KH:
Hello and welcome to Talking Property, our CBRE podcast series where 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. I'm Kathryn House, CBRE's Australian Communications Director, and I'm your host for this latest Talking Property episode. Today we'll be talking about capital flows and investment trends. It's clearly been a challenging year for Australia's commercial property investment sector with ongoing funding constraints, rising interest rates, and downward pressure on asset pricing. While some sectors have attracted continued demand, the hotel sector among them, Australia's office market has been under increased scrutiny and many investors have turned their sights to new and emerging opportunities in build-to-rent and alternative asset classes. So, what does the future hold? Will 2024 be a turning point, particularly for the office sector? Will debt funding be more readily available, and will investors increasingly look at new capital structures to drive their property investment strategies? To take us through the outlook I'm delighted to be joined by CBRE's Australian Head of Office and Capital Markets Research Tom Broderick, the Pacific Head of CBRE's Debt and Structured Finance team Andrew McCasker and by one of CBRE's newest recruits, Paul Ryan, who recently joined us from Goldman Sachs to head our Capital Advisors business in Australia and New Zealand. Thanks for joining me today.
So perhaps to set the scene, Tom, could you give us a feel for how this year's closing out. While we still have a few weeks to go, what are the stats looking like in terms of investment activity and the key trends you’re seeing, and I guess any likelihood of an end of year sales flurry?
TB:
Yeah, look, we've got the data through to the end of November and what it's showing us is that currently we're at $19.2 billion worth of transactions across office, retail, industrial, and hotels. That sits around 45% below last year's number. We do still have a month to go, so we'll probably still be circa 40% below 2022 levels for the year. The kind of difference between sectors has been interesting. So, hotels has by far been the bright spot. It's currently sitting 15% above last year's level at $2.6 billion. And in fact, it's likely to be the highest level for any year for hotels transactions since 2015. So that's certainly a positive. Every other sector is down on last year, industrial’s down around 22%, retail’s down 45%, and then, as you mentioned, office is down significantly, down 65%.
KH:
Yes, so office definitely has been one of the sectors that's been under the most scrutiny and I guess there continue to be ongoing hurdles to new investment. Andrew, I was particularly interested to read the findings of CBRE's latest Lender Intentions Survey, which shows that office had slipped below retail for the first time since you began doing that survey, on the list of sectors that lenders are keen to participate in. Can you talk us through that and the overall survey findings and what some of your key takeaways were from that?
AM:
Look, it was interesting but not unexpected that we saw the appetite for office being affected as a result of the cycle that we're in at the moment. What we are seeing is that the global platform is certainly being impacted by office prices and capital allocations into lending in the office and that's flowing into Australia. And the Australian lenders are cautious about participating in office, still have an appetite, but at a much-reduced level. And what we are seeing is that capital that they do have is being allocated into asset classes like build-to-rent, data centres, childcare and retail and hotels, as Tom mentioned. So, we're sort of looking at the assets which have been early affected by Covid and had a repricing event happen that are attracting the investment into that space now. If I look at the overall report that we had out, the interesting part was that the market is still looking for opportunities to invest in via debt platforms and the alternate space has definitely given that opportunity to be able to do it and expand their concentration outside of office and industrial, which is what we're seeing out of the surveys.
Interestingly, there's not a really big push from the responders in the survey about increase in margins and we're seeing a bit of a spread across each of the lenders that participated in the survey as to when we start to see interest rates fall and it spreads everything from the back end of 2024 to halfway through ‘25 and potentially some lenders saying 2026. So, it's very much a wait and see in that space as to what happens with the cash rate and how that flows through to the official lending rates.
KH:
Yes, I keep seeing so many different points of view on when interest rates are going to, you know, stabilise. Some people were saying we're going to see more increases. Now people are saying this will be the last rate rise that we've seen. Do you have a view?
AM:
My personal view and full disclaimers against CBRE. So, my personal view is I think we'll start to see official cash rates ease in the back end of ‘24. We potentially have one more rate rise in us, and I think that'll be driven off the back of retail sales figures through the Christmas period. The government's done what it needs to do to manage inflation and there's a few extra things that need to happen for that interest rate to come down. But I think by the end of ‘24, we'll definitely see it. I'm not sure if Tom agrees with my approach, but certainly from the data we're seeing from each of the lenders, a large number of them are pointing towards 2024.
TB:
Yeah, I think certainly the inflation figures last week were relatively positive, negative for one month and probably lower year on year than people were expecting, which helps. But look, we've been wrong before on interest rates.
AM:
Yeah, and I think too, Tom, where it's such a dynamic market at the moment, like we've got low unemployment, we've got really low vacancy rate, property prices continue to push through, everything's contradictory to what should normally happen in an economic environment.
KH:
And so, we talked briefly about office. I was interested in another one of our surveys, Tom, which was our office occupancy survey, which has attracted a lot of attention and showing that the return to work is gathering, I shouldn't say return to work, I should say return to office, is really gathering pace. Do you see that starting to change the attitude toward the office sector here from an investor perspective. Those more positive numbers?
TB:
I don't think we've seen it through transaction activity. As I mentioned, we're 65% down on last year for office investment, but it is absolutely the biggest question that we get in the office space is what the return to office is like. I think sometimes Australia gets lumped in with the US and other markets, but what our report showed was there has actually been decent momentum in the return to office throughout 2023. On average across Australia, we're sitting at 71% of pre-Covid levels, that's up from 54% 12 months ago. So that's improved quite a bit. Sydney's been the biggest improver over the last 12 months. For context, the US was sitting at around 50% at the start of the year and they're still sitting at 50%. They really haven't seen any improvement, whereas Australia has seen some improvement and certainly we're finding that the smaller markets on peak days are almost back to pre-Covid levels. I think that will help on the investment side. We probably just haven't quite seen it yet.
KH:
Yeah, no, it'll be very interesting to see how that does play out in 2024. Ss, shifting from debt to capital and welcome to CBRE Paul. You are working closely with Stuart McCann who heads CBRE's APAC Capital Advisors business, to steer capital raising, Coporate Advisory and M&A Services. I'd be really keen to hear about the trends you are seeing in that market, including how Australia's currently being viewed by offshore capital.
PR:
Thanks Kathryn. And I'm very excited to be joining the CBRE Capital Advisors team. I might start with how Australia is being viewed by offshore capital as that plays into the trends a little bit. So, when investors look at Australia, it's very much seen as part of Asia, and I think within that context is viewed as a highly attractive and transparent market to deploy capital into. The weak Aussie dollar is also seen as a positive in terms of an entry point into this market. Similar to what Andrew was saying, the interest rate cycle is viewed as coming to an end in the nearer term with the rates expected to stay higher for longer. Although trending down, I think consensus is pretty hard to pin down. But you know, broadly speaking, the end of ‘24 and into ‘25 is when investors are planning on that to flow through into the market.
I think investors, it's safe to say, are conscious that Australia hasn't repriced as far as say the US or UK Europe. So, there’s some concern that Australia seems a little expensive on a relative basis. Foreign investors have significant capital to deploy, however, their risk appetite is low at the moment. So really, sentiment needs to be assessed by individual sub-sectors. To give a bit of a feel for that, I mean office, similar to Tom's comments, is pretty challenged at the moment. You know, there is high conviction in certain pockets of Sydney such as the CBD core. We are seeing increased inquiry around discretionary retail in conversations with investors, which, you know, it's been a very long time since that's even been raised. So that's a positive sign in that space. And there still is solid interest remaining in the industrial & logistics and living sectors.
Although we would note that investors are being more selective in how they look to deploy capital within these strategies. The alternatives or niche sectors remain highly sought. Some examples include data centres, student accommodation, self-storage, land lease communities, health and life sciences, social infrastructure, tourism and leisure, and anything really exposed to the energy transition and renewables. Investors are also seeking to increase exposure to real estate debt and private credit strategies on the basis that they offer compelling risk adjusted returns versus equity at the current point in time. And in terms of structures that investors are looking to invest into Australia in it remains via JVs, SMAs or separate managed accounts, partnerships or club structures, which offer greater control for the investor and also alignment with managers. In terms of the trends that we're seeing across our business, there's three I'd call out. I think we do expect direct market volumes to increase and as Tom noted, that's off a very low base.
We expect that to happen as rates stabilise and the bid-ask spread narrows. We think that happens probably, you know, second quarter, middle of next year. We think M&A volumes will remain subdued. And we think the catalyst for that being reinvigorated is when NTA resets as valuations come down and debt financing conditions normalise in terms of both the volume available to fund M&A and also the cost of that debt. And then the last trend we're seeing, I think private capital, we expect to remain the primary source of equity financing to support in any M&A and also equity raisings, which we think will remain including partnerships, JVs and recaps particularly in the alternate asset classes.
KH:
Yes, that alternate asset class interest is coming through quite strongly. In the debt survey that you just recently did, you know, there was a doubling of the lender interest in alternatives. Why do you see that that's happening? What's the real sort of attraction there?
AM:
Well, I think similar to Paul's world is that the groups are just looking for that greater return and some continuity in relation to cash flow. We're looking at data centres or cold storage as an alternate investment asset and the certainty of cashflow over a long period of time is there, but also they're getting a greater return and more certainty of that stabilised return, than what they are in office. I'd be interested, just if I jump back for a sec, Kathryn, when Paul's talking about capital partners into Australia, the groups that had primarily focused on office, Paul, have they shut the books or are they looking to another asset class?
PR:
I think there's probably more interest in lightening up on office than bulking up in office and I think that the interest is still there to acquire, but it's being a lot more selective. So, I think as I mentioned, we are seeing strength in certain pockets such as the Sydney CBD core where occupancy is still very tight, rents are increasing on an effective rent basis and there's real, I guess, tailwinds behind that specific submarket. But outside of that where there's a lot more uncertainty around where rents are going, and the view that cap rates have a fair way to move, I think it's very hard to underwrite that exposure and that risk. So, I think it's more, yeah, looking to lighten up on office and then selectively looking to repurchase. I think in terms of the assets that we've seen come to market, it's less of the investments that people want to make. So less of the prime, really prime Sydney core assets.
AM:
So, if they're not doing office Paul, are they looking for, again, those alternates that Kathryn was talking about?
PR:
No, absolutely. They are, and I think for similar reasons that you were just mentioning. So, I mean the alternatives typically offer pretty good fundamentals, you know, compelling cash yields, they've got little leakage for example from tenant incentives. They've got strong rental income growth and typically there's, you know, very high occupier demand, for mission critical real estate. There’s often high barriers to entry. It's often hard to replicate these assets. I think for those reasons, you know, the fundamentals stack up much more strongly for the alternates than for the traditional sectors. I think investors are also seeking to diversify a little as well, you know, most of them are pretty well set across retail, office and increasingly industrial. So, in terms of just getting a bit more diversity in the portfolios, this is really where they need to get to. And I think from an Australian context, getting access to these alternate sectors is just incredibly hard to do in scale. You know, effectively there's a lot of investors chasing very few investment opportunities, which is really underpinning pricing and typically generating portfolio premiums for vendors who are looking to exit these investment classes. So yes, I just think it's good fundamental, scarcity of investment opportunities and better risk adjusted returns in the alternatives at the moment.
KH:
So, I think we just talked about cap rates, but I know we have just completed our recent Cap Rates Survey for Asia Pacific, which has highlighted this delay, you know, and lag effect. The respondents, only 12% of them cited a recovery in their local markets this year and that was largely in India and Japan, and interestingly Australia was tipped to be one of the laggards. But from 2025 onwards. I'd be really interested to hear your views on this front. You know, when it comes to capital markets, what your expectations are.
TB:
Look, we've on our numbers recorded kind of 100 to 125 basis points of softening for the industrial and office sector over the last 12 months. Retail probably not so much, particularly in metro areas, maybe in regional areas, more softening. So, it has been delayed compared to other markets in Asia Pacific, but we are certainly seeing it now because of more transactions that are occurring. We kind of feel the yields will probably stabilise sometime next year, maybe around Q3. We're pretty close to peak interest rates, we think. So once interest rates stabilise, we think there will be a delay in the stabilisation of cap rates, but we do think it'll happen sometime next year and hopefully that will trigger more transactional activity.
KH:
Yes, I mean, and the more activity we have, the more evidence that we've got so that really gives people a lot more confidence when they're looking to invest.
PR:
I think from an investor perspective I guess it's more valuations than cap rates. I think the consensus is that cap rates just have to come down. I think they’re backward looking, and the question is whether or not valuations can hold, given there's offsets between rental growth, industrial being the sort of prime example, whereas cap rates have blown out quite considerably, but a lot of the valuation impact has been offset by an increase in rental growth. So, I think it's, yeah, the cap rate question, it's not if but how far and then it's what does that flow through to value? And I think the investors at the moment are looking at valuations and just sort of taking them with a grain of salt and looking at what their forward IRR calculations or return hurdles are going to be and sort of whatever the number is it is, but typically I think that's below valuation, but for, you know, certain of these alternate sectors that are pretty highly tightly held.
AM:
I think that's a good point too, Paul, and right at the very start we spoke about the lenders’ cautiousness, particularly in the office space, and it comes down to the valuation side of things. The income has definitely been affected because of the significant increase in interest rates, but until such time that the financers can get comfortable with what the actual valuation is and having a view is that the bottom or is there further to go, that cautiousness is going to continue to apply, specifically into that office sector.
PR:
And you look at the listed market, which is trading at a pretty meaningful discount to NTA and obviously NTA’s backed by valuations that get restruck every, call it six months. So, I mean the market and investors don't believe book value and maybe it's oversold, but you know, I think the answer is somewhere in the middle. I think valuations have to come off and you know, maybe there's a bit more upside in in the listed market. But yes, it feels to me that they're overstated at the moment.
KH:
Will that start coming through at all in the next reporting season come February, will we see that start to be evidenced more?
TB:
I think it's just been a slow unwinding over the last 12 months and that'll continue again. The poor valuers are waiting for transactional evidence that has been very slow to come and it is trickling through across most sectors.
PR:
Yes, I think it's a bit death by a thousand cuts until we see that activity pick up and then it's a bit circular about when the activity will pick up versus valuation. So hopefully sooner rather than later.
KH:
Absolutely. So, Tom and Andrew, you've been on this podcast before and you know, I always like to ask sort of one big question. So, I would love to know if you have any contrary views on the outlook for 2024 and if not a contrary view, one of your top predictions. Maybe I could start with you Andrew.
AM:
Look, I always dread this backend of the recording when you ask for these comments, I've yet to get one right. I did mention that I feel that the interest rate cycle will start to soften and come off at the back end of ‘24. I do believe that the market and the cycle we're in is going to be short and sharp and potentially we could see some positive reduction in interest rates happen by June if we see the inflation figures continue the trend that we saw last month. The Christmas retail trade figures, within what the projected band is going to be. And we see a little bit of movement in the unemployment rate moving up slightly to provide a little bit of headroom as far as the employment's concerned. I think if those three key markers come into play, we could actually see that interest rate cycle come forward six months and start to ease.
KH:
I like it. What about you Tom?
TB:
Well, I think the contrarian investors are already starting to look back at office. I think a lot of the major institutional investors are still focused on industrial and alternatives about what we've talked about today. But I guess from a fundamentals perspective, there are actually markets in office that are doing better from a leasing perspective than pre Covid. The pricing is starting to look attractive, like our research yields are back to 2015 levels across most markets. And then as we've already spoken about, the return to office in Australia hasn't stagnated. It's actually progressing quite healthily and it's been all over the news recently about some large organisations who are getting a lot more serious around getting people back in, impacting on people's pay and bonuses. And so that should help in terms of the fundamentals for office moving into next year. And my bold prediction is that Andrew McCasker will get his prediction on interest rates right this time.
AM:
Well I'm cursed now, thanks Tom.
KH:
No, no, I think a lot of people would like that prediction to come true. I would for my own personal perspective with my mortgage. So, Paul, you're going into the hot seat for the first time. What's your view?
PR:
Yes, I think we'll see an uptick in capital raising activity around the alternates, and I think a lot of that will be driven by, currently a lot of them are in sort of develop to core strategies. So really shifting from that cost of capital to a lower cost of capital as portfolios have reached critical mass. I think that will be one theme that we'll see play out. And I think maybe a contrarian one, it is obviously very early days, but I think there will be an uptick in investment in discretionary retail. The non-discretionary end of the market has just held strong throughout. Obviously, anything anchored by supermarkets or anything small enough to be acquired by high-net-worth individuals has just been pretty much bulletproof. We're starting to see transactions in the bigger end of town of, you know, $200 million-plus malls and I think what we're seeing there is from peak to trough pricing, I think it's probably off 40 to 50% in some instances.
So, it is absolutely repriced in terms of the income. There's an element of stability there. I think the tenants, occupiers are in a lot healthier position, you know, from an occupancy cost and just overall health perspective. So, I think people can underwrite income, underwrite a little bit of growth and I think the e-commerce penetration has sort of played its course a little bit. It's structurally different to overseas in terms of delivery times and logistics infrastructure that's in place. I think people, investors can get a lot more comfort with the yield and the growth in those sectors and the yields are probably at a point where you can get positive leverage. You know, so in the absence of everything going bad and hitting a massive recession that impacts the consumer, I think that could be something to watch out for in 2024.
KH:
No, and let's not see a massive recession, I don't think any of us want to see that. Thank you so much for your time, Tom, Andrew and Paul. It's going to be interesting to reconnect in a few months' time to see how your predictions have played out and how market and conditions have evolved. Thanks for tuning into this latest episode of 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,
Apple Podcasts or your favorite podcast hosting platform. You can also access our latest Lenders Investment Survey and our Office Occupancy Data by clicking on the links in our show notes. And if you have any questions or feedback on this episode or ideas for future podcasts, please email us at
[email protected]. We'll be having a small break until January 8 when I'm excited to let you know that we'll have a new Talking Property Client series that will kick off for the three weeks of January. We're going to be talking to Lendlease Charter Hall, Investa, CBRE Investment Management, Aware Real Estate, Brookfield, Aliro and ISPT about where they see the best opportunities in 2024 and where they see the best opportunities for transformation in our industry. So happy holidays and make sure you tune in.
