KH:
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 commercial property investment activity, the current trends, the continued challenges, and what to expect as the year progresses. It was clearly a challenging first half with our recently released In and Out report highlighting a 50% dip in the total value of Australian deals across the office, industrial, retail, and hotel sectors. Today we'll be doing a deep dive into those numbers while examining the current debt landscape and the other drivers that will shape the market and influence investor decision making this year. To talk us through this, I'm joined by three of CBRE's market experts, Stuart McCann, Head of International Capital for Pacific and Southeast Asia, Andrew McCasker our Pacific Managing Director of Debt and Structured Finance, and Tom Broderick, CBRE's Australian Head of Capital Markets Research. Thanks for joining me today.
TB:
Thank you.
KH:
So the last podcast we did on this topic earlier in the year had our biggest Talking Property audience, which highlights just how hungry people are for intel on the capital markets outlook at the moment. So perhaps to set the scene, Tom, can you talk us through the recent In and Out report and some of your key observations?
TB:
Yes, sure. So as you mentioned, we saw a fairly significant drop in overall volumes, 50% drop, total volumes were $8.8 billion in the first half of 2023 across the four key sectors. That also included $2.3 billion worth of deals that are yet to settle. And some of those deals are subject to a capital raise. So there's a bit of uncertainty around whether they actually conclude. But one of the key trends we saw was that there was a fairly significant discrepancy between large deals and smaller deals. So the sub-$100 million transactions held up much better, a drop of 36% year-on-year. The major reason for that was that private buyers were relatively active. They probably see the current market as a bit of an opportunity where larger institutional investors are on the sidelines, but the over a hundred million dollars transactions dropped by 58%, which is typically dominated by the large institutional investors and offshore groups.
In terms of offshore investment, we've seen a 73% drop year-on-year to $2.1 billion in the first half of 2023, and it only counted for 24% of total volumes compared to 44% over the same period last year. One interesting trend in terms of offshore investors, we saw an increase in Japanese investment into the Australian market. There's been an increase in outflows out of Japan in general, and the main reason for that is their interest rates remain low, so they're at a competitive advantage at the moment compared to other investors in the market. We also saw investment come in from Hong Kong, Singapore, and North America, but they're all down on previous years.
KH:
I mean that overall decline in offshore investment activity is a real shift from what we've seen over the last couple of years. Stuart, you've really got your finger on the pulse with what's happening in those offshore markets at the moment. What's your take on that?
SM:
Yes, look, I think what we're seeing play out in the first half of this year in Australia is really no different to what we've seen as a trend globally. And look, that's been really driven by many institutional investors, as Tom said, looking to batten down the hatches and manage existing portfolios. I'd say for those that are investing right now, there is fundamentally a high bar for putting equity out the door in this environment. You know, underwrites have become more conservative, investors have become laser focused on the ability to drive reversionary income up so that they can manage and service rising debt, cash flows and service costs. So what we did see over the first half of the year is lower volumes really due to one, less liquidity in the system, and two, ultimately a wider bid ask spread in terms of our transactional activity.
I still think the positive though for Australia is that we've got an absolutely key position in Asia Pacific for offshore investors. It's really one of two, maybe three big mature markets that's easy to transact in that capital is comfortable to be in. You've also got great occupier demand across all sectors and quite big barriers to supply across each of the sectors too. So the outlook for rental growth in our market is very good, particularly when you're looking at cash flows on an unlevered basis. It is quite attractive the performance of our markets and I think the other reason that we're confident about the recovery in volumes is really that capital's recognising now is a great time to buy some of the best real estate in the market at this point in the cycle. So I guess while the first half of the year was down, we do anticipate a gradual recovery over the course of this year and a big pick up into 2024.
KH:
I guess too, it's worth noting that the figures don't include BTR at this point in time, given it is a relatively new sector here and we have seen a bit of activity happen, particularly right at the end of the first half with Mirvac.
SM:
Big time. You know, that transaction with Mirvac is, you know, it's a $1.8 billion portfolio, a sell down of 56%. It's a big endorsement of the sector across Australia. It is a great demonstration of how rapidly that sector is maturing and is very much going to become a very key pillar to offshore capital's portfolio construction across the country in the next couple of years.
AM:
Kathryn just a call out too, you're absolutely right - BTR both in the equity space and the debt space has been very active not only for the last six months, but for the last 18 months. The other bit I wanted to throw in there, keeping my debt hat on and Stuart being front and centre of this with offshore capital coming to Australia, looking at those debt platforms as well. So pivoting or adding another investment strategy to their bow going from direct property investment to direct debt investment, so a complementary asset class to what they're usually invested into. So Australia's been seen as quite an attractive platform for these groups to step off into.
KH:
And more attractive than some of the other global markets when it comes to that?
AM:
Look, I think for where Australia sits is that we've got a very transparent platform that we operate in. Our legal system is consistent with the UK and a number of the Asian groups, so it makes entry into Australia significantly easier than potentially other countries that may have a different legal system or a different way of transacting.
KH:
One of the other interesting conversations has been about the valuation side of things. I think valuations have been, really a bit in the cross hairs in Australia. You know, some commentators saying that the revaluation cycle has been a little too slow in Australia and maybe that's why we're not seeing as much activity as we've started to see in some of the other markets. I'd really love to get all of your thoughts on this point. And I know Stuart, you mentioned the other day that in Europe where the market has rebased, they've gone from having, you know, relatively low transaction numbers to having something like three billion pounds in transactions under offer in one quarter. I mean, how important is this sort of revaluation piece?
SM:
Look, it's very important, you know, we've touched on it before that when we're dealing with these international investors, they've got a relative lens and they're looking at opportunities that they can invest in around the world. And so they'll ultimately sort of gravitate to where they think the best value sits across the globe. And right now, you're right, our valuation cycle has been slower. If we look across our major REITs in the last 12 or so months as a general observation, they look to sort of wind back values up to 5%. If we compare that to the UK, it's probably been for those REITs between 5% to 10% plus or minus. So look, in fairness to our valuers, there's been less transactional activity. We were slower in terms of the tightening process than some of these other big markets, but we do think that when you do start to see some pricing and valuations rebase, you're right, we've seen offshore capital definitely returning. You know, the example that you talked about, Kathryn, was across our Western Europe office team, they have seen a massive uptick in office trades go under offer within one quarter, and you're right, it's around that three billion pounds, which is quite an extraordinary number given it was off an incredibly low base.
Interestingly, the average yields on those under offer sit between the mid to high five cap rates, which is clearly a big movement off the traditional, you know, circa-4% plus or minus across those markets in a pre-interest rate rising environment. So clearly a sign that when these markets rebase, the capital is returning.
AM:
I think too in the debt space, Kathryn, the banks have an uncertainty around what the valuation number is, so it's fine sort of working back on an interest cover ratio or a lending value ratio, but the variable that all the banks are concerned about is what is actually that valuation number. So once we can get some stability and certainty in the market that we've either hit the bottom or close to the bottom, we'll certainly see a greater degree of participation in the banking space.
TB:
Yes, I think the only comment I'd make is that there are starting to be some transactions that are trading well below book values. So to Stuart's point, the book values have unwound slower than other markets around the world, but we are starting to get that deal evidence which might start to accelerate the process.
KH:
I think one of the interesting things for me was looking at the In and Out report, Tom, and whilst virtually all of the sectors did have a dip in activity, hotels was a bit of an outlier. So activity didn't drop and was actually in line with what we saw in the first half of last year. And I know just even in the last couple of weeks we've seen a couple of really big transactions, a couple of big portfolios come onto the market. What's different in the hotel space right now?
TB:
Yes, it's not all doom and gloom out there and you're right, hotels buck the trend. $1.2 billion worth of assets sold in the first half, which was the same as last year. I think from a fundamentals’ perspective, we've seen a significant rebound in travel into Australia and both domestic and overseas tourists occupying our hotels. And in fact, if you look at the average daily rates on average in Australia, they're 26% higher than pre-COVID levels. So we've seen significant increase in daily rates for hotels and to give you context inflation in Australia over that period's only risen by 15%. So it's outperforming inflation quite significantly and it's all kind of that revenge travel that we've seen around the world, but Australia's been a key beneficiary of that and so that's driven a lot of activity in the hotel investment market and we've also seen some fairly high profile private investors enter that market as well, which has boosted some of that transaction activity.
KH:
It'll be really interesting to see how some of the other campaigns that are running at the moment pan out. I think a lot of interest in the Ritz-Carltons that have come on the market, so there'll be some really good transactional evidence moving into the second half. One sector we really haven't touched on yet is industrial and logistics, which really has been a bit of a market darling over the last couple of years. There are a lot of larger portfolios in the market at the moment. I guess Stuart, what's your view on how that sector's going to play out in the next few months and is he depth of capital still there?
SM:
Look, absolutely. You can't ignore the sector is running at virtually a hundred percent occupancy at the moment, so it's one of the strongest performing sectors and markets globally right now. And so absolutely we anticipate to see capital continue to be allocated to the sector. We did see in the first half this year a big transaction which we were fortunate enough to be involved in on behalf of Mirvac where we help them assist the establishment of a large capital partnership with Australian Retirement Trust. And so that's a great example of, you know, big capital allocation to the sector In terms of some of these other big portfolio and transactions that are in play at the moment. Look, certainly we're confident that a number of these will get executed on, but one thing we would say is that the capital's been super selective going forward and that's probably the big shift into where they allocate capital and how they allocate into the sector moving forward.
KH:
Andrew, maybe if we sort of change course a little bit, and I know we have talked about debt already, but you know, one of the areas we focused on in the last podcast was the cost of funding, which has clearly become more challenging in recent months following rate increases. But there is still an appetite from both bank and non-bank lenders, which we saw through your team's recent lender sentiment survey. Can you talk us through some of the key trends you're seeing in the debt space right now?
AM:
Yes, sure Kathryn. And it was interesting comparing our current survey to our previous survey and what we had expected is that we would've seen a much greater increase in the retail space because we've seen that asset class rebound post-COVID and has become a sought-after investment class. But what we have said is the consistency from the previous survey which showed financiers are very interested in industrial and continue to be. We've got that underlying rental growth story which will supplement any potential softening of yield in the industrial space. And the other space of course is build-to-rent and we've touched on that earlier on with the number of transactions that we've seen in Australia over the last 12 months. We did see an uplift in appetite for retail, but unfortunately the environment we're in at the moment and the uncertainty around the valuations in the office space, it's certainly approached with a great deal of caution. The one benefit that we do have in the Australian market is that the banks are still very active in that space and whilst it may not be an asset class that they're seeking, that's still able to get finance at reasonable levels at a reasonable debt cost as well.
KH:
And there seems to be quite a difference between how some of the offshore lenders and the domestic banks are approaching different asset classes right now?
AM:
Yes, very much so Kathryn and it's really influenced by where they're domiciled. So we are seeing an overlay of groups out of America having a much more negative approach towards office and still having a somewhat tarnished approach towards retail. Whereas we're seeing a different approach out of Asia on both office and retail. So it really comes down to the experiences in the home countries of those offshore banks lending into Australia.
KH:
Is that playing out for you, Stuart, in the conversations that you're having with your investors?
SM:
Look, absolutely. I think any certainty around access and cost of finance right now is providing a lot of confidence and stability, Kathryn.
KH:
So I guess a question for everyone, and maybe I'll start with you Tom. I mean, what would your top tip for investors be in the short to medium term?
TB:
I think the window is starting to open where there is some value in the market and generally that only happens kind of once every decade. We thought it might've happened when COVID hit, but then low interest rates kind of boosted asset values. But we're actually starting to see, we're seeing the valuations declining and we're seeing some assets sell at softer cap rates and well below book values. So that might start to look appealing to some of these domestic and offshore groups. And the fundamentals of Australia are still strong. We've got high population growth, the medium to long-term economic outlook's really strong for Australia. So I think we're still an attractive destination and I think the up final point is that these softening cap rates are definitely going to have an impact on the supply of new stock. It's getting really hard to make development stack up. So that's a real positive for existing assets and rental growth over the medium term.
KH:
Absolutely. Construction costs are still such an issue here. So Andrew, what's your top tip?
AM:
Kathryn, I could take the easy way out and say build-to-rent or residential property given the fundamentals that we have in relation to vacancy rates and supply demand curve. But I truly think, we touched on it before, retail and hotels, are the upcoming asset classes both for debt and for equity. There's value in both of those asset classes and the opportunity to buy assets that wouldn't normally be on the market in the cycle that we're seeing at the moment.
KH:
Stuart, lucky last.
SM:
Yes, look, I think it's a general combination of Andrew and Tom's responses, but I think it's just for the capital not to wait until the dust settles because the availability of product right now is, yes it's high, but it's been driven by a lot of the bigger institutions wanting to reduce gearing or set up big business shaping capital partnerships going forward. And you know, I think that a lot of these big institutions are making their way through these programs and are getting to a point where the balance sheets are starting to look pretty good. The capital partnerships are now in place and I think once you start to see, you know, the books close of some of these bigger institutions and then you're starting to see inflation taper into some of these other big markets in the US and you feel like you're getting to the back end of our rate hike process through the RBA, you know, this market could change really quickly and return back into the favour of a landlord market very, very quickly and ultimately the window could and can close very quickly.
KH:
Yes, it's going be very interesting to see some of the statistics that are coming out. I guess we've got Property Council of Australia vacancy rates coming out, which people will be taking a very close look at this time around. Some transactions that are coming up that will maybe give us a lot more certainty about values. So it's going to obviously be a very interesting next few months. But thanks so much once again for your time, Stuart, Andrew and Tom. I think you've given our listeners some food for thought and you know, it's going to be really interesting to see how market conditions evolve when we next catch up. So 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
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Apple Podcasts. You can also access our In and Out report by clicking on the link in our show notes. Until next time.
