PR:
Hello, I'm Phil Rowland and I'm excited to be back for our second edition of The House View with our head of research, Sameer Chopra. There have certainly been some movements since we recorded, our last episode back in January. We've seen Australian interest rates continue to rise and of course there's been considerable discussion and of course some varying views on the outlook for commercial property values and how long this current price discovery phase will last. So these are two of the topics that we'll be discussing today along with our latest market predictions and what we're hearing from our clients about the current state of play in the commercial and residential markets. So, Sameer, maybe we'll get started. Lots of discussions about the current interest rate trajectory, cost of debt, and generally how the economy is traveling. What's your perspective?
SC:
Yes, thanks Phil. Interest rates have been very volatile recently. You know, the, if you just look at the medium term debt, it's bounced between 3.2% and 4.1% - four times in the past six months. That's a lot of volatility. And globally, you know, we've seen now, you know, the US Fed increased recently by 0.25%. Canada has paused and you know, now there's growing expectation that the Reserve Bank in Australia will pause in April. But, you know, expectations are moving around very, very rapidly. It's tricky because the economic data is actually really good. You know, hiring activity is really good and you could argue and it's, it's good hiring. You know, the airlines need to hire, restaurants, need to hire, healthcare needs to hire, you know, this will solve a lot of undersupply issues we've had over the last couple of years. But, you know, we need these settled markets for transaction volumes to pick up. We'd expected that things would start to settle maybe in the second half of 2023. But now, you know, we've got this new added challenge with these bank sector issues in the US. That means there'll be some drying up of debt. It'll become really, really challenging. My own view is that a lot of international capital, particularly in the bank sector and loan sector, is going to walk away and pause for an extended period. Still, just to get back on that positive horse of mine. The news is good, you know, the economy, you know, we've got really good population growth trends. Immigration is very strong. International students have been coming back at the start of this year and that means, you know, we've got a good setup. Retail sales today are 20% to 25% above where we were pre-covid. So, you know, retail is strong, residential values through Feb and March have started to pick up. I love inner city residential and I think, you know, once housing confidence picks up, it'll be good for the economy. So look, still 1.5% to 2% economic growth, RBA on pause. And Phil, if I can go back to my cricket analogy from the previous podcast, let's just say that the best players play a long form of the game. The Australian economy like Glenn McGrath just keeps delivering, line and length economic growth and returns over the long term .
PR:
Yes, well there's some good momentum, there's no doubt about it, but I suppose, um, there are some very contrasting kind of indicators coming through, right? And certainly when we look at the underlying performance of Australian occupiers, for the most part, coming off a period of pretty good, sustained growth post pandemic, you know, so many sectors such as professional services, banking, you know, they're up 30% in terms of, you know, they're pre pandemic levels. But from recent data it looks like we're seeing this top out and certainly some sectors such as tech, you know, clearly coming off and not faring as well as others. What are you seeing around sort of occupy performance at the moment?
SC:
Yes, Phil, I think we're getting a little bit more bifurcation in the occupier markets and that'll become more stark, you know, as the cycle matures and it's very sector by sector, I think like auto is doing really well. Consumer goods companies are doing well. Both of those have really good pricing power. There's really good conditions in retail as well. And that's playing out in high occupancy in the shopping centers that we continue to see. There's good pricing and occupancy in hotels and, you know, the banks and insurance companies benefit from these higher interest rates. Having said that big challenge starting to emerge in logistics and some of our early indicator data is suggesting that the sector has seen about a 6% revenue compression from its peak and the peak was sort of mid last year. So we're mindful, you know, of whether logistics companies have the ability to take up more space tech and healthcare is very mixed bag. I think in tech it's longer sales cycle. There's some softness in advertising and in healthcare a lot of these firms are cycling this big covid boost that they had. Overall, you know I'd say corporate Australia is doing fine, but everyone is very worried about input costs and how that affects their margins.
PR:
Yes. So given that backdrop Sameer, how are these kind of trends playing into leasing activity in first quarter of 2023?
SC:
Yes, Phil, in terms of leasing activities, you know, it's very geographic and, and sort of sector driven. We're seeing not bad conditions in office rental in Perth and Brisbane where incentives are coming down and face rents have moved up just modestly. But that, that's enough to sort of give you some confidence in those two markets. Sydney has seen a slight creeping up incentives, though face rents are still growing and Melbourne on the other hand, we're starting to get a slightly bigger step up in incentives than what I'd expected at the start of the year. And in industrial, you know, vacancies is just super tight and that's really boosting rents on new deals. The new hero in the market is Melbourne, where rents are moving up a lot faster than they are in some of the other markets around the country. But the issue in industrial is there's just not enough stock to do deals. And you know, I'd say overall it looks like our leasing teams had a pretty busy first quarter.
PR:
Yes. You know, from what we're seeing in the numbers despite this volatility that we're seeing in the financial markets, we are seeing the sort of resilience and the underlying demand that's coming through and leasing volumes. There's no doubt about that. So I like, I think this is going to come under some pressure. I don't think there's any doubt about that. But for now I think that that sort of momentum coming out of last year that we talked about in the, in the occupier community seems to be holding up for now. So we've talked about the local state of play, but a lot of our clients are also asking this big question, which is whether the Australian office market will follow the trends we're seeing in the US where we're seeing vacancy seriously elevated, particularly in some of these West coast markets. Are there concerns about the structural decline of the market in the US and what is our research view on these themes and is there carry over into the Australian market?
SC:
Super topical Phil, super, super topical. It's probably one of the most inbounded questions around to us right now. Maybe I'll just paint some thoughts around it. You know, the Australian office sector has much lower vacancy right now than the US. The difference is about 5% at a national level and the two markets have been moving in slightly different direction over the course of the last sort of three years or so. In Australia, interestingly, sublease declined a lot through 2021 and 2022 and it's now back towards its historical levels, whereas in the US sublease has increased. So there's a lot of this hidden vacancy on top of disclosed vacancy. And then you've got this issue around cap rate expansion. When the US market, there's been a lot more faster sort of cap rate expansion in Australia. You know, question is, you know, are we different? Are we going to play sort of catch up with them? But when you look below the surface, I think there's a couple of things that are different in Australia. One is commute, then there's our return to work posture in Australia, the location of offices in Australia, you know, the age and the kind of amenity set up.
PR:
Yes. The quality of stock.
SC:
Yes. Very, very different in Australia. I like commute. Commute's an interesting point; in Australia about 50%, almost half of the market takes public transport to work in the us That's about a quarter. That means in Australia, you know, people you could argue are a little bit more productive or have other options for at least half of the population on route to their office. We're also finding return to work has been much faster and better. In fact, I was speaking with a law firm very recently and the partner there mentioned to me that their office occupancy is running at about 65% and the planning is at 70%. You've always got some people on leave, part-timers. 65 of a 70 expectation is pretty good and law was one of those professions where we were worried what return to work would look like. So looks like people are coming back in Australia. There's a lot more of that. The office infrastructure is also a lot more newer in Australia.
PR:
With good transport infrastructure.
SC:
With good transport infrastructure, right? Which is why people can - I take the bus to work kind of thing, have done forever. It's very easy and convenient. We also find like offices in Australia, very ESG friendly. So about 45% of offices have a five-star or a six-star NABERS rating. So they're kind of designed and are newer and the kind of structure. And then we've got very good amenities, a lot of shopping, cafes, restaurants. So there's a lot of sort of pull factor around it. And sometimes that's not always the case in the US where there's a lot of sort of campus-based type offices where you don't have those same amenities, philosophical view. But I think, you know, I look at things as systems and I think when a system starts to get a lot of momentum or critical mass, things sort of flourish and the more workers that come into the CBD, the more retail opens up, which then drags in more office workers. And if there's more people in your office, then there's more in-person meetings, which means more people come back in. So I think, you know, we're at that sort of point where we have this flourishing, critical mass systems underway in Australia that doesn't deny that, you know, we're not going to have hybrid work. But I think we'll get to the end state on that probably sometime this year. Phil, that would be, would you say?
PR:
Yes. Look, there's definitely momentum towards that. There is no doubt about that. And we've just got to make sure that we sustain that. But switching to capital values though, Sameer, that's obviously the question mark on everyone's minds. Despite all the great momentum, those very clear differences between the Australia and the US market. Let's be clear, the US market is under some serious pressure around cap rate expansion. So how do you see values in Australia moving from here?
SC:
Yes, Phil, I've probably turned, more cautious on it late. Bit more cautious on it. And I think that's because interest rates have risen a lot more aggressively than what I had expected last year and even at the start of this year. To balance that sort of what's going on with cap rates, we've also got much better rent growth expectations, particularly in industrial and residential. All up, the conversations and our own sort of modeling is suggesting we'll end up with something like a hundred, 125 basis point cap rate expansion on average. There'll be stuff that's worse and there's stuff that's a little bit better, but there's just a lack of deal evidence, right? Like, we're hoping that more deal evidence bills as a kind of year progresses. For me, one of the most interesting questions that's coming in is, and this applies to buyers and new build, is what's the bond rate you want to assume longer term? When you want to sell this asset again in five years' time? What's the long bond rate you want to use? I'm sitting at 2.7%, which is kind of way it's been historically. There's some who are who are assuming it's between three and three and a half percent, that's a big difference. That can move your valuation very, very significantly. So, you know, I'd encourage all our clients that actually a lot of the homework needs to be about long term. Five years from now, where do you think the cap rates are going to be? And that's driven by these long bond rates. What's your view, do you think this inflation is here forever or do you think, you know, we go back to some kind of, some kind of normal. And by the way, I'll just give a plug because my two favourite sectors right now where I'm a buyer is inner city residential. Last six months been super positive that space. And the other theme is just I like retail, I like CBD retail, I like shopping centre retails. I think that's a sector that's been ignored and I really like it.
PR:
Well on that note, Sameer, when we last spoke in our first episode we discussed three themes. The first one was the return to CBD, the second one was this concept of premiumisation and then your more controversial view about construction costs and seeing some scope for deflation there. Where are we at on those three?
SC:
We'll start with the best of the worst. And return to CBD, Phil, definitely playing out. We've seen that sort of momentum pick up more in the first quarter of this year. I'll start with the residential where it becomes very evident. Inner city residential vacancies now just a bit below one and a half percent. It's gone below sea change, tree change suburbs. And it's been a while since we were there. CBD office occupancy is also picking up very evident in Brisbane, Adelaide, Perth, where those markets are, call it 20% shy of where they were pre-covid. Sydney's in the middle and I think Melbourne and Canberra still need to do some heavy lifting, but return to CBD definitely, definitely a theme you can sort of hang your hat on. Premiumisation is just an enduring theme. I don't think it's a 2023 theme or 2022, it's just happening steadily. We are seeing it now play out in other markets like hotels as well. In fact, if you look at the development pipeline in hotels, a lot of what's coming out is this premium branded offerings. And it's a big topic of discussion in the built-to-rent community as well around building these premium end product construction cost deflation. That's a tougher theme. I get a lot of pushback on that theme. And the feedback is, you know, raw material prices are stabilising, maybe even coming down. We met a large construction firm yesterday and that was the theme that was coming out in that discussion. The problem is labour and what we're hearing is that there is this tremendous competition for projects from government. This big infrastructure pipeline. Well, you're all across what's going on in western Sydney. And you know, it's not just transport, it's like...
PR:
Transport, healthcare.
SC:
Education. And so the feedback is, 'Hey, Sameer, yes look, raw materials, yes. But labour just be cautious.' And on labour what we're hearing is there's the reported numbers and then there's big sign-on bonuses and a lot of behind the scenes stuff. So maybe the labour cost growth is bigger than what we'd been anticipating. That's early. It's the first quarter. I'm not conceding yet.
PR:
Yes.
SC:
We'll keep this conversation going.
PR:
Yes. Well that was a topical discussion at the PCA actually about how we could probably benefit from some better sequencing of, you know, government infrastructure spend to alleviate that.
SC:
Phil, if you don't mind, can I ask you a question as well? You know, you're just back from a range of meetings with our clients in Asia and you know, these firms nowadays represent the bulk of sort of capital that's coming in and who've invested in Australia. What's their perspective? Is there any strategies they're looking to pursue? What's their urgency?
PR:
Yes, look , it was a good trip. You know, I hadn't been back up into Asia for, well, for four years really. So it was very good to get back there and get a sense for how Asian based occupiers and how Asian capital kind of see the world today. I think the first thing or the most overarching kind of takeaway for me was that Australia still represents a very safe place for capital. So despite, you know, a lot of capital still, you know, sitting on the sidelines at the moment, there is still a lot of conviction on Australia for the reasons that we all are aware of, but it's even more relevant in the conditions that we're in right now. And so a very strong sense that there's still a lot of capital wanting to access good quality product and with proven local partners. So I think that was a resounding theme that came out of that trip. From a kind of a sector standpoint, one interesting takeaway was around retail. As you know, very, very strong capability around retail in Asia. And so some of those larger investors and operators looking into Australia and seeing opportunity around how to reposition and they can see value. So I thought that was interesting. From an occupier perspective, a couple of quite interesting themes. Certainly, you know, really strong conviction on the China led recovery. And so with China opening up the sense of positivity that brings for key markets like Hong Kong and Singapore, to me has a lot of indirect and flow on impacts as we think about the Australian economy. So I think that was a very clear message that I picked up. The other interesting one was just the fact that in Singapore and Hong Kong anyway, there was some examples that I saw where the CBD occupancy was performing better than suburban decentralised locations. So in other words, the return to office was a lot stronger in those CBD locations than some of those more decentralised locations. And I think that goes to people, you know, what we talked about before, people want to be, have good amenity, they want to be together. And so that was an interesting observation that I saw and sort of reinforces this return to the CBD theme that we're seeing here in Australia.
SC:
Great. Thanks, Phil.
PR:
Well, I hope you enjoyed our latest edition of Talking Property: The House View. We will be back with our next edition in early July. So if you like what you're hearing, make sure you hit the subscribe button and leave us a review.
