KH:
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 it's great to be back with CBRE's Head of Research, Sameer Chopra for the second edition of The House View for 2024. If you recall, we made some bold predictions in our first edition back in January, and I've got a bottle of Coleraine on one or two of those with Sameer, so we'll be sure to revisit those in one of our later episodes in the year. But for now we thought it would be good to cover what's top of mind for investors as we close out the first quarter of this calendar year and get back to the basics and zero in on what we're seeing across the primary asset classes of office, industrial, retail and living. So Sameer, perhaps we can kick off with a discussion about what's topical for our clients right now. I know you've been very busy helping clients interpret the market and embed strategies to reflect those conditions. So what are the most pressing things that you're getting asked?
SC:
Phil, it's been definitely a very busy period of presentations, in helping clients prepare their investment committee reports. We're at this juncture where there's broad agreement on some of the longer-term tailwinds for real estate in Australia, but there's just not enough conviction yet on the strength of future rent growth and on exit values and in some cases the regulatory environment. So a lot of good investment ideas are spending more time than usual in due diligence or have stalled for now.
PR:
Well this stalling of deal flow is real and it's certainly reflective of the market that we're in. Just reflecting on it in January, there was an improved shift in sentiment as investors anticipated improving conditions, but the timing of some of those indicators such as inflation, moderating and rate cuts moving out a bit, we've certainly seen that sentiment weakening for the time being. But how does this contrast with what you're hearing from offshore Sameer in the Americas and in Europe?
SC:
So broadly similar dynamic overseas. So, in the US real estate valuations have corrected more significantly and there's good pockets of local opportunities for those investors. But transaction flow is still low in a historical context and real estate as an asset class has been left behind as equities and fixed income saw these really healthy returns in the back half of last year and into Q1 of this year. I'd say offshore investor interest from North America and Europe tends to favour our growth sectors. So industrial and residential. Asia has favoured value and so they're likely to play in office and previously in retail. How about you Phil? What are you hearing from our clients?
PR:
Well I would say a couple of things from the discussions I've had over the last couple of months. Firstly, ways to improve operational and cost efficiency through this period of compressing margins. We're certainly seeing higher outgoings, higher cost of debt, lower development activity, all that is putting pressure on margins. Look, this isn't new clearly, but our sense is that we are certainly through the worst of that cost pressure, but there's still a lot of work to do to get the cost out so that as the market recovers, we see margins improve, which obviously everyone's anticipating. The second one is just figuring out the sources of capital that line up with the strategies and the development pipelines of local investors and developers and then also figuring out where to deploy that capital, particularly geographically in this part of the cycle.
So to the first point, there's really no shortage of capital that has got conviction on Australian real estate, but finding the right strategic capital partner at the right pricing that's ready to commit now is proving to be a bit of a challenge. On the topic of where to deploy, Sydney remains a priority market, that's for sure, but when you look at the data and I'll get you to expand on this a bit Sameer, but there actually are parts of Australia such as Brisbane and Perth, that are indicating kind of better returns. So there's I suppose a challenge of focus coming up there. What do you make of that?
SC:
Phil, look I have always been a fan of quality and liquidity and so I think the Sydney market will continue to sort of command that premium. We've typically seen that at 25 to 50 bps of better yields in Sydney. It's a very safe choice for investors, particularly when they're dipping their toe for the first time. But in consumer-facing sectors, like residential, in retail, in hotels, you can afford to extend your horizon and look at those cities, Phil, that you mentioned here, Brisbane and Perth are indicating sort of better returns.
PR:
Okay. Well let's dive into the core asset classes. I'd like to do something a little bit different here, Sameer, and just tackle one question in each of them if I may which really gives us a moment to ask the simplest question so that we can get to the real fundamentals. So let's start with retail. There's been fresh interest in retail and shopping centres, particularly from the private market. And of course, we all know that retail was a sector that went through a period of real pressure through 2017 to 2021. We were concerned about the post pandemic changes in customer behaviours, leakage to e-commerce, and of course legacy asset composition. But retail has really weathered that storm. So what's happening in the fundamentals in retail that's making us fall in love again?
SC:
Well, there's actually quite a lot to like about the current outlook for shopping centres. Firstly we've got this booming population and retail spend is expected to grow to about 500 billion by the end of this decade, sitting at about 420 billion right now. So you've got this very strong demand. And then secondly, new supply for shopping centres is around half of what it's been historically and this drives up the productivity of shopping centres, which is a big reason why my US colleagues turned positive on the sector.
PR:
And when you say productivity Sameer, what do you mean? Elaborate on that.
SC:
Phil, we measure productivity through a metric called GLA per capita, which is basically space per person. And that GLA per capita for shopping centers has dropped from 0.8 to 0.65, which is quite a sizable move. And just along these lines, vacancy rates have now dropped below 5% nationwide. It should continue to keep falling as city centre shopping centres get filled up. Our historic low in vacancies being 3%. So that would be a nice target for us.
PR:
Yes. Trending that way. So what else supports retail?
SC:
We’ve got this increasing return to work rates, but the real big reason here in Australia is Australian shopping centres are underpinned by daily need supermarkets, which is a real draw card for repeat visitation by customers. Our own analysis shows that about 94% of shopping centres in Australia have at least two supermarkets in them. And so it means, people are always visiting these shopping centres.
PR:
That's been a real hallmark of the resilience for sure. So three really solid themes supporting retail. I'll chip in with one more and that's really that occupiers are continuing to evolve their e-commerce strategy so they have a more omnichannel approach. Again, that's not necessarily new, but certainly a continuing theme and companies are rediscovering this need for in-person interaction with clients, whether that's a showroom, a try before you buy, returns, you name it. Or even a shift towards direct to customer business models. So one final question on retail, Sameer, what about leasing spreads they've been looking pretty positive?
SC:
Phil, one of the things that really got me more constructive on retail is that these releasing spreads have now swung into positive territory. So the occupancy costs were lowered during the last three years, with some categories, for occupiers, where we saw about 15% lower rent to turnover ratios. We saw that with mini majors, we saw that with women's fashion. And as vacancy has tightened, rents can be rebased higher, much higher.
PR:
Well it's a good outlook for retail. Alright, so we've covered that off. Now let's tackle office. As we all know, this is the sector that really is in the eye of the storm right now. So I've got a fundamental question for you Sameer. So you and I have always been constructive on Australia core office, but investment sentiment remains really, really challenged. So as you think about office, why do you think we have this sort of yawning gap between the fundamentals and the sentiment? Is it differing views on the fundamentals or is it just price?
SC:
I'll tackle both. We'll tackle fundamentals and then pricing. So just on the fundamentals, return to work has seen a strong uplift in the early part of 2024. If you recall last year we were talking about CBD visitation sitting at about 71%, almost three quarters of the pre-Covid level. And that was Australia wide. Sydney was in the mid-seventies, Melbourne was at 56%. And now what we're seeing is that there's good momentum in Melbourne. Melbourne has improved to early-sixties, maybe mid-sixties and this should continue to increase as the year progresses. The other positive has been jobs growth in Australia. So the Australian economy added about 1.3 million jobs since the start of 2020. And nearly a third of these jobs have been your traditional white-collar workers. So people in professional services, financial services and government.
So there should be this continuing good demand for office space. So the fundamentals are good. Let's maybe just look at pricing. Cap rates in office expanded and I'd say we're getting close to sort of cycle high in Australia. Cap rates went up by about 50 bps in that second half of '23. And the latest conversations we've had with our own CBRE brokers and valuers suggest that we're getting close to stabilisation for that prime CBD stock. And in the US cap rates for office expanded by a little bit more, by 50 to 75 bps in that second half of '23. And now when we ask our US investors whether they expect further expansion, that percentage is starting to trend down. It used to be about 70% thought there's more cap rate expansion coming, now it's less than half and so it seems like we're getting near the trough of the office valuation cycle. Having said that, getting capital to actually take an active position in office is a whole different matter.
PR:
Yes. I think what you're saying is very supportive and undeniable fundamentals around return to office, population growth, white collar jobs growth. You didn't mention the transport infrastructure, but I think that's something that is a real tailwind for Australian office, pretty hard to match that. So I think what I'm hearing you say it's pricing.
And we're on our way there.
Okay, let's turn our attention to the living sector Sameer. As we've covered in our previous editions, living is probably the most vexed sector in that we have this unprecedented set of demand conditions that would have any investor constructive on the opportunity to serve multiple types of housing in Australia. But we have equally unprecedented supply side barriers in planning, taxation, construction costs and labour shortages. So the one question I have for you for this sector is how do we keep the faith in the living sector knowing these supply side challenges?
SC:
It's a very attractive market, Phil, in my view. We just cut our future supply pipeline forecast by 9%. So in 2023 and 2024 we see around 50,000 apartments delivered, which is around half of cycle peak rates. And supply over the next five years will hover around 50,000 to 70,000 apartments, demand is running at 75,000. Much, much higher than supply. So, at least on our numbers, vacancy will remain below 1% for the next five years.
PR:
Well it's interesting isn't it, sub 1% vacancy is very similar to what we experienced in industrial through 2022 and 2023, right? So rents increased in Sydney and Melbourne by about 70% during those two years. So practically, if you think about it in dollar value rent growth, what could we expect these tight conditions to create?
SC:
Our number is about $155 per week growth in the median rent for a two-bedroom apartment between 2023 and 2028. So, the average apartment’s rent is going to increase by about $155 per week. It's a bigger number, it's a much bigger number in markets where rent is already elevated. So if you think about, say the Lower North Shore of Sydney, I'm expecting rents will sit around $1,250 to $1,300 per week for a median apartment.
PR:
Well it's pretty aggressive rent growth and income levels are not growing at that pace, right? So how do you reconcile that with affordability?
SC:
It's an unfortunate situation in a tight market because vacancy is likely to remain at these very ultra-low levels. And these high prices are needed Phil in some ways to encourage supply. And my view is that this annual demand-supply mismatch is not going away anytime soon and consumers are just going to need to navigate these higher rents through a lot of different avenues. A larger share of many people's income is going to go towards rent, in some cases there'll be subsidies from the government. Some people will need to make a choice around location or around the type of dwelling or dwelling structure that they're in or maybe even the number of people that are contributing towards the rent or mortgage. We're constructive on both rents and prices. In rents, I've got about 28% rent growth over the next five years and potentially, a similar level of improvement in pricing, higher prices, but over a much, much shorter timeframe.
PR:
Alright, well look extending the chat on sectors with low vacancy let's have a look at industrial. 2023 saw takeup of 2.9 million square metres, which was down on 2022, but in line with 2019 and close to historical average. Actual takeup in Q1 of this year was 400,000 square metres. So a lower number, something to track and maybe an early indicator there Sameer. So can we see some space come back onto the market as the strength of demand from occupiers starts to moderate?
SC:
Phil, we were expecting that there could be a lot more sort of sublease space coming back into the market in late 2023, but this never eventuated. So it was a risk, it was something we were worried about. It just hasn't eventuated maybe at a scale where it causes market disruption and even as we speak today, our rent numbers are moving in a flat to mid-single digit type growth rate for 2024. There is a sense right now that supply chains destocked quite considerably during last year, in anticipation of soft consumer demand. We saw inventory levels come down by about 2% through the course of last year, but we've had these recent issues Phil with Australian ports getting blocked and global shipping and this is making clients rethink whether they should have more inventory sitting in Australia.
PR:
Alright, well there's some food for thought across our traditional asset classes. Sameer, before we wrap up, I just have one final question for you and that's just, zoom out a little bit and give us your overall view on the investment market.
SC:
Phil, I’d say I'm constructive on three things. On rents we've been raising our rent growth forecast now for the past six months and I expect that this'll continue. I'm more bullish on asset pricing, partly because we don't have too much distress selling in Australia. And the third one is, I expect more and earlier interest rate cuts over the next two and a half years. I'd say I'm more bearish on two things. Whether any of this mooted supply, whether it's office, residential, retail, whether any of this mooted supply will eventuate and just the pace of recovery and transaction volumes. How about you Phil, your thoughts?
PR:
Well, you know listening to you, it sounds like you're coming around to my pick on the timing of rate cuts. So I'm looking forward to that bottle of Coleraine, Sameer. But look, I think we're through the toughest part of the cycle and the re-rating has largely taken place and you can see that in the listed space, but it's going to take some more time, another quarter or two before we see confidence improve and pricing starting to align, what you touched on before. But when we do, I certainly expect volumes to increase pretty quickly. Alright, well thank you Sameer. In our next House View in July, we'll look to revisit our bold predictions from the first quarter and give you our views on where we see the market heading into the second half of the year. So be sure to tune in. I hope you've enjoyed this latest edition of The House View. A quick little plug though that we'll be continuing to release new
Talking Property episodes each fortnight. So be sure to subscribe through your favourite podcasting platform. And of course, if there are any topics you'd like to hear more about, you can email us at
talking [email protected]. Until next time.
