0:09

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

0:12

with our Head of Research, Sameer Chopra

0:14

for our first edition of The House View for

0:17

2024. We've already chatted to a number

0:20

of our major clients this year on our Talking

0:22

Property podcast to find out what they're

0:25

focusing on this year. So, plenty of insights to

0:28

inform our discussion today and of course

0:30

a lot can happen in three months. Certainly,

0:33

a fair bit of water has run under the bridge, which

0:35

is shaping the operating environment that

0:38

we're in. On a positive front, we’re seeing

0:40

signs of inflation moderating, we've probably

0:43

seen peak interest rates, employment remains

0:46

resilient, and it feels like we're getting

0:48

to the top of cap rate expansions. All

0:51

of which is flowing into what we can see

0:53

is some improving investor sentiment. But of

0:55

course, we are in a very, very volatile and

0:58

uncertain geopolitical environment, which is

1:01

deeply concerning, and we can

1:04

also see some of China's economic woes starting to

1:06

heighten. In this edition of The House

1:09

View we'll be discussing CBRE's key predictions following

1:11

the release of our Market Outlook report. We'll

1:14

hit pricing, investor intentions, vacancy,

1:17

cost of living, and

1:19

of course we'll throw out some predictions that

1:22

I'm sure will generate some debate. So, Sameer, let's

1:24

get started. I'd like to kick

1:27

off with the elephant in the room. Is it time to buy and

1:30

would you go now, or will

1:32

you wait till later in 2024?

1:36

Phil, look, I'd say it is time to

1:39

get constructive on commercial real estate.

1:41

I think there are three compelling reasons right now.

1:43

Firstly, my sense is

1:46

that we're at the 9:00pm mark on repricing. So, in

1:48

other words, we're three

1:50

quarters of the way through the cap rate expansion. Markets have largely

1:52

corrected. Super prime industrial cap rates

1:55

are now 130 to

1:57

170 basis points higher than

2:00

where they were 18 months ago.

2:02

Office CBD Prime is about 100

2:04

to 160 basis points higher, retail and hotels by

2:08

more modest, but 50 to 75, living

2:10

sectors by about 25. And I

2:12

think bidders can achieve this sort of final stretch

2:14

of cap rate expansion during

2:16

negotiations. Secondly, Phil, I think a

2:19

bit more of a complex topic, but there is this

2:21

thing called the denominator effect. Typically,

2:33

a super fund or an investor

2:35

would have their portfolio allocation with

2:38

about 60% sitting in shares, 15%

2:40

in bonds, about 8% in

2:42

real estate, and the rest sitting in cash. Recently what

2:46

we've seen is a very strong rally in

2:48

shares and bonds. Shares are up

2:50

by about 20%, bonds are up by about

2:53

5%, and so the portfolio allocation

2:56

needs to be reset higher for

2:58

real estate. My view

3:00

is that new allocations may start to

3:02

replace redemptions as we

3:04

go through 2024. And finally, Phil,

3:07

we expect bond deals to start

3:09

descending. I've got bond deals at 2.75%

3:11

over the medium term. They're currently

3:13

about 4.1, 4.2%, and this

3:16

should spur investment activity.

3:24

Well, to contrast a bit of that Sameer, maybe I

3:28

can just cover what we're seeing in the US. Cap rates have

3:30

increased by roughly 150 basis points between early '22

3:33

and and late '23 depending on market

3:36

and asset type, and of course this

3:38

implies about a 20% decline in values for most property

3:41

types. But we think cap rates

3:44

have probably got a little way to go

3:46

and may expand by about another 25 to 50 basis

3:48

points in 2024. Office cap rates rose by at

3:51

least 200 basis points. And similarly, there was

3:54

a significant expansion in logistics by

3:57

around 150 basis points. Retail by

3:59

160 and multifamily up about 180 basis points.

4:02

Having said that, our most recent

4:05

APAC Investor Intentions Survey showed investors

4:08

view Australia favourably in ‘24,

4:10

certainly alongside Japan and Singapore. What

4:13

that survey also indicated is by

4:16

sector, offshore investors really like

4:19

industrial, probably the most. But

4:22

I suppose just coming back to Australia,

4:24

Sameer, what about new developments? How

4:27

are these being impacted by these

4:29

higher cap rates? We've obviously got elevated

4:32

construction costs and of course higher interest

4:35

rates and cost of debt. So, how's all

4:37

that flowing through and impacting development

4:41

pipelines?

4:49

Yes, Phil, this is an area where we're working

4:51

very actively with a number

4:53

of clients. A lot of work is going into

4:55

investment cases for new

4:58

developments and it's tough, right? Like

5:00

let's say if you plug in today's cap rates, which

5:03

are, let's say 150 basis points higher

5:05

than where they were two years ago. You add

5:07

in another sort of 35-40% higher construction

5:10

costs, put in debt sitting at six

5:12

and a half, low single digit rent

5:14

growth. It's tough. It makes it really,

5:17

really hard to stack up

5:19

an investment case.

5:23

Yes we're seeing that a lot. So, but with vacancy

5:25

at the levels they

5:28

are across most sectors, even premium office,

5:30

do you think rental growth

5:33

could be better than low single digits?

5:36

There's definitely a case for that, Phil and I think

5:39

this is where we need to get a

5:41

lot more constructive and clients need to get a little

5:43

bit more micro into precincts. My suggestion would

5:45

be, increase the rent

5:48

at the outset. So, rents could

5:50

start off on a much higher bar

5:52

for some of the latest warehouses, some of the

5:55

best offices or good residential sites. And

5:57

there's a case to assume that

5:59

bond yields return back to

6:01

the cycle average. So, you know, helping with that cap

6:04

rate compression.

6:09

Alright, so given all that Sameer,

6:11

what are some of the angles that can

6:14

be run here?

6:16

Yes, we've got a couple of angles. So Phil, one, you

6:18

know, I'd say we're seeing pockets

6:21

of strength in Australia, and I'd suggest

6:23

that investors can get very localised in their

6:25

understanding of the dynamics. So, even

6:28

if you look at office, in the last

6:30

year we saw a 25% spread in rent growth

6:32

between parts of Melbourne and Brisbane. So,

6:36

you could have had exposure to

6:39

office and it could have been

6:41

a great year or a tough year.

6:43

I'd say as you think about the longer term, the first idea

6:45

I'd have is one, look at precincts. There's a lot of

6:47

large-scale infrastructure development that the government

6:50

is putting in and

6:52

we should ride their coattails. One is

6:55

the Sydney Metro rail,

6:58

you've got the Western Sydney Airport, Melbourne's Arden Health District,

7:00

Brisbane and Perth also have rail lines

7:02

going in.

7:12

I think the precincts and the infrastructure is

7:16

a comparative advantage of Australia. Absolutely. And

7:18

these precincts offer clients an opportunity to

7:21

deploy money in a really programmatic

7:23

way over a five, 10, 15-year period,

7:25

and importantly into a really diversified

7:27

product. And of course we have large

7:30

infrastructure investment, which really adds to

7:32

the value and benefits of these

7:34

select locations and sectors. Last year

7:37

I spent quite a bit of

7:39

time on Western Sydney

7:42

and I'm always impressed by the sheer

7:44

scale of what's being delivered. We've obviously

7:46

got the Western Sydney airport, which is due to open

7:48

in 2026, and this will be a game

7:50

changer for the region's economy and its

7:53

connectivity, particularly up into Asia and of course the development

7:55

of the surrounding Aerotropolis. So, if

7:57

you map that against the new Metro

8:00

line between the airport and Parramatta,

8:02

you've got major motorway upgrades, you've got

8:04

Parramatta light rail, Western City

8:07

Parklands, which will create a massive urban park.

8:09

I think it's larger than Central Park in

8:12

New York. So, you combine

8:14

all these initiatives and investment. It

8:16

will improve transportation, it will create

8:18

jobs and really boost Western Sydney's economic

8:21

prosperity and in a district that is home

8:23

to 10% of Australia's population,

8:25

I might add.

8:40

Massive opportunity. Our second idea is that returns

8:42

also vary a lot during periods

8:45

of interest rate change. I expect

8:48

that we'll have value investors hunting for undervalued

8:50

office, like grade A

8:53

type office. That's where we're seeing

8:55

some clients. And also shopping centre assets.

8:57

But over longer periods of interest rate

9:00

change, the assets that perform

9:02

well are those that can

9:04

sustain really strong rent growth and

9:07

that’s my third idea, 'beds, meds,

9:09

sheds', or industrial, healthcare, residential and student accommodation

9:11

should be well placed

9:14

in this lower interest rate

9:17

environment that hopefully we get

9:19

in the next few periods. Our

9:21

US team also favours industrial and multifamily,

9:23

same thing. Strong fundamentals. And I think Phil,

9:26

retail has also got these improving fundamentals,

9:28

supply related, but improving fundamentals. Phil,

9:31

any colour that you're getting from

9:33

clients on new sectors that they're looking

9:35

at?

9:44

Yes, well, in December we had a set of interviews with

9:46

a number of Australian real estate leaders and

9:48

to your point around beds, meds and sheds,

9:51

Sameer, that is certainly a recurring theme. There's a

9:54

lot of focus on the living sector and alternative

9:56

assets, like healthcare and life sciences, in product types

9:58

like private hospitals, medical precincts, innovation districts

10:00

and seniors living. But at the

10:02

same time, there's an ongoing

10:05

focus on strong performing core

10:07

asset classes like industrial and to the point

10:09

around core asset classes, despite the

10:12

lingering sentiment around office, there's real

10:14

conviction from some of our clients around core office product,

10:16

particularly premium assets as

10:19

we see that new supply

10:21

starting to shrink and occupiers continuing to focus on

10:24

high quality assets that

10:26

obviously plays into their employment proposition.

10:29

So, I think that those themes are

10:31

coming through strongly.

10:43

Phil, you mentioned core office. What are we

10:46

seeing in terms of our own leasing volumes in

10:49

CBRE's business in Australia?

10:52

Maybe I'll take industrial first. Overall industrial

10:54

take-up was about 530,000 square metres

10:56

in the fourth quarter

10:58

of '23. That was down about 20%

11:01

on a year-on-year basis. But we

11:03

did see a recovery in the fourth quarter compared to

11:05

the third quarter and pre-lease activity helped last

11:08

year, even when the vacancy was very

11:10

tight. Early indicators, January has

11:12

had a reasonably promising start on an inquiry

11:14

basis. For office, we saw more healthy

11:17

levels of leasing activity throughout the year. Volumes

11:19

grew about 25% year over year with

11:22

a particularly strong second quarter. Of

11:24

course, this was essentially driven by that

11:27

momentum that we've seen around

11:29

the flight to quality, so that premium

11:31

product and new developments. Of course, we've

11:34

still got a fairly resilient labour market, so

11:36

that's what we're seeing driving those volumes. We are

11:38

seeing it sort of come

11:40

off a little bit and I expect that to continue

11:43

as we see occupiers become just a little bit

11:45

more cautious and we get through the backlog

11:47

of demand post pandemic. So, that was a local angle. Sameer, when

11:49

you are talking to your international colleagues,

11:52

what are you hearing from them around the global

11:54

leasing activity and particularly vacancy too?

12:12

Phil, similar to the points you were making

12:14

about Australia, leasing activity did slow down in 2023,

12:17

but there were some really interesting dynamics

12:20

below the surface. So in office, vacancy rates are

12:22

being driven more by demand conditions,

12:25

whereas in logistics and retail,

12:27

it's much more of a supply related picture.

12:29

So, if you look at

12:32

vacancy and logistics, across the world, it

12:35

looks like vacancy has increased by about 3%

12:38

year on year. Mainly because we've

12:40

had a very strong supply response. In

12:42

office, vacancy was already very

12:44

high in the US, it's running at a

12:48

15 to 35% range, depending on

12:50

the city. It's in the high single digits in

12:52

Europe, but showing signs of

12:54

stabilising. And in retail, vacancy

12:56

has improved due to supply curves. And

12:59

maybe just to give you

13:01

some flavour around the numbers, if

13:03

you look at logistics, Chicago logistics

13:06

vacancy is around 4%. In the UK it's

13:08

about 5%. In contrast,

13:10

Sydney and Melbourne vacancy is

13:13

0.6% and 1.5%. So, we

13:15

have a much, much tighter market

13:18

here. In office, vacancy in Washington DC is

13:22

21%, in Ottawa Canada it’s about 13%

13:24

to 14%, London is 9% and then Canberra

13:26

is 8%. So again, sharper

13:29

than some of our global

13:31

comps. And in shopping centres,

13:34

US vacancies now sub 5%,

13:36

that's about where we

13:38

are sitting in Australia as well.

13:51

Maybe switching gears a little bit, I just wanted

13:53

to touch on cost of living. It's obviously an important

13:55

topic, not only here in Australia, but globally.

13:58

And it's a major concern amongst the

14:00

business community, amongst government, and of

14:02

course the property sector. Even as some goods and fuel

14:05

prices start to normalise, it's very apparent

14:08

that consumers are starting to feel that

14:10

massive pressure from higher interest rate costs. And of course,

14:12

these basic necessities of rents and electricity and insurance,

14:15

which do remain pretty elevated. Sameer, one

14:17

of the major considerations for the

14:20

property sector is construction costs. So how

14:22

are you seeing that?

14:30

The cost of construction, it's

14:32

up by about 40% over

14:35

the last four years. So, along with

14:37

higher funding costs, it's going to make it

14:40

really hard to bring supply-based competition to the

14:44

market. I think that's the real worry, to actually get

14:46

inflation down you need more supply and with

14:48

these high construction costs, these really tight

14:51

funding markets, it's tough to bring

14:53

new supply.

14:56

Look, I think the sector that's obviously feeling the

14:59

most is in apartments.

15:01

The supply of new apartments is sitting near

15:03

decade lows of 55,000 a year. We

15:05

definitely need to accelerate that and

15:08

of course, given the housing

15:10

crisis, a number of our clients are looking

15:12

at affordable and essential worker home opportunities

15:14

just given the need for that type of housing.

15:16

Sameer, what are your thoughts

15:19

on the scale and timing of affordable and

15:22

essential worker housing?

15:29

Phil, I think the first thing people need to

15:32

understand is it takes about three to five years to drop

15:35

supply into the market. So, I think

15:37

delivery of this affordable and essential worker home

15:40

opportunity will take three to

15:43

five years before it starts to gain traction. And after that

15:45

it might be possible to start delivering

15:48

something in the range of

15:50

a few thousand apartments under some sort of

15:52

scheme. But in the short term, because this is

15:54

a near term issue, there's scope for

15:57

higher rent relief subsidies to manage cost

16:00

of living challenges.

16:04

Just staying on that for

16:06

a second. So, what type of subsidy might be needed

16:08

do you think to provide that kind

16:11

of rent relief?

16:14

Rents are up a lot. Rents in

16:16

Parramatta are up 20% in the last 12

16:20

months. They're up 20% in the southwest of

16:22

Perth, they're up 17% in North

16:24

Melbourne. So, realistically a subsidy would

16:27

need to be in the range

16:30

of 50 to a hundred dollars per week just

16:32

to offset some of this cost growth that

16:35

we've had. Now, we know that a third of Australians

16:37

are renters and if you offer this to the 10% of

16:41

families that are really struggling, then I think

16:43

the annual cost for the government's

16:46

only about 750 million. It's very doable.

16:51

Well, rental affordability is obviously not just

16:53

an Australian issue. It's a

16:55

global phenomenon. You know, we're seeing this in the

16:58

US, the UK, Spain, Singapore, New Zealand, and of

17:00

course it's partly driven by

17:03

the attractiveness of global gateway cities. And, and

17:05

there are a handful of cities and countries

17:07

that have really picked up significant

17:10

inflow of new migrants. So, this demand shock is

17:12

causing, real outsized challenges in housing and

17:14

of course the property sector really

17:16

does need to keep offering

17:18

up these creative solutions in close

17:20

coordination and partnership with government to address these

17:22

kind of challenges. Sameer, I want to get towards the

17:24

end of our discussion here

17:27

and it's time for our controversial

17:29

predictions, and we can revisit these

17:31

in three months and we'll see who's right and see where we

17:33

land. So, I thought we'd hit three things,

17:36

vacancy, office visitation or CBD visitation

17:38

and interest rates. Perhaps we can start with vacancy. What's

17:40

your prediction there?

17:54

Phil, I expect that we will see vacancy

17:58

stabilising or falling across the

18:01

board in late 2024, all

18:04

sectors. So I'd expect that, vacancy rates in

18:06

office, retail and residential will be lower

18:09

in the second half than the first half

18:11

of '24. And maybe we'll

18:13

see this in logistics as well. That's a tougher

18:16

one. And this is because of supply

18:18

getting pushed back and still strong

18:21

occupier activity. I think supply is getting crunched.

18:24

Okay. I can kind of see

18:26

that. I'm a little more cautious than

18:29

you on how quickly occupiers are making leasing decisions,

18:31

particularly in logistics where the take up was so

18:34

strong in '21 and in 2022. We

18:36

could still see vacancy rising. What about return

18:39

to office?

18:44

Yes, return to office. I

18:47

expect that peak day CBD

18:50

visitation or office attendance will

18:53

be at similar levels to

18:55

2019. And I think we'll see

18:57

it pretty soon. It's been encouraging Phil,

18:59

just to see the CBDs are very busy in

19:02

Jan. You know, people seem to have

19:04

really come back and our data into the

19:07

fourth quarter of last year was suggesting that

19:09

peak day visitation was running at 83%

19:12

of pre-pandemic levels in

19:15

Sydney and almost close to 100% in Perth.

19:21

Yes, I think that that general trajectory of

19:23

people coming back

19:25

to CBDs and the general trajectory of people returning

19:28

to office is positive and there's no reason

19:30

to see that slowing. And I think we've clearly

19:32

seen a lot of organisations just

19:34

continue to reinforce the importance of being together,

19:36

having the in-person experiences. The way that office

19:39

precincts are being curated is really

19:41

helping in that regard. So,

19:44

whilst hybrid work is something that

19:46

is here to stay, I don't

19:48

necessarily see that as being

19:51

the demise of office or necessarily we see

19:53

visitation come back. Okay. Interest rates.

19:55

Last one.

20:10

This will probably be my most controversial one.

20:12

I expect at least two interest rate

20:15

cuts in Australia during 2024.

20:18

It'll start around the third quarter and

20:20

the reason I'm probably in that space

20:22

is that interest rates are very restrictive

20:25

right now. People are paying

20:27

about 2-2.5% more in interest rates than

20:29

they would in normal circumstances. This is also

20:31

making further challenges and contributing to a

20:35

tight supply market in real estate down the road.

20:38

Very much the case in case in

20:41

residential. So I'm expecting, Phil, at least

20:43

two at a touch. Maybe even three.

20:52

Oof. Alright, well I think I might put the money on that one.

20:56

<Laugh>. Yes, I don't know, I think on this one Sameer, I'm not

20:58

sure I'm with you. I think whilst that would be welcome,

21:01

I'm just not sure about that. I just think

21:03

the strength of migration, the resilience we're still seeing

21:07

in employment, I think that's going to make

21:09

that case difficult. But we'll see.

21:12

Well Phil, I think I'll try and have more certainty

21:14

on my interest rate predictions rather than

21:16

whether Australia will lose a cricket game.

21:20

Oh , very good. Well, on that note, I hope you've

21:22

enjoyed our latest edition of Talking Property,

21:25

the House View. Uh , Samir and I will be

21:27

back with our next house view in early April.

21:30

So if you like what you're hearing, be sure to

21:32

subscribe. Uh , and in the meantime, CBRE

21:34

will be releasing , uh, new Talking

21:37

Property episodes each fortnight. So let us know if you

21:39

have any topics you'd like us to discuss

21:42

via talking [email protected].