Kathryn House
Hello, and welcome to Talking Property with CBRE. I'm Kathryn House, your podcast host, and I'm excited to be back with the second part of our Australian office series. In this series, I'm getting perspectives from four of the country's leading office owners - IFM Investors, Charter Hall, GPT, and Dexus, about the current market drivers and how they expect the office sector to evolve in both the short and long term. Having already spoken to IFM's Amanda Steele and Charter Hall's Fiona Denison, I'm now gearing up for more industry insights.
Andy Collins
Atlassian Central is going to be proof that ambition on sustainability and commercial performance can be the same thing, not necessarily a trade-off.
Kathryn House
That's Andy Collins, Executive General Manager, Office, at Dexus. Andy has more than 25 years of experience in institutional real estate, including 10 years at Dexus, where he oversees the group's $22.4 billion dollar office portfolio.
Matt Brown
What you're seeing now too is those buildings where they've actually driven that innovation, generally are carrying higher levels of occupancy, and ultimately, that's translating into better forward returns.
Kathryn House
And that's Matthew Brown, Head of Office at the GPT Group. Matthew has over 25 years of multi-sector experience in executive real estate roles with deep domestic and international expertise, and is responsible for managing GPT's full service, vertically integrated office portfolio. I hope you enjoy our conversations. To kick us off, I'm joined by Andy Collins of Dexus. Thanks, Andy, for coming on the show.
Andy Collins
Yeah. No problem, Kathryn. I'm very happy to be here.
Kathryn House
So perhaps to set the scene, Dexus has been actively repositioning its office portfolio, most recently announcing the $715 million sale of Hickson Street office buildings in Sydney and 123 Albert Street in Brisbane. What's driven that divestment program, and what are your reinvestment plans?
Andy Collins
There are two main components to it, Kathryn. So firstly, we committed to our unit holders two years ago that we would look to sell $2 billion in the balance sheet portfolio between FY25 and FY27. And so with the sale of 123 Albert Street and 30 Hickson Road, we've now exceeded that target, having sold $2.5 billion since then. And so this is disciplined capital allocation in action. And so what we are observing is that the performance of office markets and office assets within those markets is uneven. And so by allocating our capital, our investors' capital, into assets that are more likely to outperform in the future, you know, we are creating a competitive advantage. And so this capital recycling is really our objective. To give you a simple example, I would rather take money out of an asset like 30 Hickson Road in Sydney, which from our perspective is a replaceable asset, and put it into the development of Atlassian Central, which is relevant on the global stage in office. It's recently reached its topping out, and we're looking forward to practical completion at the end of the year. And at that time, it's going to be fully let with a 15-year lease and produce a much better risk adjusted investment experience than the assets that we're selling out of.
Kathryn House
And I think we will talk more about Atlassian later in the podcast, but while we're talking about that repositioning program, is that one of the areas where Dexus sees the biggest opportunity in the office sector in the next three to five years, or where do you see there's some real potential?
Andy Collins
To answer that question, we first have to establish a baseline. And the fact of the matter is that not all offices is the same. Not all office markets are performing to the same standard. And if you zoom right out, the major office markets are all printing positive net absorption, which is terrific for the sector. But within the data, what's really obvious is that the premium grade market sectors are outperforming. And so in premium grade assets that are located in the core markets, they're performing even better. So to the point where vacancy in the Sydney CBD core premium is extremely low, and because of that, net effective rents are going to grow. Similarly, Brisbane in the Golden Triangle, you know, premium led assets there are also experiencing far better conditions than non-core locations or even office markets in the sort of metro locations which aren't performing so well. And so over the next three to five years, we see that dynamic as continuing to amplify the significance of quality and location in the minds of tenants. And so because of that, we expect that the performance outcomes will be very different.
Kathryn House
There has been a lot of chat in the market recently about leasing incentives in Australia, and I have asked some of the other guests on this series a similar question. But give us your view on incentives, and are we likely to see any shift on that front, do you think, in the short to medium term?
Andy Collins
Look. It's a great question. And the more we can talk about incentives, I think, the better the health of the general market. If you look at the Australian office market in the context of the region and in other global markets, the prevalence of incentives of Australia is not really seen to the same extent anywhere else in the world. That's the first thing to note. And, you know, we do work in a global market where we compete for global capital. And so having an anomaly like this does require offshore investors to look through the headlines to understand the actual cash flows in the assets and in the portfolios. You know, it used to be that incentives were used to support tenant demand in the absence of fundamental demand. And for the past few years at least, well, since COVID, essentially, we've seen incentives embedded at what we think are unsustainably high levels across the market. And so, that relationship between demand and incentive looks to be weakening, and we think that is unsustainable. And the more the market can recognize that and shift, the better it will be for the whole office market and the sector in general. What I think is readily observable in the data is that incentives are lower in markets where there are concentrated tenant demand and an absence of supply. So take, for example, the premium grade office market, particularly in Sydney core and Brisbane core. Tenant demand is highly concentrated in those areas where organisations are looking for amenity, connectivity, and buildings that can support the experience that they want to give their people. They want to be close to other organisations that are relevant to them, and so the clustering effect in those submarkets is really strong. Because of that, we are seeing incentives fall. And, accordingly, net effective rental growth is, the data is showing, that net effective rental growth in Sydney's CBD core is 10 to 15% per annum and about the same in Brisbane's CBD core. The more we can suppress incentives, the better the net effective rental growth rate will be.
Kathryn House
Because it's crazy, say, looking at Melbourne and you're hearing about incentives of, you know, 70% in some cases in certain areas of that market.
Andy Collins
Yeah. I've heard those anecdotes as well, and there are always examples, I think, of outliers in a data set. You know, Melbourne CBD is the last of the core CBDs to recover from the COVID work from home impacts that were felt right across the office markets. But even in Melbourne, you know, this is something we spend a lot of time talking to investors about. You know, you need to distinguish between Melbourne and the main and the submarkets because the east end of Melbourne up around Exhibition and Collins Street, that's where there is higher demand from tenants than there is for space in the Western core and even Docklands and, you know, let alone markets like St Kilda Road. And so the incentives are just not as high in those markets where there is a concentration of tenant demand. The other factor to consider is supply. So we know that the forward read on supply, we can see that with some accuracy, and we know that Sydney, Brisbane, and even Melbourne will have lower supply over the next five years than those markets have had over the past five years. So concentrated demand and an absence of meaningful supply will further support better performance outcomes in better quality assets in great locations.
Kathryn House
So let's switch to something that I know you're particularly passionate about, and that's how the industry approaches office fit-outs and how to solve this capital intensity of owning offices. Can you talk us through how you're approaching that with Dexus' 'Forever Fitout' concept? Because I've heard you talk about removing the friction from traditional leasing.
Andy Collins
Well, this is something that we're really excited about, and it builds on the conversation we've just had about the prevalence of incentives. And so what is an incentive in this current market? It is a way for a tenant to fund a fit out and to fund all of the friction costs that exist in moving from one location to the next. The trouble is most of our customers are great at being lawyers, financial services, organisations, consultants, etcetera, and they're not necessarily great at doing fit outs. And where we see an opportunity to reduce the capital intensity of owning office as well as reducing the environmental intensity of owning office and the waste that comes from this one and done approach to office fit outs where every tenant insists on doing its own fit out in its own way that works for them for five to seven years and then gets thrown out. So it's hugely wasteful. It's wasteful financially, and it's wasteful practically. In a world where scope for three carbon emissions matter, then the market will respond to a better way of delivering fit outs. We think a better way of delivering fit outs is the turnkey model. And, look, speculatively built fit outs are not new. We're not the only ones doing them. But looking at the core markets over the past 12 to 24 months, more lease transactions have been done for fitted out space than for clear space. So the market's inclined to accept this model anyway, but, you know, the forever fit out approach is a way of building enduring fit outs that can work just as well for the second or third tenant as they do for the first. These spaces can respond to changes in preferences during the leases and between the leases such that there's less downtime between the leases and lower incentives over time. So this is really all about creating a performance gain for us and then for our investors in a financial and environmental context, and I couldn't be more excited about it. It's not just me. We are deep into this pilot, and this is something that Dexus has been thinking about for many years. And so to see the pilots come to life is really exciting. The first pilot, we've completed at 1 Bligh Street with the Clean Energy Finance Corporation as our customer, and that space has been co-designed by us with Woods Bagot and with CEFC. And so, you know, that space exists. It's alive and kicking, and I can't wait to see the experiment expand and continue to produce data points that will allow us to prove our hypothesis that better quality offices built in a way that anticipates the changes in preferences can derive better performance both financially and environmentally.
Kathryn House
So moving from fit out cost to overall building costs, Dexus did recently delay some of your planned office towers, including 60 Collins Street in Melbourne, and construction prices don't look like they're going down anytime soon. When do you see the equation shifting?
Andy Collins
Right now, even though we are beginning to experience sustained and effective rental growth in premium grade assets in great locations. There is still a gap between the market rent and what we call the economic rent, the rent at which it makes economic sense to build a new development. And that is a function of inflation generally, especially escalation in construction costs. It's also a function of the costs of site consolidation in some of those key markets where there just aren't that many opportunities to develop. And so, for so long as that dynamic prevails to the cost of building new supply, it exceeds the benefit, then we see a terrific opportunity for stabilised assets to capture meaningful market reversion. That's the first thing to note. And the second thing to note is that at some point, there will be a supply response, and those opportunities are limited. 60 Collins Street is one of them. 60 Collins Street is a development site in Melbourne on the corner of Exhibition and Collins Street. You know, it's probably one of the best development sites in Australia, and we consolidated that site sort of late cycle, seeing the potential in the real estate. And it remains a terrific opportunity, but, you know, applying our strict capital allocation model, in order for us to invest in the development of that site, it needs to produce a better risk adjusted return than other investment opportunities in our investable universe. And so therein lies the challenge when development costs exceed the benefit of developing. So it is a terrific development opportunity. If not in this cycle, certainly, the next. And it's probably the one site that we get the most interest in from the market, both in terms of tenants asking when we are going to activate it and other developers or investors asking when we are going to sell it. And so watch this space.
Kathryn House
Excellent. Well, one development that you've already mentioned that is, you know, steaming ahead is the Atlassian skyscraper in Sydney. It's the world's tallest hybrid timber structure. How important do you think this type of building innovation will be in the future?
Andy Collins
Look. I'm really excited about Atlassian Central. It's something that we are delivering for our partners at Atlassian. The idea was conceived by them initially. But Atlassian Central is going to be proof that ambition on sustainability and commercial performance can be the same thing, not necessarily a trade off. You know, as you've already said, it's the world's tallest hybrid timber structure. It's 180 metres if anyone wants to know. So it demonstrates that the winners in built form benefit from great connectivity as part of Tech Central above Central Station. It's amenity rich with everything that it connects to and having next generation ESG credentials whilst being anchored by a globally relevant Australian unicorn tech company, has all the ingredients for success. It also shows that innovation isn't necessarily just a badge or a label. You know? This is, it's a mass timber construction, electrification, and high energy performance throughout design from day one, and that's where global occupier demand is headed. And Atlassian Central demonstrates the next frontier of environmental performance, and I really do think that's going to catch on.
Kathryn House
So perhaps two questions to finish us off. Firstly, where do you think we'll see the biggest market shifts in the Australian office sector in the next five years?
Andy Collins
I think that's likely to be in markets that benefit from concentrated demand and constrained supply. And I think we're already seeing the potential that is in office markets and office buildings that don't have the characteristics to outperform in the future. We're seeing potential in those structures and assets to be converted to other uses. And George Street in Brisbane with our conversion to a purpose-built student accommodation ahead of schedule and budget, I think, is a terrific example of that where we've been able to identify an office building that has not got the characteristics really to continue to outperform and point it towards a different use and execute to a really high standard. I think that those two initiatives are probably examples of how performance will be created in future cycles.
Kathryn House
And so last question, maybe a big one, but what do you think the biggest market challenge is going to be?
Andy Collins
So I think it's difficult to imagine a conversation in three or five years' time that looks back on how the office markets have evolved without observing two things. Firstly, the impact of AI, and by then, it will be in retrospect rather than everyone guessing. And secondly, we'll be able to see just how quickly and just how far net effective rents have run in that premium space. That's what I'm looking forward to.
Kathryn House
Well, Andy, thank you so much for joining Talking Property. I think I'm going to have you take me on a tour of your Forever Fitout out in Bligh Street.
Andy Collins
Kathryn, I'd be delighted to take you through a tour of any of our Forever Fitout pilots, and you'll see one shortly anyway as CBRE's own premises in Brisbane is being delivered in collaboration with Dexus in a forever fitter configuration, which I'm really excited about. So thank you for supporting this initiative.
Kathryn House
I'm now joined by GPT's Matt Brown. Matt, thanks for joining Talking Property.
Matt Brown
Hi, Kathryn. Thanks for having me today. It's great to be here.
Kathryn House
So, Matt, GPT took the market by storm late last year with the $860 million acquisition of a half share in Grosvenor Place, one of Sydney's best known corporate addresses. It was a major vote of confidence that the office market was recovering and that office valuations had bottomed. What made GPT decide that it was the right point in the cycle to make such a big bet?
Matt Brown
Well, I think we've very much got a research led thesis driven approach to how we invest, and we look to invest at scale in those sectors in which we have high conviction. When Russell Proutt joined the business as CEO, one of the the first things that he did was reestablish the chief investment officer function and also our research capability. And I think, ultimately, that's what's helped us to drive a really fixed approach in relation to those markets in which we have high conviction. What we also saw was the beginning of a sustained recovery in physical office market demand in the Sydney core market, and, ultimately, this opportunity was introduced to us through an existing mandated client. There's a couple of things that we really liked about the opportunity. The first one is really it's one of Sydney's most iconic premium assets, and they're very hard to come by generally at any time in a market cycle. There was also a good opportunity for us to use our operational capability to relet the vacancy within the building and really bring leasing product to market and reposition the building in an improving market. And, ultimately, this acquisition aligned with our strategy to invest alongside great investment partners. So as I mentioned earlier, this transaction was introduced to us through an existing mandated client. The acquisition also really supports the growth of our $17 billion office platform, which is an important component of why this opportunity made sense for us.
Kathryn House
So is that a growing focus to invest with partners?
Matt Brown
Yeah. It's definitely an area of focus. We really want to continue to find great opportunities and invest alongside those partners to ultimately drive great return outcomes for them.
Kathryn House
So we've talked about Sydney and your focus there, but are there other markets that GPT is zeroing in on?
Matt Brown
Yes. So as I mentioned before, we've got a really disciplined approach to how we invest across different markets, and we have pretty high conviction in Sydney. And what we have seen across both the core market, Midtown, and Western Corridor is that continuance of a sustained recovery, which has ultimately been driven by leasing demand. But other areas where we've got focus generally are along the eastern seaboard. So for us, Brisbane's one of the markets in which we have the highest conviction, particularly in that Golden Triangle part of the market. And there's a couple of reasons for that. We're seeing good leasing momentum for tenants looking to occupy high-quality core space, particularly along the river. And what that's ultimately meant is positive effective rental growth and face rent growth, in that market. Like other markets, there's also good levels of supply constraint as well, which is positive as an existing owner. And we're still to see the positive tailwinds of the Olympics, but we know that we'll see, a pickup in demand as a result of the Olympics when they start to build those projects over the course of the next few years.
Kathryn House
Yes. There's a lot of focus on Brisbane right now. A few other guests on the show have also called out Brisbane. So turning to cap rates, I guess everyone's wondering where they're going to head this year. What is the GPT view?
Matt Brown
Well, generally, we've seen a stabilisation of those cap rates for premium assets, across the country, and we've actually seen positive revaluation gain over the last 12 months, across that prime portfolio set. I think we're starting to see improved levels of deal flow as well across the market, and, generally, those trades are starting to be priced at or around book value, which kind of helps to support that stabilisation of cap rates across the country. But we're very much looking at an income driven recovery in the market here rather than a recovery driven by cap rate compression. So I think, you know, that's a key point of difference with this recovery versus other market recoveries that we've seen. That being said, though, we're still thinking deeply and looking deeply at the impact of inflation on the market and what that means for cap rates and what means for both bond rates and interest rates and the corresponding impact on office values.
Kathryn House
So let's take a more of a helicopter view. Where do you see the biggest shifts occurring in the office sector in the next five to ten years?
Matt Brown
Well, I think the biggest defining factor over the course of the next ten years is really the change in available supply in markets. And so when you look across some of the major eastern seaboard markets, we're going to see the lowest level of supply that we've really seen since the mid 90s, and that's driven by that large economic rent gap. And, ultimately, there needs to be a good movement in face rents before we see meaningful new supply come to market. And so what does that mean? It ultimately means that you'll see continued high levels of demand for existing high-quality buildings. And, generally, what that ultimately means is that you will see that continuance of base rent and effective rent growth in the market, but also that push down of those incentives as well. And so I think our view is that there'll be a continued divergence in portfolio returns for those better quality buildings versus more of those secondary buildings in those lesser quality locations. And I think centralisation really is a key theme that we'll continue to see across the country as well.
Kathryn House
So another bigger question and that's around AI. It's something that I've talked to all the guests about on this series. It's interesting that GPT has produced an AI white paper on the subject called 'Human and Machine, Is There an Elephant in the Room?' So is there an elephant, and what were your key takeaways?
Matt Brown
Well, I still think we're very much in the early days of the world's AI journey, and I think there's a couple of different schools of thought in relation to the AI impact on office. And you've got a school of thought that talks to product augmentation and job creation through AI, and you've also got some views in that talk to, you know, selective job displacement. And I think from our perspective, when we look at the research and we talk to our tenant customers, I think our view is that you'll see that augmentation as a productivity enhancer, which ultimately doesn't see a material movement in office space demand. And what's interesting too is when we looked at our research, we surveyed our top 20 tenant customers across our office portfolio. And, generally, what we found is that they're looking to generally maintain their headcount over the course of the next three to five years, and they don't see any major impact on office space requirement over that same period. And so that's a positive view that we've seen from those tenant customers. But interestingly, when you look at some of the other research that has been recently released to the market, so the Department of Employment and Workplace Relations have just started releasing a quarterly data series. The findings from that data series also showed that there's no measured impact on demand from AI. The other thing too is Revelio released some recent research, where they researched around 20,000 firms, and they found actually that the early adopters of AI actually saw net employment gain over their business versus those slower adopters. So it's quite interesting to see that narrative shift in the press in relation to the impact of AI on office space demand.
Kathryn House
So if we go back to leasing, and you talked a little about it when you talked about Grosvenor Place. Incentives have been one of the biggest topics of conversation recently, and we do have some of the highest office incentives globally. Do you see that shifting in the short term?
Matt Brown
Well, I think we're generally seeing incentives stabilise across the country, over the course of the last 12 months or so. We've also, for those better quality assets in some of those higher performing submarkets, seen that continued downward pressure on those incentives. And, ultimately, our view is that that'll help drive that positive effective rental growth and face rent growth that I mentioned earlier. But I still think that leasing decisions for tenants ultimately continue to be led by requirements for fit out, especially if you continue to see that flight to quality. So, tenant customers are ultimately looking to attract those knowledge workers back to the office, and so I think you'll see a continuance of that requirement of the landlord to contribute towards that capital to fit that space. But as I mentioned earlier, we are seeing a downward pressure. And, also, that mix of incentive is starting to change as we're seeing more positive lease momentum. So a shift from that capital contribution towards more of an abatement towards that lease incentive.
Kathryn House
So, Matt, GPT has been particularly active on the leasing front. What trends are you seeing on the ground?
Matt Brown
Yeah. There's a couple of key trends. So one is this concept of adaptive reuse. There are a lot of tenant customers are very focused on cost of fit out, and so they're looking at ways that they can adaptively reuse older fit outs to effectively move into a tenancy at a cheaper cost. And so that's definitely a trend that's alive and well. Also, the ability for the landlord to provide fitted space because there are some smaller tenants that don't want to go through the process of finding a construction firm, running a construction project. They'd rather move into a completed space. So that's definitely a trend that we're seeing. We're also seeing an increase in whole floor occupier interest. So I think as we came out of COVID, it was predominantly driven by those SMEs, and we're definitely seeing an increase in ultimate inquiry from those larger occupiers. And as I mentioned earlier, that recentralisation theme, that flight to quality are definitely things that are alive and well. The only other key trend that I'd point out is just there are long lead times now to leasing space, so tenant customers are definitely coming out a lot earlier than what they had been previously, and it does take time to convert that interest into a signed lease. So, yeah, there are a couple of key trends that we're definitely seeing.
Kathryn House
How far ahead do you see some tenants coming out with leasing requirements?
Matt Brown
Well, we're seeing, anywhere from 12 to 24 months out, generally, for some of these larger tenant customers. And even some of those smaller to midsize tenant customers have similar lead times. So it's definitely something that has been a shift as we've come out of COVID, that long lead time.
Kathryn House
So talking about fit outs of office space, GPT has an experience first philosophy when it comes to its office assets. What does that look like in practice? When we were preparing for the podcast, you talked about office as a service rather than a commoditised product.
Matt Brown
Yeah. So I think it's really important as an owner to be able to differentiate your building versus your peers, and there has been, for some of that more secondary quality office stock in the market for it to become more of a commoditised product than an actual product that is an attractor to tenant customers. And so from our perspective, looking forward, there's really three key pillars to our approach to how we, own and operate buildings. And one is a driving community within the building. So tenant customers and employees of companies really want to feel part of the community, in the building that they're in. And so it ultimately comes down to experience and really as a landlord being the curator of that experience that drives the community I think is really, really important. And one of those other major factors that tenant customers are looking for is wellness. They want their employees to leave the office better than when they came into the office. And so as a landlord, you really need to think deeply about how you can offer that wellness in the buildings that you own and manage. And I think when you look around the world, at what's been happening, as we came out of COVID, necessity really drove innovation in markets like London, and New York. And so when you actually look at some of those buildings and you see the level of amenity and service that's being offered, it's quite interesting. So some of those buildings now offer things like cinemas, libraries, exclusive clubs, restaurants, spin rooms, gyms, etcetera. And that's all targeted around how you can attract those knowledge workers to the building. So I think that's really important. And what you're seeing now too is those buildings where they've actually driven that innovation, generally are carrying higher levels of occupancy, and, ultimately, that's translating into a better forward return. So I think it's really important to think about where the market's heading and adapt your buildings accordingly.
Kathryn House
Yeah. It's interesting. I was reading about an office building in New York, and it had quite a vacancy issue, and they put a major art gallery in the bottom of the building, and the whole dynamic shifted. So it's interesting to see what draws tenants in and what can make a difference, things that you might not necessarily expect.
Matt Brown
Yeah. That's true. And the key thing really is to actually have an active dialogue with your tenant customers and listen to them about what's driving their business, what is attracting their employees to their business, and, really, it's all about a partnership with those tenant customers to provide that level of service and amenity that they're looking for in the buildings that you own and operate.
Kathryn House
And so is there anything that keeps you up at night when it comes to the office sector outlook?
Matt Brown
Well, there's nothing that that really keeps me up at night. I sleep really well at night.
Kathryn House
You're very lucky.
Matt Brown
But there's things that that I think deeply about. And, really, for me, it's how you continue to actively curate the portfolio to attract those tenant customers and drive returns. And I think there's a couple of key things that are important. One is really thinking deeply about how you continue to innovate, staying ahead of the curve, thinking about what's going on in other global markets and how you can adapt that towards the Australian market. I think the other thing too important is that a lot of owners have significant amounts of data. So how you can actually capture and use that data to make informed decisions, I think that's really important. And how you can use technology and AI to be able to inform better decision making is, you know, a really important thing that we're thinking about at the moment. And I think the other interesting thing is really just listening. So you're listening to your investors, listening to your tenant customers, about what they're looking for and really match that need with an opportunity for you to provide that level of service. And I think, hopefully, that then continues to build trust, and I think trust is probably the most important thing with both investors and tenant customers because it takes a long time to build, but it can be lost instantly. And it's something that is at the forefront of our business for sure.
Kathryn House
Well, Matt, thank you so much for coming on the show. It's great to see the office sector back on track, and it'll be interesting to see what's in store for the rest of the year. Thanks again.
Matt Brown
Thanks, Kathryn.
Kathryn House
To our listeners, I hope you enjoyed this episode of Talking Property. If you don't already subscribe to Talking Property, make sure you do so wherever you get your podcasts. And we'd love for you to rate or review the show, which will help other people find us. Until next time.
