Kathryn House
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, 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 conversation.
Phil Rowland
Hello, I'm Phil Rowland and it is great to be back with Sameer Chopra for our first edition of The House View for 2025. There's a lot to unpack, including some of the key themes from CBRE's new Market Outlook report for Australia and New Zealand, where we will highlight the opportunities, risks, and challenges in the year ahead. What really stands out to me is the market's growing focus on exceptionalism, and this is an investment theme that you've characterised, Sameer, which better describes how we'll continue to see a market divide between strong rent and capital growth in premium, well located assets and much slower gains elsewhere due to a range of factors. We'll also explore the latest international trends and also what we're seeing locally. And be sure to stay with us until the end of the podcast when Sameer and I will be discussing some of our key market predictions. So Sameer, let's start off with a global perspective. What are we seeing in other markets? And maybe we start with leasing.
Sameer Chopra
Phil, yes, look for office, our US team is calling out three trends for this year. Firstly, occupier sentiment will shift from contraction to stabilisation and even expansion as business confidence starts to strengthen. Secondly, we expect many occupiers will opt for renewals. And thirdly, in terms of prime space, it'll become scarcer due to the slowdown in construction that we've seen. And in fact, the US team thinks vacancy could actually return to its pre-pandemic rate of around 8% by 2027.
Phil Rowland
And the US market has now seen a few quarters of positive net absorption. In fact, we recorded a small drop in US office vacancy of around 0.1% in the fourth quarter, a first since the start of the pandemic.
Sameer Chopra
That's quite an important development, because as improving US fundamentals play out, I think that's very good for, and very healthy for, investor appetite. It's not just the US though. If you look across to the city of London, right at the core, the central London office market, we're looking for outperformance with around 8% rent growth in that particular market.
Phil Rowland
Yes. It's very solid. And interesting, when we look it, Asia had a slightly softer leasing market in '24 after very solid volumes in recent years, although Japan and India are both poised to drive some increased leasing activity in 2025. So Sameer, let's shift to global trends and logistics. What are we seeing there?
Sameer Chopra
Phil, in logistics the US team expects robust demand for new warehouses because occupiers are increasingly looking at things like automation and amenities. In Asia Pac, in contrast, we're expecting leasing volumes will be flattish on last year. We think there'll be a lot more renewals and occupiers will look to consolidate into some of their core logistics operations.
Phil Rowland
Okay. So encouraging indicators in leasing. So, let's touch on some of the investment trends in the US. What's our US team forecasting on cap rate movement?
Sameer Chopra
Phil, so the US team expects cap rates will decline, but they'll still end up higher than where they were in the previous cycle. So if you look at this year, they're expecting that cap rates will be about 30 bps tighter in logistics, about 24 bps tighter in retail, about 17 bps in multifamily, and about seven bps in office.
Phil Rowland
Okay. Well, that looks broadly similar to what you've baked in for Australia, Sameer, although I think you are slightly more bullish on office cap rate compression, particularly in the Sydney core.
Sameer Chopra
Yes, we're slightly more constructive, Phil, on office cap rates for Sydney core, partly because we have tighter vacancy in Sydney core. There's evidence already of rent growth. We've also got assets that are newer vintage and there's already some pretty good evidence around high office attendance rates.
Phil Rowland
Yes, and just to round out our discussion on the global outlook, Sameer, just tell me what was the one thing that surprised you from our global 2025 outlook reports?
Sameer Chopra
Phil, it's the supply story. In the US, multifamily supply is expected to be about 74% down on 2021, about 30% below pre-pandemic supply. And in every sector in almost every region, new supply is just drying up.
Phil Rowland
Yes, that's stark and you can see it everywhere. You're absolutely right. Even in hotels, despite this booming global tourism, we're seeing supply’s been drying up and it's increasingly aimed at the premium end. And certainly, high construction costs and interest rates have really driven this thematic in a lot of markets. So just shifting gears for a minute, Sameer. That's a good picture around what we're seeing globally. Let's walk through some of our house views for 2025 as they relate to Australia and New Zealand. We opted to use the word exceptionalism in our Market Outlook report to describe the investment approach for 2025. Let's unpack that a little from a capital and income returns perspective. And I'd also like to dive into whether investors are more looking to buy or build in this next cycle. So perhaps we can dive into that.
Sameer Chopra
Yes, Phil. So we expect pockets of exceptionalism around premium assets that are well located. In these markets we think rent and capital value growth could comfortably exceed mid-teens this year. For the remainder of the commercial and residential market, we'd expect rents will be broadly flat to low single digits and capital growth to be flattish. So, you've got about a quarter of the market that is exceptional and just leaves the rest behind.
Phil Rowland
Well, we saw this concept of exceptionalism start to build out in 2024. It was certainly evident in the office sector where I think you calculated that the top 20% of buildings saw solid net effective rental growth of at least 10% year over year. But in contrast, about 1/5th of office buildings had net rents decline by at least 5% year over year.
Sameer Chopra
That's right. And you could see it clearly in Sydney where the core office precinct between King Street and Circular Quay, the main financial district, saw rents accelerating to an average of 8% growth. And that could be repeated again now, next year, the year after, as occupiers scramble to access limited space. Where this concept of exceptionalism though is most stark is in residential markets. Properties in Sydney, in Melbourne, in Brisbane that already have a high median value have experienced significantly faster growth over the last 10 years compared to their more affordable counterparts. In many cases, this capital value growth for these higher value properties is at twice the rate of their market wide counterparts. And Phil, talk about a very different type of exceptionalism, we at CBRE had a strong end of the year in 2024.
Phil Rowland
Yes, as a company we did, and of course the investment activity across Australia was up 34% on '23. So some good signals about increasing activity. We saw a particularly strong deal flow in office and retail. And the investor base appears to be gaining confidence that we're past peak interest rates through the bottom of the cycle, and that capital values are now at more attractive levels. And interestingly, our latest Asia Pacific Investor Intentions survey showed that Sydney and Melbourne are placed number two and number seven respectively as desired destinations for cross-border investors in APAC as they're keen to pursue these value add strategies in the region.
Sameer Chopra
Phil, also, just on that CBRE investor survey, they continue to highlight that office is now starting to gain traction. Industrial and logistics has enduring appeal, but office is starting to pick up. Within alternatives, surveys are showing investors favour healthcare, then data centres, and then private credit. These are the three leading sectors of interest.
Phil Rowland
Yes. Well, one other thing to monitor this year will be how the market moves in terms of larger ticket sizes, which brings into question the outlook for cap rates. So, while we all know Australia's lagging in the rate cut cycle, what's the outlook for commercial real estate pricing?
Sameer Chopra
Phil, cap rates driven by bond yields in the outlook for rent growth. And our latest forecast for Australia has office yields tightening by about a hundred bps from now until the end of the decade led by Sydney and Sydney's core precinct. Logistics super-prime yields we think will tighten by about a hundred bps and shopping centres by about 60 bps. And that's from early this year until late 2027.
Phil Rowland
And I presume assets that display these exceptionalism characteristics will be the first movers?
Sameer Chopra
Yes, look, exceptional assets or those that exhibit this exceptionalism, they're the ones typically in the prime precincts. They're the ones that'll move first. We could see about 25 bps of cap rate compression for these assets through the course of this year. I think, Phil, it'll also be a very interesting year for our colleagues in valuations because they're still navigating the tail end of some valuation decline in the secondary stock, but you've also got some of these exceptional assets that have valuation increasing at an accelerating rate. Tough year for them.
Phil Rowland
Okay. Well, before we get into a quick discussion on each of the sectors, I do want to go over this buy versus build investment thesis, which has come under really stark contrast in the last year.
Sameer Chopra
Phil, just to illustrate, there's a 30% gap right now between replacement costs and prices of recently traded stock in the Sydney CBD. For example, replacement costs around $31,000 a square metre and transacted prices are below $22,000 per square metre. So, you've got this about 30% gap - jaws, as I call it - and the jaws are getting even wider when you move away from Sydney CBD to other locations, and particularly as you move away to other cities.
Phil Rowland
Yes, well, rising construction costs, which by the way have increased by around 40% since 2020, really continue to put an enormous drag on development returns and feasibility. And so, despite some moderation, we've seen a bit of that, costs are going to remain elevated, primarily driven by labour shortages.
Sameer Chopra
Yes. Agreed. And the supply of real estate stock, whether it's retail, office, residential, is suffering from these high construction costs and elevated debt costs. Even in logistics, global trends suggest that new supply will be curtailed off its recent highs. In residential Phil, our outlook is this year the supply will be very similar to the levels we'd last seen in 2011.
Phil Rowland
Yes, it's amazing. At a time when we need it most.
Sameer Chopra
Yes.
Phil Rowland
Look, so let's do a quick tour of the outlook across each sector Sameer, starting with logistics. Australia's vacancy is 2.5%. New Zealand sitting at 1.7%. These continue to be amongst the lowest levels globally. What are we expecting in terms of rent growth?
Sameer Chopra
The logistics rents paced up a lot. They grew significantly in '22 and '23. Growth rate has slowed now, and for this year we're forecasting 4% face rent growth. Incentives will also increase. They were 13% last year, we think they could get up to 17% this year. So net effective rent growth might be flattish, and then we get a lot more constructive as we head out into '26.
Phil Rowland
Yes, and of course with the tailwinds from e-commerce and of course the dividend we're getting off population growth, occupier sentiment should hopefully improve as we see some of these rate cuts materialise. Moving to office, there was strong evidence of more staff returning to the office in 2024, but our leasing book was also showing a greater propensity for renewals. Around 60% of our transactions last year were renewals, up from 50% on prior year. So, what's the prognosis for rents in office Sameer?
Sameer Chopra
Phil, look, leasing velocity was slow last year. Nonetheless, net effective rents still managed to grow by about 5%. This was partly because you've got these pockets of exceptionalism around Sydney CBD Core and Brisbane. This year we expect most office sub markets will see at least flat and maybe even low single digits of growth in net rents. But we also forecast that the Sydney CBD and Brisbane CBD should outperform and could get another set of high single digits of net effective rent growth. High single digits.
Phil Rowland
Okay. And in retail, look, despite the challenges from high interest rates and cost of living, occupancy in shopping centres and large format retail is trending to above 95%. So, the lack of new supply coupled with this population growth has driven good real estate productivity.
Sameer Chopra
Yes, we're expecting low single digit rent growth for shopping centres. The main concern I have this year for shopping centres is the high fit out costs for retailers. Particularly restaurants and luxury goods that might be looking to expand footprint. They've just got this CapEx challenge around fit out costs.
Phil Rowland
Okay. And then residential, you're forecasting apartment supply will hover around 50,000 apartments in '25 lagging the demand of 75,000 per year.
Sameer Chopra
And so you can get more constructive on rents for residential and for student accommodation. Over the next five years, expect 5% per annum type rent growth to 25% in total over five years. We also expect that newly built apartments will sell at a 30% premium to the older vintage counterparts in that same suburb.
Phil Rowland
And this does highlight why Australian real estate is attractive and why there's currently this buy versus build thematic. Okay. So moving on, let's tackle some predictions for '25 Sameer that we can get a report card on at the end of the year. So hit me with your first one.
Sameer Chopra
Phil, I got the interest rate call wrong last year, but I continue to have a lot of conviction around rates and that rates will fall faster and further than market expectations. Whilst in our models, we're using three rate cuts my non-consensus personal call would be for four cuts in 2025.
Phil Rowland
Always got to have that non-consensus view Sameer. Well, that non-consensus view did get me that bottle of Coleraine, which I'm quite happy with, but I know that I'll share that with you and that I think your prediction for '25 is probably right. So, I'll leave it at that.
Sameer Chopra
Phil, my number two prediction would be we get this cap rate compression going through this year, particularly for exceptional real estate where we think 10 to 25 bps of cap rate compression is possible. I would expect that in premium office in Sydney CBD, core market in Brisbane, in prime inner-city logistics, regional shopping centres, and even in Sydney and Melbourne student accommodation. Ten to 25 bps of cap rate compression.
Phil Rowland
Yes, all right. I think the third one to watch will be whether we get an improvement in leasing velocity in the second half of the year as we cycle past these anticipated interest rate cuts. And of course we have the Federal Election coming up. So, you could couple that with an uptick in business confidence and some narrowing opportunities in securing some of this future supply.
Sameer Chopra
Yes, and particularly as incentives are still high, I think leasing volumes could bounce back. There is a carrot. The incentives are a carrot for the occupier. And so maybe we do get these leasing volumes up five to 10% in the second half of this year. My fourth prediction, Phil, controversial one, is that there'll be a lot more pressure for five days return to office in some sectors, particularly financial services and government. And here I'm talking about requirements where branch staff and essential workers who need to be in person compared to the colleagues in head office. I just wonder through the course of this year, if we start to get more parity across these workforce types.
Phil Rowland
I think it's a real thing. Look, many organisations have got very diverse workforces, diverse personas, so I think it's a real consideration. I also think though, that we've turned a corner on the importance of the office. There's really strong conviction now that despite flexible work patterns, the office is a critical central point of an organisation. And this rebalancing that we've been seeing is grounded in the simple fact that organisations and people are more effective when they're physically together. We're seeing this and the stance being taken by organisations and of course we're seeing the corresponding visitation numbers come up. All right. So I think that wraps us up. Thank you Sameer, and of course, thank you to our listeners, I hope you enjoyed this latest edition of The House View. You can always send us your feedback and any questions that you might have via
[email protected].We'll be back with The House View in Q2 so make sure to subscribe to Talking Property so that you don't miss this or any of our fortnightly talking property episodes. Until next time.
