about. We're seeing that from a tenancy perspective. So secondary assets are going to come off, I think, significantly more than what we'll see in prime assets. But prime assets will come down as well, and I think there'll be an opportunity to access the markets, fairly tightly held in Australia usually, but there'll be an opportunity to access product in the gateway markets where typically you couldn't previously do that, particularly for global investors who want to hold some of the iconic buildings in gateway markets. And I think you'll be able to buy those buildings at a discount to replacement cost and in some instances, possibly even a discount to construction costs. In other words, wiping the value of the land out altogether. And I know that sounds a little dramatic, but for some of the secondary assets, we are already starting to see a little bit of that emerge because if it is a secondary asset, you have to really think about whether it's reached the end of its lifecycle, and if it has, then the improvements actually have a negative value.
KH:
The other area we touched on was build-to-rent. Aliro Group has been a real early mover in that sector, and I think people are really looking at what's going to happen there in 2024. What are your thoughts on the BTR front?
DS:
I'm really excited about that sector. I feel that it is an emerging sector. It's been a long time coming for Australia. Part of that is just because of our tax system and the way that's worked previously. But what I really love about it is that, you know, 33% of our market rent and they've really for many years in Australia kind of been treated as second class citizens. They haven't been given the best products with the best amenity, with the best sort of ongoing maintenance regimes. But the biggest issue I think is that inconsistency around security of tenure. And I think offering up a build-to-rent product that is institutionally backed, that has a brand around it from an operational perspective, is a great thing for a third of our market who rent. So, it's giving them that choice.
They don't necessarily have to rent a mum and dad investment product that is very inconsistent in terms of the offering. They can come into something that is brand backed, institutional capital, that is there for their purpose. It is built to rent specifically for that. It's not strata-titled and held as stock for sale in the future. And some groups out there call themselves build-to-rent, but they're not really build-to-rent. They're build-to-hold for a period of time and then sell, and in the interim period they'll rent. So, I think that as we see that sector really emerge, we'll see more local capital get behind it, which I think will be a significant change. The early movers are typically backed by global investors who see this sector really working well in other parts of the world. And the correlation between the UK and Australia is very strong.
UK is ahead of us here in Australia, but it's almost a hundred percent correlation between what we see in terms of growth, what we see in terms of yield differential for this product. Total returns that are coming out of this product are in that sort of 10 to 12% range where you would expect them to be because you have to be a developer in this space, you have to develop to core, the product doesn't actually exist today. And so, you have to know what you're doing from a site origination perspective, from a planning and approval perspective, then from a delivery perspective and then ultimately through stabilisation, the leasing and then operational. So, you need specialist providers in the living sector, whether that be in build-to-rent, traditional, conventional build-to-rent, or whether that be in co-living or student accommodation, serviced apartments sort of more akin to hotel operation, but they're all classified as the living sector.
And so I think the space is incredibly exciting. It's emerging. The total returns that you are getting, I think are attractive relative to other sectors. The yield on cost that we are working towards is anywhere between five and a half to 6.5%. So, the perception that yields are going to be really tight, returns just aren't there. If your formula is right and you know what you're doing and from a development perspective and delivery perspective, those returns are very much there. And when I think about them on a net effective basis relative to other sectors, because whilst yes, you'll need a sinking fund for capital as you do in all the other sectors anyway, there are no incentives in this sector. And so, your net effective returns relative to those other sectors where even in industrial your incentives can be anywhere between five to 15% and in office you're at sort of 30 to probably 50% if you really unpacked all of the incentives that are on offer there at the moment.
So, yes, it's an exciting sector and I think we'll see it continue to emerge strongly here in Australia. We really need it. There's a significant undersupply of stock relative to the demand, particularly with our immigration aspirations here in Australia. We've got to provide accommodation, as affordability is a real issue. Some of the inflationary pressures that we're seeing coming through is impacting the build to sell product as well. Gone are the days where you could just sell 80-90% of your apartments with a 10% deposit and hope you could deliver them for the cost that you thought you could. And so that is putting a real lid on supply of stock, which is impacting affordability.
KH:
There certainly is a real need for more housing all around the country. So, we need a lot more groups looking at build-to-rent. So, one final question for you, David. I'd be interested to know where you think the biggest opportunities are for transformation in the property industry.
DS:
Yes, it's a great question because I think you always in property, you have to be agile in your approach. Things are changing all the time. Gone are the days where you could just set and forget. I can remember back when retail was the strongest sector from an investment perspective. That's no longer the case these days. It's gone through major transformation and will continue to do so. Office is having its retail moment, it's going through a reset. It's going through a reset, not only from a valuation perspective, but also when you think about how tenants want to use the office space these days. And with flexible working, you've got to be able to respond in a way that provides the additional amenity that your people are looking for, but actually attracts them to come together and collaborate at the office, which is difficult to do over Zoom or Teams.
And whilst I think there's very much a space for flexible working going forward, you still need to be able to provide great space for people to come together. I certainly find in our own business that we do better work when we're working together and we're working together in the same space. So what we want to do is to be able to provide a reason for them to come to the office, not a reason for them to stay home. And so I think the whole sector has to transform in terms of the way that it thinks about the offering. And it's been doing that for a number of years in terms of amenity within our buildings. But even now from a health perspective in terms of what sort of densities are you looking to cram people into and how do you create those spaces that are collaborative spaces that genuinely work well to increase productivity.
So, yes, I think we've just got to be agile and the changes that we're seeing in the living sector, are something that’s emerging I think reasonably quickly in Australia after a long time of sort of just being quite stagnant in terms of how we responded to things like housing supply. That's changing. It's bringing institutional capital into the mix. And we've got a fabulous superannuation fund industry here in Australia. We've got to capitalise on that for the benefit of all Australians. We're also very attractive to global investors who look at us in the Asia Pacific and say, well, where are we going to invest down here? We've got a certain allocation to Asia-Pac, and really at the moment it's Australia, Japan, which is great but tough to get invested in and stay invested in. And Korea, they're probably the areas that are the most focused for global investors at the moment. So, Australia's a very attractive place for them to bring capital. And one thing I think that we need to make sure is that our governments here, both state and federal, want to continue to attract that global capital, which will help the growth of Australia rather than trying to overtax it, which I think is unfortunate and creates a degree of sovereign risk that for many years we didn't have. So, I think we need to sort of settle that down to stabilise that and continue to keep the doors open for global capital.
KH:
Thank you so much, David. I really appreciate you joining and for giving us your insights and all the best for 2024.
DS:
Thanks Kathryn.
KH:
So that's a wrap for our Outlook series to kick off 2024. If you like the show and want to check out more, visit
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Apple Podcasts, or your favourite podcast hosting platform. We'll be back to our normal fortnightly podcast schedule from February 8, starting with our Q1 episode of the House View featuring CBRE's Pacific CEO Phil Rowland and Pacific Head of Research Sameer Chopra. Until then.
