Hello, and welcome to our quarterly Talking Property series, The House View. Together, CBRE's Australia and New Zealand CEO, Phil Rowland, and Head of Research, Sameer Chopra, will investigate what's next for the Australian property sector, the potential disruptors, emerging opportunities, and what's top of mind for the industry's major players. We hope you enjoy their conversations.
PR:
Hello, I'm Phil Rowland and I'm excited to be back for our third edition of the House View with our head of research, Sameer Chopra. Since our last podcast in early April, things have definitely become a little bit more challenging. We've had two further rate hikes, adding 50 basis points to the cash rate, values have certainly been coming under some real pressure. Pricing discovery is continuing to be very challenged, and we are beginning to see some early signs that occupies might be becoming a little more cautious off the back of what's been a period of real resilience to the prevailing conditions. So, what lies ahead? In this episode, we'll discover pricing, occupier feedback, and also dive into one of the hottest topics in Australia right now, the residential market. So to kick us off though, I did want to start the discussion with debt funding which is logically a very hot topic right now. So Sameer, your team has recently done some surveying on the commercial lending market. So, what are some of the key findings?
SC:
Yes, Phil, look, we did see a modest decrease in lending appetite in Australia since our last survey, but there's still a significant number of lenders who do want to grow their loan book and for lenders, industrial once again remains a favourite asset class with about 80% of lenders looking to sort of grow their book in that sector. The domestic banks seem to like stabilised office and non-banks continue to prefer build-to-rent and build-to-sell sort of projects. And then, you know, if you move to pricing, what we are hearing from the lenders is that they expect credit margins will increase by another sort of 20 basis points over the next three months, and that'll make things a little bit tougher in terms of commercial real estate debt for acquisitions and also for construction.
The lenders are also putting a lot more focus on ICR or Interest Coverage Ratio to make sure that the repayments are, you know, can be easily accommodated. An ICR of around one and a half is what the market is looking for. The other big highlight in debt markets is just the growth in credit funds, you know, at the current interest rate levels and with the current credit margins, senior secured debt can provide a really good risk reward for investors. So we're starting to see a lot more sort of interest in that space. But Phil, you recently caught up with Brian Stoffers, CBRE's Global President of Debt & Structured Finance. Does that appear that the US markets are now starting to stabilise? They went through a few wobbles in in March and you know, are they saying that things are starting to resume back to normal?
PR:
Well, in short, there's really not any evidence to suggest this. US markets are still very much in repricing stage and it certainly could be a few more quarters before we get a new equilibrium there. Investment volumes in the US were down nearly 55% in the first quarter, you know, with office down about 66%. So what's clear is that the credit constraints and the higher cost of debt are having a big impact. On valuations. We estimate office valuations have declined by about 34% and industrial and retail down by high teens. The US is certainly ahead of us, and dealing with some very specific challenges that, you know, such as high levels of debt that aren't so acute, here in Australia. But when we think about that contrast, Sameer, you know, what do you think about it from a domestic standpoint? You know, how closely is Australia following the US and other global markets?
SC:
Yes, Phil, look, in Australia there's definitely some repricing of commercial real estate, but it's much more sort of gradual pace. And there's some differences to global markets that are sort of explainable. You know, we expect that by the end of the second quarter 23, the office and industrial cap rates would've expanded by between 70 and a hundred basis points off the levels that they were last year. And this is for a real prime grade stock. There's quite a few transactions in the market and this will give us a sort of better price discovery. The market is, you know, vibrant in the small transaction size. It gets a lot more sort of illiquid as you move up into larger ticket size. But I do expect, you know, the valuation metrics will be quite different in Australia compared to away from us.
There's a few unique features. You know, if you think about office, for example, office occupancy in Australia is recovered at a much faster pace compared to US and Europe. You know, the office assets here are much newer built. They're much more sort of ESG friendly and so there'll be less CapEx hungry going forward. In industrial, you know, our vacancy across most Australian cities is much lower than global averages. And in retail, you know, we've got this immigration tailwind, so there's a couple of reasons why Australia may be a little bit better placed than some of the other markets. We've got maybe a little bit better income growth that helps hedging the valuation. I'd encourage all our clients to kind of really dig into this, dig into the detail with us. We have really good data here.
PR:
Yes. Well you mean you're right, Sameer. You know, the income growth has been a much needed cushion to the cap rate expansion that we are seeing. But the real question is, is this going to continue to hold? Or do we anticipate some softening, you know, as the economy begins to cool? You know, occupier demand, as I mentioned earlier, particularly in office and industrial, has been remarkably resilient throughout the year. And, you know, we've seen net absorption in office at 95,000 square metres odd, industrial at 2.9 million square metres. So the demand has been resilient. And what we're seeing here is a really is a reflection of the underlying health of the economy despite the industry environment that we're in. And so, and you look at the May employment numbers, I mean, they were just remarkable, right? Which is further evidence of this resilience and the demand.
I mean, I think it was May added 76,000 jobs, and you layer that on to what jobs have been added since the end of the pandemic and a million jobs have been added in Australia sort of post pandemic. It's quite remarkable, really. But this resilience is not going continue. You know, the levers that the RBA are pulling is dampening sentiment, there's no doubt about that. And it will ultimately cool the economy and this is going to cascade into the occupier market. But what's your view of that? You know, what do you see happening with rents and with occupancy and enquiries? What are some of those early indicators?
SC:
Spot on, Phil. They are trying to cool the demand, you know, it's way too hot. But let's say, you know, if you dive into rent growth in office, it's a very bifurcated market right now. Over in the west, in Perth, you know, net effective rent growth is running at 15 or 16% year on year, which is like, wow. And, you know, you've got rents growing, incentives falling. Brisbane is sitting at about 8%. And then on the other side, you know, Melbourne's doing sort of minus 2% minus 3% with a slight increase in incentives. So very bifurcated market. In industrial, you know, whether it's Auckland, Melbourne, Sydney, you know, in all markets we have seen sort of double digit rent growth now. And in retail it's more like sort of mid single digit rent growth in kind of shopping centres and CBD retail, a lot of our sort of fast moving, early moving data is showing this caution that you talked about.
Phil, you know, in occupier activity for industrial firms, revenues fell sharply in April, and they're back to May 22 level. And I think this will play into some of the enthusiasm around new space. We're also seeing a slowdown in the activity from some of the discretionary services companies, for example, in recruitment firms. So they're pulling back and, you know, some of this thematic about upgrading to better quality buildings, I think will start to, you know, reach a new plateau. It might pick up again, but you know, you could start to see a bit of a slowdown in momentum. The thing I'm most looking out for Phil is actually Black Friday and Christmas sales. I think that'll be a really interesting period. A lot of occupiers need to really think about how do they want to stock up for that period. You know, you've got a segment of Australia that's pulling back on spend, but there's also part of Australia that actually wants to continue to spend that's doing well. So, you know, after a quiet winter we could see a final splurge towards the end of the year. So I expect, you know, demand for industrial sites and sort of high quality retail to remain healthy with a bit more pushback around rent growth for 2024 renewals. But yes, really looking forward to seeing what comes out of Black Friday.
PR:
I want to focus back in on office Sameer. You know, we typically see some slowdown and upgrades during tougher economic times. Of course, this has been a little contradictory feature of the market post-pandemic with the ongoing flight to quality, you know, even as the economy cools. But you know, what about occupancy? You know, we're seeing hybrid work begin to normalise and, you know, with some increasing evidence of, you know, of large Australian occupiers getting a little bit firmer on more time in the office. How are you seeing firms shape their hybrid working settings and how's this impacting on, you know, their size requirements?
SC:
Yes, Phil, there's definitely sort of more chatter around this. There's better recognition of getting an appropriate balance between in-person and working from home posture. We've seen a lot more sort of firms coming out and clarifying their desired working posture. It's really hard to get very accurate occupancy data in Australia, very different to the US, but in all the conversations that our teams have been having with clients, it looks like, you know, we're somewhere around 50% to 80% occupancy on peak days. And it depends more on the size of the occupier, depends a lot on the industry you're in and depends a lot on the city you're in. There's Australia factors, but then below that it's actually, are you a big company, a small company? Which industry you in? Which city are you in Australia? The vacancy, you know, interestingly is also quite much lower in CBD prime CBD offices compared to suburban offices, which is quite different to what we're seeing in the US.
So, you know, overall as, as the year sort of progresses, I expect we'll start to see occupancy, you know, just keep ticking up even if leasing volumes do slow down to the point that you made overall in Australia. What our data is showing us is that office occupiers that take up less than 4,000 square metres, have grown their footprint by about 8%, and occupiers that have more than 4,000 square metres, so slightly bigger occupiers, are shrinking their footprint by about 8%. And that's what got you to that number, you know, which was kind of a net zero kind of thing. Or a flattish sort of number. So, Phil, we've had a pretty broad discussion about the commercial sector. I know you were recently down at the Property Leaders Summit in Canberra. What are some of the hot topics at the moment?
PR:
Yes, well, firstly, what I'd say Sameer, is I thought the PCA and Carmel and Anthony did a great job in organising the summit. I think that was my third one, and that was, you know, by far the best one. But I think there were really two things that struck me. First one is that regardless of where you sit on the political spectrum, you couldn't not come away with a sense that government leaders are highly connected and very consistent and have a very clear plan. I think we had about six federal ministers come and address the summit in at different times. And the messaging was all really clear and really consistent. And so I think we all came away feeling very encouraged by that. The second thing is that, you know, despite a wide ranging agenda, it's no surprise the discussions were really centered on housing, housing, housing. You know, I could say it's a big national issue requiring, coordinated approach across all levels of government, Commonwealth, state, local, and of course, you know, the private sector. So, the fact that it was all about housing was actually a, you know, a good thing. And because, you know, we've really got to get on with it. Look, I know you've been very focused on the residential market, Sameer, and I know you've been long calling out the strong investment fundamentals, around the sector, you know, what's your view?
SC:
Yes, Phil look, the fundamentals are very strong, particularly in inner suburban markets. This is something we've been banging the drum on for the last six months or so. You know, my estimate is that Australia needs about 570,000 homes by 2026 next three years. And, you know, supply is running at about 55,000 apartments per annum and that's it kind of thing. So you've got this big mismatch, but what's really important is the location. Just thinking about that, you know, looking back over the last 12 months, about two thirds of Australian precincts, you know, saw about 10% rent growth and one third saw 20% rent growth. So while rents are growing, some segments of the market are growing at double the pace of others. And our work, you know, keeps suggesting that this inner city precincts will continue to see outsized population growth. Just to give you some numbers here, Phil, you know, we need almost 50,000 apartments over the next three years in the city centre locations. And so that's Sydney CBD, Waterloo, Pyrmont, Melbourne City, Carlton South Bank, Brisbane City, Fortitude Valley, New Farm, you know, Perth City, Subiaco, Adelaide, Canberra, Civic, just this little small cluster in these cities needs about 50,000 apartments. So, this will create a lot of opportunity for investors, for developers, for government. I'm really bullish on residential.
PR:
Well, I suppose one thing we're going to have to look into too, Sameer, is of all that supply and in those locations, how is it segmenting in terms of the type of residential supply, right? So I think that's something I'm going to have to dig into. If you had to sum up the current environment we're in, what would you say?
SC:
Yes, look, Phil, overall, the current interest rate settings are creating a lot of uncertainty in the market, pays to be cautious. And, you know, to keep using my cricket analogy, there are a few cracks in the pitch. All I'd say is, you know, there's never a dull moment in real estate and just stay engaged. Lots of data.
PR:
Cracks on the pitch, right? And of course the Aussies kind of dealt with that last night in England. And, you know, I'm sure the market will, you know, in time, and I think the next few months will continue to be a challenge. There's no doubt about that, but, you know, with it some anticipated and really some required resetting. But beyond that, you know, I remain very confident about Australia's comparative strengths. That will continue to attract talent and it's going to continue to attract capital. I noted today the economist intelligence unit rated Melbourne and Sydney is third and fourth. Most livable cities in the world out of 173 cities. And you've got two Australian cities in the top five. And that speaks volume. So that comparative strength will attract talent and capital. And I think that's only going to be good for the property market long term, you know, once we've kind of reset. So on that note, I hope you've enjoyed, the latest edition of Talking Property: The House View. We will be back for our next house view in early October. And if you like what you're hearing, please make sure to subscribe. Until next time.
