Talking Property | Future Sydney – Opportunities for Occupiers

SB: 
Hello and welcome to Talking Property with CBRE, a podcast in which our team of experts, our clients, and industry specialists share insights into the way we live, work, and invest through the lens of commercial real estate. My name is Sass Baleh, Head of Industrial Logistics Research in Australia and Director of New South Wales Research and your host for today's episode, The Investable Universe in Australia across the mainstream commercial property asset classes, office, industrial logistics, and retail currently totals around $896 billion. The highest share of capital stock across the three sectors is in the Sydney market, totaling $369 billion or around 40% of the national total. The Sydney investable universe is expected to grow to $464 billion by 2026. As always, with growth comes opportunity on today's episode, we'll be diving deep into the future of major cities as we face unprecedented population growth and we'll explore the vast opportunities available to investors that come with it. Here's to help me unpack the true potential of Sydney for investors is Leif Olson, Director of Retail Leasing in Australia, James Perry, State Director of Capital Markets office, and Jason Edge, Senior Director of Capital Markets and Industrial Logistics in Australia. Thanks for joining me everyone. 

JP: 
Thanks Sass 

JE: 
Thanks Sass 

SB: 
Before we get started, could you give our listeners a quick overview of your role at CBRE? Let's start with you Leif. 

LO: 
So I look after a national retail leasing team. We've got about 35 executives and focusing on shopping centres, high street and large format retail. 

SB: 
Fantastic. And how about you Jason? 

JE: 
Thanks Sass, Jason Edge. So I work in the capital markets team for logistics with Chris O'Brien, so focusing on sales in particular investments, capital deployment specifically in logistics Australia. 

SB: 
And James. 

JP: 
I'm James Parry, I'm responsible for office investments in Sydney, so Sydney CBD and Metropolitan Sydney. 

SB: 
Fantastic, well thank you all. Let's just start with the first question. We have the investable universe growing by 26% over the next four years across the mainstream commercial market. So what makes Australia an attractive destination for offshore investors to allocate capital to this market and how are they allocating capital? Perhaps we'll start with you James. 

JP: 
Yeah, so Australia's always been a very highly rated investment market for offshore capital. When you look at the transparency of the market, the size of the market and the sophistication of the market, that's why it's always been highly regarded. But also when you look at it within the realm of the Asia Pacific, you look at what is the alternates and you know, across the Asia Pacific there are less mature markets and markets that are really hard to invest in. So for example, Hong Kong Singapore are very tightly held and then you've got Tokyo as another major market. So you know, within the scope of Asia Pacific, Australia is easier to get into and it helps offshore investors get their Asia Pacific allocation. 

SB: 
And Jason, from an industrial logistics perspective, how easy is it to get capital across into that sector in Australia? 

JE: 
Easy, I don't know if that's the word, but from a demand perspective, why do they look at logistics in Australia? I think it's the stability. It's not too dissimilar to what James said. It's an asset class that you can certainly invest in. I think the fundamentals I've seen in Australia are in their infancy in particular around e-commerce. And I think the point you touched on earlier about population growth in the medium to longer term is something that's really going to drive our sector and that's really positive from a capital flows perspective. 

SB: 
And I would assume that population growth story would be relevant as well to the retail sector. Leif, how we seeing things in terms of the occupier space in retail for Australia? 

LO: 
We're seeing um, retail spend I think is due to increase by about $8.4 billion over the next three to five years. That's off the back of you know, migration with more people coming into the country and we'll continue to see the um, retail growth throughout that time period. 

SB: 
Now given the rising cost of capital, how are we seeing the investment market being affected at the moment? So that impact on pricing and transactional activity? I might throw that to you James, with respect to the office sector. 

JP: 
Yeah, the cost of debt's having a fairly major impact on it. So to put that in context, if we're selling a building a year ago you could probably get all in debt on it for 2.5%. Now it's probably 5.5% percent. So where debt was really helping buyers get their returns, it's no longer there yet. They still need to achieve, you know, similar returns for if it's value add or opportunistic or core plus the returns for the most part haven't changed, but the ability to get debt to help you get there is really difficult, which means the only way to do it is through some other part of the equation. So whether it's rent growth, which you know, the tenant market is quite healthy or an adjustment in price and that's what we're seeing at the moment is pricing is definitely under pressure. 

SB: 
And that pricing piece, where do you see yields play out? You know, at the moment I think there's a lack of transactional evidence, but where do you think that'll sit in the next three to six months? 

JP: 
It's a really, it's the multi-million dollar question, right? So, we know that there's probably pressure on 50 basis points. The better the building, the less slippage and the more secondary of the building, probably the more slippage in in yield. So you know, you might be looking secondary suburban and maybe that should have shifted out or may shift out by a hundred basis points, but then high quality CBD assets may not. And that's also where you've got some pretty strong tenant fundamentals to assist you as well. So you've really go to take the whole equation into it. But you know, for the most part you've got this flight to quality and you know, buyers want to buy where tenants want be and if you've got flight to quality and upward pressure on rents, then that's where buyers will invest. 

SB: 
Yeah, and that upward pressure on rents, you know, where are we forecasting, say office CBD rental growth over the next 12 months? 

JP: 
Over the next 12 months? It's fairly modest because we've gone through the last two years of lockdown and, and a lot of uncertainty. But we certainly see three 4% over the next 12 months. But I mean this is an ongoing question because you know, owners and buyers will refer to valuers for where you know, the 10-year average should look but then you know, there's so many different parts that we need to factor in. So replacement costs, are going through the roof because it's hard to buy materials and labour and there's more tenant demand for better quality buildings. So I think we'll be surprised on the upside with rent growth, not to the extent that we've seen in in industrial, but I think there's a much stronger story in rent growth than is being told at the moment. 

LO: 
Interestingly, we've seen rent plateau in retail and I think we're still going through a pretty significant level of change. And I think looking at CBD locations, definitely those secondary markets are becoming less of a focus for retailers. Really the prime stood up and super prime stood up really well and I think we'll continue to see that. But owners that are kind of rolling their sleeves up and being more creative with deals are definitely the ones that are getting much better results. 

SB: 
Have there been any uh, recent examples of that life? 

LO: 
You know, traditionally we've probably seen, you know, when you're looking at rental, we are probably looking at five year to 10-year deals and we've started to see owners be more creative and retailers being more creative in terms of doing shorter term deals or link to turnover, you know, and that's been pretty interesting over the last couple of years. 

SB: 
Yep. And I think with the expectations of yield softening even in the industrial space, Jason, how much do you think that'll be offset by the expected rental growth or further rental growth in the industrial space? 

JE: 
Yeah, I think yields in the first instance, there's a lot of wait and see and price discoveries and it's not too dissimilar to any of the other sectors we've spoken of at the moment. Where do yields stop in relation to particular those long lease assets. The rental growth piece is real and there's examples where we've seen groups and vendors, you know, running ROI processes for lease assets. So that's something that I've never seen in 20 years and that's factual and happening certainly in markets where it's, you know, we've got sub 1% vacancy, which is almost every submarket in Sydney, but you've seen rents, I think year to date by the end of 2022, you'll see the rent growth story sort of somewhere between 35 and 40% this year, which is just, I guess it's coming to a point where we're now having our clients saying when does it end? 

The comment that James talked about rental growth for next year still think we'll see really strong rental growth next year and probably the year after and it's just based on supply. There's just no ability to increase supply, to satisfy demand. So when we're talking to investors who's sitting on their hands, long wale core capital is probably still in that price discovery mode. Where we're seeing genuine activity in the market is still those short leased assets, land rich assets or even land where people can activate and take advantage of the market now versus waiting for whatever it looks like in 2024 and beyond. 

JP: 
Edgy, that's like unprecedented rental growth. I've been around for a while, never heard of that sort of rent growth before and is that still getting buyers pretty excited and actively buying or are they taking a breather with the cost of debt issues? 

JE: 
So the cost of debt is same as what you mentioned, sort of that all in five and a half pieces is challenging, which is why I think groups that can't capture that rental growth in fixed reviews for a long dated term is challenging. And that's where a lot of those, you know, what would traditionally be just a core logistics 10 year lease is challenging. So for the same things that Leif talked about, you know, people getting creative about rental structures, lease terms being shorter, you're having some of the, the groups banking on this rental growth saying, right, we'll give you three year lease terms. I mean that's something that rather than a 10 year leased asset, midterm reviews. So they're things that from a tenant's perspective is just not something they want to see. But unfortunately when you've got genuine competition for two or three assets that are currently available across the market and you've got occupier demand still strong, they don't have much choice. So it's a really landlord friendly market at the moment if you've got a vacant building or open vacancy, 

JP: 
So yields hold 

JE: 
Yep. On short waled assets, absolutely I think they'll hold because you can capture that rental growth and hit IRR expectations, but it's really challenging when you've got a 10 year lease to a multinational and it's just fixed 3% reviews for that term. So I think those are the ones that'll probably soften a little and where they stop not too dissimilar to what you said James, where they stop. I guess it's still that price discovery piece. 

JP: 
Yeah, it's interesting because I think the least amount of capital or buyers for us in office is, um, longer wale, but then I think about what next year might look like and I can see that it might be a softer economy and that flight to safety could well back in an environment where debt might be a bit cheaper as well. 

JE: 
Yeah, I think that's one of the things when we speak to our clients is this just a moment in time or to your point, do people go back to that income certainty with strong covenant? And that'll be sort of more those macro economic drivers which, you know, Sass can run through. But that's the thing I think that we're not quite there yet because we've still got this discrepancy between buyers and sellers and that standoff for six months is whenever a market shifts is always the case, it's just how far into that six months are we? 

SB: 
Now, I think, um, just coming to more of the concluding points, if you could all give me the top main factors that drive the attractiveness for your respective markets. So perhaps Leif we'll start with you with respect to retail. 

LO: 
Well, I think it's really sitting in and around, you know, the covenant strength as we've kind of talked about today. Making sure that, you know, that the retailers that are sitting in there, that would definitely be number one and I think really looking at at lease term and getting those incremental reviews right would be, um, would be that for retail. 

SB: 
Yep. James.

JP: 
I think in two years we'll look back on this period and there'll be a whole lot of people wishing they had done something that they didn't do. You know, we've seen it on previous downturns and I think there's going to be great opportunities either to upgrade quality of building or buy at reasonable pricing in this next short period. 

SB: 
Yep and Jason? 

JE: 
Yeah, I, I think from an occupiers perspective, the e-commerce thing was in its infancy. I think COVID just put a accelerator on that, but I don't think we're quite up to the global standards yet. So I think we've still got a little bit of growth there. So that's from an occupiers perspective, I think one of the things in any downturn is this allows some groups that have been priced out of the market for the last five to seven years to allow to come back into the market. So I think we'll get to a point very soon where we've seen investors probably sit on the sidelines of being priced out for a long time, being able to come back into our market whilst others still have that price discovery with capital discussion. 

SB: 
Yeah. Well it's gonna be an interesting six to twelve months just to see where the global economy heads and where sort of Australia follows from that as well. Um, so thank you all for joining me. We've had a great discussion and thanks for listening to Talking Property with CBRE. 

LO: 
Thanks Sass. 

SB: 
Thanks for listening to Talking Property with CBRE. If you like the show and want to check out more, visit cbre.com.au/talking-property or subscribe through Spotify and Apple Podcasts. You can hear more from our experts on this topic by listening to the episode, Future Sydney: Opportunities for Occupiers. You can also learn more about the trends shaping Sydney by reading the full report Future Sydney Investment Destination. Simply click on the link in our show notes.

Until next time, take care.