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 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.
PR:
Hello, I'm Phil Rowland, and it's great to be back with CBRE's Head of Research, Sameer Chopra, for this third edition of The House View for 2024. We made some bold predictions in our first two episodes of The House View, and we're going to be revisiting these later in the podcast to see whether our bets have actually paid off. So be sure to stay tuned. We'll also be delving into why alternative asset classes are on the investment radar, examining the growth potential in data centres, healthcare and hotels. We'll also give our take on the outlook for rents, vacancies, demand and investor appetite across the office, retail and logistics sectors. Kicking off with alternatives, acknowledging, though, that there are some differing definitions on what constitutes alternatives, but I thought we could zero in on data centres, renewable energy and healthcare as some good examples. Many of our clients want increased exposure to these types of assets, but at the Property Council's recent Property Leaders' Summit, the discussion centred on the limited investment opportunities. So Sameer, am I right in saying that each of the buckets in the alternative sector is currently only about 1/ 10 the size of the core commercial property asset classes?
SC:
Yeah, Phil, look, that's correct. If you think about office, industrial and retail, they collectively are about a $ 900 billion investment market in Australia. Alternatives collectively is worth about $100 billion currently. So if you want to hit scale in alternatives, it's a little bit more challenging. There'll probably be room for only two or three participants to gain an efficient position in each of these alternative sub-sectors, at least over the next three to five years.
PR:
Yes, okay. Well, certainly a bit challenging, but against that backdrop, there is some scope for acquisition activity to consolidate the market over the coming years, particularly if construction costs delay new supply. So let's zero in on some of the growth sectors in Australia starting with data centres. From a global standpoint, data centre inventory has grown by about 20 to 25% year over year in 2024, and there are certainly consistent growth patterns across our different global geographies. But one number that really stood out for me, Sameer, was that Sydney currently ranks fifth globally when it comes to the size of the city's data centre inventory.
SC:
Look, Phil, Sydney's a very large market from a data centre perspective. It also, by the way, ranks 7th globally in terms of net absorption. If you think about rents, which in data centre land is measured in kilowatt-hours, rents are increasing at about 20% type levels in the U.S. by about 5% in Europe, and in Sydney, they're broadly stable. When you look at global pricing, Sydney ranks mid-pack, and in the U. S. pricing is about 25% cheaper. Sydney has good availability right now, which is attracting these global cloud providers. This availability should also attract clients who are looking at AI compute, but power accessibility remains a real global challenge and that's affecting development timelines.
PR:
Look, there's a lot to consider around energy transition pathways as data centres, real estate electrification, and of course, EV put huge demand on our grids. So this is leading a number of clients to explore real estate related ideas to get exposure to the energy thematics, whether it be owning solar and wind farms or battery sites. But just switching tracks for a second, Sameer, healthcare, it's another sector in the spotlight. Australia's healthcare spend was around $260 billion last year, and we are estimating growth of around 3.5% per annum over the next five years, which is obviously going to outpace GDP forecast, but due in part to our aging population. So that's clearly a tailwind for the sector.
SC:
Phil, look, aging and population growth are the two tailwinds for the healthcare sector, which by the way, now counts for 1 in every 6 jobs in Australia, used to be 1 in 10 mid-2000s. It's now 1 in 6. Another positive for the sector is Australia is not oversupplied with hospital beds compared to other developed countries. We have about 3.8 beds for every 1000 people in Australia. In most other developed markets, the average is 4.3 beds.
PR:
Yes. Well, that's clearly driving investor demand, and we've typically seen clients gain exposure to healthcare by investing in hospitals, research facilities, medical offices, medical centres, pathology labs, etc. But I know we've discussed some newer, I suppose, emerging opportunities, particularly in healthcare precincts, Sameer.
SC:
Yes, look, Phil, I think some of this is because we have this unique situation where there's significant investment coming in from government in redeveloping public hospitals. You can see this from the state governments, and these can seed opportunities to build out these large-scale public-private precincts. So when I think about a precinct, it typically would include a public hospital, a university, a private hospital, a couple of specialist hospitals such as an oncology centre or an eye hospital. You can have medical offices that have consulting suites in them, path labs and also you can expand into some other things like essential worker accommodation, car parking, amenities. It's almost like a mini suburb.
PR:
Yes. Great diversification opportunities and, of course, to be successful you really need to build deep relationships with all the stakeholders, hospital operators, government, of course, which takes a big investment of time. Alright, so just switching tracks again, Sameer, I'd like to turn to hotels. This is a market which recorded strong capital markets activity in Australia in 2023. As investors got better clarity on the fundamentals, domestic visitor nights in 2023 were about 7% ahead of 2019 levels, which is quite remarkable given the cost of living and the high interest rate environment. International visitation has also been rebounding with New Zealand, the U. S. and the UK being Australia's top three source markets. So, Sameer, what do you make of this backdrop?
SC:
Really interesting, Phil, when you reflect back that domestic visitor nights are up by 7%, given all the economic challenges you spoke about. I think population growth has a lot to do with this. It has a dramatic impact on hotels. It's a point that often gets missed. At least on my rough maths, for every 1 million new Australians that we have, we need 11,000 more hotel beds. That's about 20 new hotels that need to be built. At least the way we're seeing forward supply, there's only about 5,000 hotel beds at best in the supply pipeline, and it's very skewed towards luxury and upscale. Hotels look and feel a lot like residential, by the way, Phil. Supply is half of demand very much at the premium end of town.
PR:
Of course, similar demand and supply gaps as student accommodation, so some consistent themes. When I was looking at some of the other hotel statistics another positive has been the bounce in occupancy rates, which have returned to 2019 levels. Average daily rates have also recovered pretty quickly and range 20 to 40% higher than 2019 levels, which is really helping to offset the cost of doing business as wages and outgoings rise.
SC:
Yes. Look, Phil, fundamentals were positive, and they were starting to turn positive towards the back end of 2022 and I think this drove a lot of the investment activity. Last year, we traded about almost $2.5 billion of stock, which brought hotel investment activity back to its 2015 levels.
PR:
Yes. Sameer, one last question before we look at our bold prediction scorecard. What advice do you have for investors as they consider positioning for the second half of the 2024 calendar year and into 2025?
SC:
What I would say is that returns tend to vary significantly during this period of interest rate change. We will have value investors that are hunting around for undervalued office and shopping centre assets. We're seeing that right now. But over longer periods of interest rate changes, assets that can just deliver consistent, sustained rent growth should be well-placed to perform. I'd expect industrial would be one of those. Healthcare, residential and student accommodation, these are some of the sectors that'll do well. Our U.S. team also likes industrial and multifamily just on the strong fundamentals. They're also constructive on retail, by the way.
PR:
Yes. Well, the improving retail outlook was something that Henry Chin mentioned on our last podcast, and we're certainly seeing some more activity there. So look, I think it's time now, Sameer, to look at our scorecard and how we're tracking against some of our predictions from earlier in the year. We made some calls on a range of topics. We made some predictions on the outlook for rents, vacancies, office visitation, pricing, transaction volumes, and of course, the most vexed one, interest rates. So let's start off with rents and vacancies. You were expecting that rent growth would persist in 2024, albeit that there might be slower leasing activity, and alongside this, that vacancy would continue to remain flattish. So Sameer, what's transpired?
SC:
We might break this one down by sector, Phil. So if you think about office, prime office rents are tracking to about 1 to 3% quarter-on-quarter growth into the second quarter. We've just had our meetings and that's what's happening. Incentives are flat to slightly lower in CBDs and then the market's just bifurcating, Phil. CBD office is outperforming because what we're seeing is occupiers are moving inwards. It's a very different story out in suburbia.
PR:
Yes, absolutely. Even within CBDs, there's a large variance with the core outperforming more fringe locations, and certainly our leasing teams are really encouraging clients to come early to the market as vacancy tightens up in the premium product. To illustrate this point, in the U.S. prime office buildings have had a net absorption of around close to 50 million square feet since 2020 compared to non-prime and with a negative net absorption of 170 million square feet.
SC:
Just speaking about that premium office point, Phil, we've been very constructive on law firms as an occupier group for the past two years. That's an industry which has continued to see growth. They're hiring very actively as well, and they're very active in the pre-leasing market. So yes, look, I continue to like law firms as an occupier class. I'm also sticking, Phil, with my controversial call that Brisbane CBD prime office will have the strongest rent growth this year out of any sector geography combination. We're looking for mid-teens' growth there. So that basically means Brisbane CBD office rent growth should outperform industrial, retail, residential, any sector asset combination this year. In logistics, we came into this year cautious. A number of the 3PLs, the large warehousing companies, logistics companies, they'd been really active in 2022 in particular. The outlook for retail sales is pretty uncertain right now just given these economic pressures. Rents have also gone up very significantly, by 70% in some markets. But it appears that right now face rents are holding firm quarter-on-quarter, but there's a creep up in incentives.
PR:
Well, certainly from a leasing standpoint we are seeing some signs of softening in demand, although in the second quarter we did see a bit of an uptick in inquiry in the food sector. Of course, globally, we're seeing a lot more emphasis from occupiers renewing leases rather than relocating in the current environment.
SC:
Look, and then the final one is just shopping centres and we're seeing flat rent growth. There's been some outperformance in Western Australia, but ex-Western Australia shopping centre rent growth flat. In resi markets, by the way, rents are showing signs of stabilising. At the current high level, vacancies also paused. Some of this is just seasonality, Phil. You normally get a very strong first quarter when a number of students come to the market. There's also a whole bunch of people that graduate from university and have their first jobs, and all of that transpires in the first quarter. So second quarter, things are softer, slower, and Perth continues to outperform. Vacancy is super tight in Perth.
PR:
All right. So broadly speaking, we're comfortable with the prediction on positive rent growth and relatively stable vacancy across sectors despite the slow GDP growth. Our other bold prediction had been that return to office would continue to gain some momentum. So I recall, Sameer, you expected we could return to 2019 levels on peak days, so what's the data telling us on how we're tracking?
SC:
We've built our own office visitation tracker, Phil, so that's sitting at about 76% of 2019 levels. On peak days, office visitation in Perth, Brisbane and Sydney is near or above 90%. Melbourne also is showing better signs of recovery in 2024. It's following Sydney's trajectory from last year. I just caution, though, the data is very constructive on CBDs, but it fades as you head out towards suburban markets. There are some real nuances also around occupier types.
PR:
Yes, that really should allow occupiers to have a little bit more confidence in making their workplace decisions. I also heard a really interesting anecdote from New York that subway usage during workdays for prime locations is nearly 90% of pre-pandemic levels, so perhaps some more positivity to come in the U. S. also. So next prediction, I recall you saying, Sameer, "I am bullish pricing and bearish volumes." So that does seem to have played out in office in resi, where transaction volumes have been softer, but there do seem to be some green shoots coming through for shopping centres and logistics.
SC:
Yes. Look, Phil, on overall investment volumes, I still believe that this year, 2024, is going to end up being flattish on last year. Pricing's a very different story. Maybe let's start off with some positives. Residential values are tracking up to mid to high single- digit growth in 2024. That was one of our big calls, by the way. Shopping centre and logistics pricing also looks like it's found a floor. Prime shopping centres are trading near low 6% cap rates and logistics with a high fives cap rate.
PR:
Sameer, I presume based on some of the recent transaction activity that cap rates are widening a little more in office.
SC:
Yes. Look, Phil, we had expected about a 25 bps widening in the first half and then flat for the rest of the year, but it looks like they could be up to 75 bps of widening. So a trough to peak cap rate expansion for a grade A asset in CBD location could be closer to 200 bps overall. Whereas my previous expectations had been 125 to 150 bps.
PR:
Yes. Well, it was interesting to hear Henry's view that cap rates in Australia are trending towards parity with what we've seen in the U. S. and Europe. So perhaps this helps get buyers and sellers a little closer in the bid ask gap.
SC:
Yes, look, but we're still not expecting to see a large amount of distressed selling in Australia. Gearing levels appear to be pretty conservative. Incentive levels remain the other key thing that the market's very focused on right now, Phil. People just want to get a read through on what's the true effective yield on these assets.
PR:
Right. Let's talk interest rates, Sameer, which is probably where we've had our most divergent view, you and I. So, you were expecting two rate cuts in Australia during 2024. Now inflation is still tracking at the mid-high 3% level and, of course, the RBA has not given any indication that they see policy being eased. It does appear that a rate cut is unlikely in 2024, but what do you think?
SC:
Look, I acknowledge I've got a contrarian view. I still expect interest rates will be cut in 2024. Maybe let me lay out the case. There are three things on my mind, and we'll just see how they pan out in the second half. The first one is inflation has come down quite a lot, and it was very high in 2022. It's come down from its peak levels and yes, it's been stubborn more recently. Second one is the underlying economy itself is actually, it's got a real cold draft to it, particularly when you look at retail sales or GDP per capita. Of course, the immigration tailwind that we've had is going to be much slower from here. The third thing at the back of my mind is it takes 12 months for the impact of any interest rate hikes or cuts to start to come through. So any course correction that needs to happen because of this slowing in retail sales or GDP, it needs to start early. Also, Phil, don't expect the first one or two interest rate cuts will have a material impact on things like retail sales. Most mortgage repayments in Australia are set at a fixed amount per month and any rate relief people get will just be used to pay down their mortgages at a faster rate, at least initially. So it probably won't be until we're well into the cutting cycle that it actually starts to provide some impetus in the economy.
PR:
Yes, I agree with that, but I am going to stick with my view that we won't see rate cuts until next year. I just really think, as I've said, that inflation remains very, very stubborn. So you'd better get down to the store there and get your bottle of Coleraine lined up, mate, because I'm going to be looking for it.
SC:
I've googled the price, Phil.
PR:
All right. Look, let's discuss the two other elephants in the room, construction costs and land taxes. Both of these are increasing and likely to continue to make for very challenging investment cases. So, what's your take, Sameer?
SC:
Yes, look construction costs are really problematic. They're 35 to 40% higher than they were in 2019. We had expected that they would stabilise, maybe even see some downward pressure late last year. As you'll recall, cost went up a lot because of higher energy costs, higher shipping costs. But after stabilising in the third quarter, they're now starting to reinflate again at a faster clip every quarter.
PR:
Yes well, this obviously implies that the cost of bringing each square metre of real estate product to the market is nearly 40% more expensive today. So that's certainly going to be a drag and should drag up asset values and rents over time.
SC:
Yes, that's right. An unintended consequence of this is that the only areas where you build new stock or redevelop an asset is in premium markets. We're seeing this playing out in residential build to sell, in premium office, in luxury hotels, in premium retail. The only stuff getting built is premium.
PR:
Yes. Well, it continues with your ongoing broader theme about premiumisation. It's not just construction costs, but the most recent state government budgets also saw some pretty significant escalation in stamp duties and land taxes. Of course, a number of these were targeted at foreign owners, which really have a profound implication for foreign capital.
SC:
Yes. Look, the taxes are part of an outcome of rising infrastructure spend across the Australian states. Collectively, governments’ net debt has doubled to about $800 billion over the past four years. That's both state government and federal government, and infrastructure spend is still growing over the next few years. So I expect we're in for an extended period of these real estate tax hikes.
PR:
Yes, it's concerning. It really is a double- edged sword. Taxation is creating a real impediment to the supply that we so dearly need, but in turn, of course the infrastructure spend on trains, roads, airports and hospitals, it really is a comparative advantage for Australia, and of course, backbone for really good quality development across all asset classes. Alright, 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 send us your feedback and any questions you might have via
[email protected]. We'll be back again in October, so make sure to subscribe to Talking Property so that you don't miss the next House View and CBRE's fortnightly Talking Property episodes. Until next time.
