0:00

Hello, I'm Phil Rowland, and I'm excited to

0:02

be back for our fourth edition of the

0:04

House View. I'm joined by our head of research,

0:07

Sameer Chopra. Since our last podcast

0:09

in early July, we've continued

0:12

to see challenging market conditions,

0:14

particularly in the real estate capital markets

0:16

as cost of debt

0:18

rises and sentiment wanes. Of

0:21

course, we have the big national challenge

0:23

of the day, which is our acute supply

0:25

side issues in housing, but

0:27

it's not all bad. Overall leasing activity

0:30

has been quite buoyant, particularly in the office

0:32

sector and there's been a growing

0:34

focus on alternative asset classes. So,

0:37

what lies ahead in this episode? We'll

0:40

discuss the economic outlook, what

0:42

to expect when it comes to asset pricing

0:44

and the debt markets, and also the

0:46

outlook for the leasing sector and some of the

0:48

opportunities that investors are looking

0:51

at in the alternative space. But

0:53

to kick us off, let's talk about

0:55

the overall economic outlook. So,

0:57

Sameer, we seem to have skirted a recession, both

1:01

in Australia and most

1:03

other major markets globally. It's good

1:05

to see inflation moderating at a range around 4

1:07

to 5 percent after being up

1:10

at 8% in December of 22. So

1:12

having said that, the slowdown

1:15

is very evident to everybody. How

1:18

would you frame the overall

1:20

economic outlook for the next

1:22

quarter and into 24?

1:25

Thanks, Phil. Yeah, look, we've managed

1:28

to get through a large part of the fixed rate

1:30

mortgage cliff without too significant of

1:32

an impact on the economy. Retail spend is

1:35

broadly flat to maybe even slightly positive

1:37

over the last 12 months, but it's up

1:40

over 30% on 2019 levels. And the

1:43

employment picture has

1:45

also been very robust with over a million

1:48

jobs added since early 2020. And

1:50

jobs and population growth

1:54

have been the real positive surprise

1:56

and they've helped to shield the

1:59

economy. That being said, from here on

2:01

we expect more pedestrian growth

2:03

over the next four

2:06

to six quarters, potentially at half of the

2:09

usual rate of growth. So not a recession,

2:11

but a slog. And what we

2:14

find during these more challenging

2:16

times is quality matters. During boom

2:18

times everything gets

2:20

a tailwind, but during tougher times,

2:23

the quality really starts to

2:26

matter.

2:28

Yes, absolutely. And I think

2:31

we're definitely seeing this play out

2:33

in the leasing market, particularly in office

2:35

where this bifurcation of prime

2:38

and secondary markets is

2:40

really taking hold. And what's

2:43

been very interesting has been the resilience

2:44

of the leasing market, particularly

2:47

in office in the last couple of

2:49

quarters, which of course heavily contrasts with

2:51

the investment sentiment in the

2:53

sector. Occupy sentiment earlier in

2:56

the year was strong, as companies

2:58

came off a two-year period of strong

3:00

financial and employment growth,

3:02

really wanting to set their

3:04

workplaces, post pandemic. But

3:07

of course, the wider economic

3:09

environment has shifted, there is no

3:12

doubt about that. Normally with the lowering levels of

3:15

business covenants like we've seen over

3:17

the last six months, leasing

3:19

should have slowed down, but

3:21

that's not actually what we're seeing,

3:23

especially at the premium end of the

3:25

market. So Sameer, what

3:27

are the stats on rents and vacancy

3:30

telling us?

3:31

Yeah, Phil, look, we've just done a check in with the

3:34

teams on the ground, and rent

3:36

growth is moderating now. It's almost

3:39

flatlining as the year sort of wears on.

3:42

But it's all very location specific. So

3:44

if you look at office, there are two very

3:47

sort of contrasting markets in

3:49

Perth and Melbourne with Sydney

3:51

somewhere in the middle. So Perth has

3:54

continued to see face rent growth

3:56

and flatter sort of declining incentives.

3:59

So we're on pace for low

4:01

to mid-teens of net effective rent growth,

4:04

which is really good in Melbourne

4:06

net effective rents are likely to be down

4:09

about 6% for the year, and that's

4:11

mainly because incentives have started

4:13

to increase in that market. Look,

4:16

Phil for me, you know, the single biggest driver of rent

4:18

outlook continues to be

4:20

supply of new stock in the

4:22

short term. So, you know, your supply

4:25

continues to impact sort of the incentive outlook.

4:27

Industrial is a different ball game . Rent

4:31

growth continues, but

4:33

with all this new supply coming in both

4:35

in 23 and in 24, both

4:38

existing and spec stock, along

4:40

with a little bit of sublease, we

4:43

are just starting to see some

4:45

signs of incentives rising , while

4:47

face rents are now sort of just holding

4:50

firm, maybe rising a

4:52

little bit depending on the sub-market. In

4:54

industrial I'd say just keep it

4:56

out on the incentives and rent's kind of flat

4:58

lining. But Phil, you know, you mentioned the strength

5:00

in our leasing business. Is

5:02

this widespread or just in some pockets?

5:05

Well, it's a bit

5:07

of a generalisation I suppose. So it’s

5:09

not totally broad-based, inquiry levels

5:12

are certainly healthy in office. But we're

5:15

seeing some softening in industrial. If

5:17

we look at Sydney leasing for example,

5:20

the size of the individual inquiries has increased

5:22

by about 10%, in aggregate square

5:25

metre of inquiries

5:27

in ‘23 should exceed 2022

5:30

by about 10%. So occupiers

5:33

are keen to come to the market

5:36

with briefs well in advance of those lease

5:38

expiries. So they can really methodically

5:40

work through their really important

5:42

shifts in their workplace

5:44

settings post pandemic. Interestingly, some sectors

5:47

that have been a little quieter of

5:50

later, like technology for example,

5:52

are now active again. To

5:54

your point around industrial Sameer, leasing

5:56

inquiry volumes are really

5:59

returning towards more normal market

6:00

conditions. So we're seeing

6:03

some 30 to 35% reduction

6:05

across the board from the peaks

6:07

that we saw in in ‘21 and ‘22.

6:09

The majority of that reduced

6:12

demand is from the larger end occupiers

6:14

in that sort of 15,000 square

6:17

metre plus range. But we're still seeing

6:19

good activity for those smaller ticket size deals.

6:24

One of the other things of course in

6:26

the conversations is that

6:29

outgoings are a real challenge. They've increased

6:32

by 10 to 20% adding to

6:34

cost pressure for clients and that's everything,

6:36

right? Like electricity, building insurance,

6:38

land taxes, and just

6:41

on this outgoing particularly taxes and stamp

6:43

duty. Speaking with our

6:46

commercial valuation teams they've been

6:48

highlighting the risk to capital values just

6:51

from recent regulatory changes that

6:53

we've seen.

6:54

Yes, no doubt. Alright, Sameer,

6:56

I might just switch to

6:58

some global perspectives. I think it's always important

7:00

to consider that and get

7:03

back to the leasing trends. Perhaps we can

7:05

touch on what we're seeing globally on vacancy. There's

7:08

a lot of focus obviously on US

7:11

office vacancies, which range anywhere

7:13

from 20 to 35% depending

7:16

on the market. And of course, industrial vacancies

7:18

have been in the low

7:20

single digits in most markets

7:23

around the world. So, what can we

7:24

learn from how this picture is

7:27

evolving? Do you think it's getting tougher?

7:30

Yeah, Phil, office is really interesting. The

7:33

office vacancy is very nuanced

7:36

globally. We do have that 20 to 35%

7:39

in the US but you know, away from that

7:41

it's high single digits in Europe and mid-single

7:43

digits in parts

7:45

of developed Asia. What I'd say

7:48

is in the first half of this year,

7:50

office vacancy globally appeared to be

7:53

stabilising. So put it another

7:55

way, it's a tough story and

7:57

it’s not getting incrementally worse.

7:59

Vacancy may be

8:02

up, but at a much slower rate, industrial vacancy

8:05

on the other hand has started to

8:07

pick up more markedly, right? It is still

8:10

low by historical context, but decision making

8:14

is slower and slower take up means we

8:16

are starting to see industrial vacancy increase.

8:18

And just on industrial, I

8:21

think the way occupiers are thinking about their inventory situation,

8:24

I think we're going to start seeing more

8:26

of this return

8:29

back to ‘just in time’ from ‘just in case’

8:32

and that could, you know, put

8:35

some upward pressure on vacancy.

8:37

Each piece of inventory actually costs business a lot.

8:39

It costs them in working capital, it costs

8:42

them in storage, it costs them in obsolescence.

8:44

So I'd say take up

8:46

in industrial would be maybe slower

8:48

than what we've seen

8:51

before.

8:56

Yes, and on cap

8:58

rates, the US, UK even

9:02

New Zealand markets have started to readjust.

9:04

And our line of sight on that

9:06

is that, US cap rates for office have

9:09

expanded by around 200 basis

9:11

points, which is about 50 to

9:14

75 bps softer than what

9:16

we were expecting things to settle just six months

9:19

ago. So we're seeing big movements

9:21

there, Sameer, there's no doubt about that, so just

9:24

what's your take on that?

9:26

Yeah, Phil. That's right. You know, if you look at the Investor

9:31

Intentions Survey, it paints a picture of

9:34

tier one cities’ office cap

9:36

rates ranging from five

9:39

and a half to 8%. And

9:41

industrial class A stocks

9:44

valued at five to 6% range and shopping

9:47

centres in that kind of 6% to 7%

9:50

range. So, to your point, Phil, the

9:54

outlook for cap rates has probably

9:57

softened by another 50 to 75 basis

10:00

points as the year has gone on. Things

10:02

are getting a little bit softer in

10:05

terms of pricing.

10:06

Those are big movements

10:08

in the US. So

10:10

from what you've observed so far, what's

10:14

different in your mind and do

10:16

you think those differences are going to hold?

10:19

Yeah, Phil, I think, in Australia we will

10:21

probably see almost price

10:23

parity with the US, maybe

10:25

a little bit firmer than the US, particularly around

10:28

markets like office where we don't

10:30

have the similar sort of structural challenges, but

10:33

when it comes to say, industrial or shopping centres,

10:36

I don't see why there should be any

10:38

big difference between us and Australian

10:41

cap rates. So we've kind of softened

10:43

by 50 to a hundred in

10:46

the first year. I think in the next

10:48

six months, I'd expect maybe

10:51

another 50 to a hundred to

10:53

go from here as well.

10:54

Okay. Well, one of the ways that cap rates

10:56

in Australia might adjust more rapidly to their steady

10:59

state, I suppose, is if debt maturity leads to asset

11:02

sales and, and some repricing. What can we say

11:04

on the maturity cycle?

11:09

So the kind of overall

11:11

debt envelope in commercial real

11:13

estate sector in Australia is about Aussie

11:16

$370 billion, And our

11:19

assessment, that just 4%

11:21

of this existing debt comes

11:23

up for maturity in ‘24, and then

11:26

there's another 10% in 2025. The

11:29

big maturity years are ‘26, ‘27,

11:32

‘28. So potentially about 15%

11:34

of the debt will come up

11:37

for refinance maybe in the next

11:39

12 months. I'm not expecting

11:41

that'll be a catalyst event for a

11:44

massive set of forced sales. I don't

11:46

think debt is the driver.

11:49

Yeah. But, the cost of funding's

11:51

increased by two and a half, you know,

11:53

3% and bank

11:55

credit committees are continuing to

11:58

be super vigilant on serviceability.

12:00

So is this going to trigger more

12:03

or less activity, as interest

12:05

rates settle?

12:05

Yeah, it's really tough being a buyer right now

12:08

in the market. It's really constrained

12:11

the buyers. We've seen

12:15

probably more interest right now from credit

12:16

funds who look

12:19

at the market right now and returns on

12:22

some of these credit funds can be 10 to 12%

12:25

in the current settings. And these credit investors

12:27

are typically looking at

12:29

turnaround situations. They're looking

12:32

at developments and other segments

12:34

where covenant structure might need

12:37

to be a little bit different. But Phil, just

12:39

on interest rates and sort of the outlook for

12:41

interest rates, I'm not expecting

12:44

any urgency to cut interest rates

12:47

till late ‘24. But just

12:50

having interest rates stabilise just

12:52

lets people get on with the decision making.

12:56

Absolutely. So

12:58

Sameer, let's talk alternatives, I

13:01

suppose a brighter spot and we've

13:03

both got young children that

13:06

will be graduating high school shortly and looking

13:08

at university options. I

13:11

know we've both been looking at what that means from a

13:13

student accommodation standpoint. Where are they going

13:15

to house themselves? So, as you

13:17

have gone through that process, what have

13:19

you learnt from that about the PBSA market?

13:22

Phil, look, my son recently

13:24

applied for a spot for on-campus

13:26

living, and there were about 1600

13:29

applicants for 200 spots.

13:33

It is very tight, it was a very

13:35

stressful situation. There's

13:37

around 1.6 million university

13:40

students in Australia and currently we

13:43

have one purpose-built student

13:45

accommodation bed for every

13:48

16 students, one for every 16

13:51

students. So it's a deeply underpenetrated

13:53

market.

13:55

Yes. I agree with that and even with some of

13:57

the supply coming through over the next three

13:59

years I think there's about 8,000 beds,

14:02

the market's going to continue to remain very

14:05

tight. So how are you seeing rents for student

14:07

accommodation?

14:08

Yeah, look, there's a lot of dispersion in

14:11

rents. A lot depends on location

14:13

and you know, whether it's a new recently

14:16

built facility with some amazing

14:18

amenities around safety and

14:21

socialising and gyms. So

14:23

I've seen everything from, suites

14:25

that are at $350 a week, up towards

14:28

$800 a week. But, we

14:30

have a lot of proprietary data at CBRE on

14:33

this. And what it's showing is

14:35

that on average, student

14:38

accommodation has rent growth of about 5.5%

14:41

per annum.

14:42

It's a pretty decent rent growth market.

14:44

Very.

14:44

And this is an asset class which has

14:46

been favoured by global investors. Yields

14:48

have been more resilient to

14:50

changes than the

14:52

more traditional sectors, but that are about

14:55

0.75% higher than build-to-rent.

14:57

So the other alternative sector where we're

14:59

spending more time with our clients is around the energy

15:02

transition. There's certainly a growing

15:04

role for real estate investors to carve out

15:07

the value of the hard assets like land and infrastructure

15:10

from energy supply. And this could

15:12

be like what we experienced a little bit

15:14

with the telecom towers and healthcare for example. It's

15:17

a high growth business where we are

15:19

dedicating more time and resources. Sameer, getting

15:22

towards the back end of

15:24

our chat here, I thought we would just go

15:26

to a few thought-provoking ideas and thoughts, a

15:30

couple of picks. So let's discuss the outlook

15:33

for a few topics where there's been a

15:35

lot of debate and a bit of controversy

15:37

in the market. Why don't you hit your first

15:40

one?

15:41

Alright, I'll start off with residential.

15:44

Look, we've been very bullish on the residential market.

15:47

I'd probably say well before others. It's partly

15:50

because of the robust jobs picture that we

15:52

just discussed. And our new controversial

15:55

view here is that the

15:58

fastest growth will be

16:00

at the front end of the cycle and late

16:03

cycle. So I'm expecting 2023 and

16:07

2025 will be

16:09

sort of double-digit capital value growth, whereas 2024 will

16:12

be more modest and next year it'll

16:14

be more modest sort of flat, low single digits.

16:16

So I'm calling it plus 10% this

16:19

year plus five next year and then plus 10.

16:21

So you get to about 25% price growth

16:24

over three years and that reflects

16:26

the cost of the higher cost of building

16:28

new stock. My second controversial

16:31

topic, Phil for you is, office occupancy.

16:36

I expect office occupancy to be

16:38

back to 2019

16:41

levels in CBD offices

16:43

around the country as late as

16:45

maybe the end of this year, early next year. I

16:48

was on a plane recently, Phil, and it dawned on

16:50

me that it feels just

16:52

like before and you know, and speaking

16:54

to friends, their kids who are going

16:56

to university are all talking about, better

17:00

experiences like their parents had and

17:03

retailers are talking about returning back to

17:05

just in time supply chains. So

17:08

why not the office environment? I expect office

17:10

occupancy will start to, we won't

17:12

even probably talk about office occupancy

17:14

next year.

17:15

Well, that's almost like a belief in

17:18

humanity I

17:21

think you’ve g0t there Sameer. I’m with

17:23

you. Well, it was interesting,

17:25

our global Office Occupier Survey also found

17:28

that over one third

17:30

of firms still expect office utilisation to grow

17:33

from current levels compared to less than 10% who

17:35

expected it to

17:37

fall from

17:40

current levels. So there is upside, and portfolio optimisation

17:43

could also lift that utilisation, but we

17:45

also need to be cognisant of

17:49

the opportunities that are offered from hybrid work as well. But, I

17:52

tend to agree with

17:54

you, I think that normalisation is a good trajectory. Okay what's the next one?

17:55

Third one is construction

17:58

costs. So in my view, we

18:01

know construction cost growth sort of peaked in 2022,

18:04

June 22 when it was increasing at

18:07

about 17%. And currently

18:09

it's increasing, but at about 7%

18:12

year on year. So it's kind of halved

18:14

in terms of its growth rate. And my view is that we'll see

18:17

flat growth by year end and

18:20

the key here will be just what goes on with

18:23

construction, labour wage pressure,

18:26

whether it starts to ease as some of these residential

18:28

projects get completed.

18:29

Yes. And just given the size of

18:31

the infrastructure pipeline and the tightness

18:34

in the labour market that you refer to there I still expect

18:37

we'll get to mid to high single digits, construction cost

18:40

growth, which I'm afraid continues to add

18:43

the challenge to the development pipeline, particularly

18:46

in housing as you reference. Okay. So

18:48

last one, Sameer.

18:50

Last one is refurbishment

18:53

CapEx. So a

18:56

number of our clients have articulated

18:58

some very large pipelines of new

19:00

projects, refurbishments

19:03

including on net zero initiatives. And these commitments

19:07

were all made when debt was cheaper.

19:09

Construction was cheaper, valuations were

19:12

higher. I expect that

19:15

we will probably see a major downshifting, unfortunately. Not

19:17

because clients don't

19:19

want to do this, but more because

19:22

the economic climate does not

19:25

let them do it.

19:26

I think it's fair to say, Sameer, there's some rain

19:29

clouds building, but , I'm hopeful

19:31

you're not going to say we're pulling the

19:33

covers out

19:35

Not yet.

19:35

Good. Okay. Well, hope everyone

19:38

enjoyed our latest edition of Talking

19:41

Property, the House View. We'll be

19:43

back with our next House View early

19:45

next year. If you like what you're

19:47

hearing make sure you subscribe.

19:50

Until next time.