0:09

Hello and welcome to our quarterly Talking

0:12

Property series, The House View. Together

0:15

CBRE's Australia and New Zealand CEO. Phil

0:17

Rowland and head of Research, Sameer

0:19

Chopra will investigate what's next for

0:21

the Australian property sector, the potential

0:24

disruptors, emerging opportunities,

0:26

and what's top of mind for the industry's

0:28

major players. We hope you enjoy

0:30

their conversations.

0:32

Hello, I'm Phil Rowland and it's great to be

0:34

back with CBRE's Head of Research, Sameer

0:36

Chopra for the second edition of The

0:39

House View for 2024. If

0:41

you recall, we made some bold predictions in

0:44

our first edition back in January, and

0:46

I've got a bottle of Coleraine on one

0:48

or two of those with Sameer, so we'll

0:50

be sure to revisit those in one of our later episodes

0:53

in the year. But for now we

0:55

thought it would be good to cover what's top of mind

0:57

for investors as we close out the

0:59

first quarter of this calendar year and

1:01

get back to the basics and zero in on what

1:03

we're seeing across the primary asset classes

1:06

of office, industrial, retail

1:08

and living. So Sameer, perhaps we can

1:10

kick off with a discussion about what's topical for

1:13

our clients right now. I know you've

1:15

been very busy helping clients interpret the market

1:17

and embed strategies to reflect those

1:19

conditions. So what are the most pressing

1:22

things that you're getting asked?

1:23

Phil, it's been definitely a very busy

1:26

period of presentations, in helping

1:28

clients prepare their investment

1:30

committee reports. We're

1:32

at this juncture where there's broad agreement

1:35

on some of the longer-term tailwinds for

1:37

real estate in Australia, but there's

1:39

just not enough conviction yet on the

1:41

strength of future rent growth and on

1:44

exit values and in

1:46

some cases the regulatory environment. So

1:49

a lot of good investment ideas are spending more time

1:52

than usual in DD or have

1:54

stalled for now.

1:55

Well this stalling of deal flow is real and

1:58

it's certainly reflective of the market that we're

2:00

in. Just reflecting on it in January, there was an

2:02

improved shift in sentiment as

2:04

investors anticipated improving conditions, but

2:07

the timing of some of those indicators

2:09

such as inflation, moderating and

2:11

rate cuts moving out a bit,

2:14

we've certainly seen that sentiment weakening

2:16

for the time being. But how does

2:19

this contrast with what you're hearing from offshore Sameer in

2:21

the Americas and in Europe?

2:23

So broadly similar dynamic

2:26

overseas. So, in the US real estate valuations

2:28

have corrected more significantly and there's

2:31

good pockets of local opportunities for those

2:34

investors. But transaction flow is still

2:36

low in a historical context and

2:38

real estate as an

2:41

asset class has been left behind as

2:43

equities and fixed income saw these really

2:45

healthy returns in the back

2:48

half of last year and into Q1 of

2:50

this year. I'd say offshore

2:52

investor interest from North America

2:54

and Europe tends to favour our growth

2:56

sectors. So industrial and residential. Asia has

2:59

favoured value and so

3:02

they're likely to play in office

3:04

and previously in retail. How about

3:06

you Phil? What are you hearing from

3:08

our clients?

3:10

Well I would say a couple of things from the

3:12

discussions I've had over the last couple of months. Firstly,

3:15

ways to improve operational and

3:17

cost efficiency through this period of

3:20

compressing margins. We're certainly

3:22

seeing higher outgoings, higher

3:24

cost of debt, lower development activity,

3:27

all that is putting pressure on margins. Look,

3:30

this isn't new clearly, but our sense is that

3:32

we are certainly through the worst of that cost pressure,

3:35

but there's still a lot of work to

3:37

do to get the cost out so that as the market

3:39

recovers, we see margins improve,

3:41

which obviously everyone's anticipating.

3:44

The second one is just figuring out the

3:46

sources of capital that line up with

3:48

the strategies and the development pipelines of

3:51

local investors and developers and

3:53

then also figuring out where to deploy

3:55

that capital, particularly geographically

3:58

in this part of the cycle. So

4:00

to the first point, there's really no shortage of

4:02

capital that has got conviction on Australian

4:04

real estate, but finding the right strategic

4:07

capital partner at the right

4:09

pricing that's ready to commit now

4:11

is proving to be a bit of a challenge. On the

4:14

topic of where to deploy, Sydney remains

4:17

a priority market, that's for sure, but when

4:19

you look at the data and I'll get you

4:21

to expand on this a bit Sameer, but there

4:24

actually are parts of Australia such

4:26

as Brisbane and Perth, that are indicating

4:28

kind of better returns. So there's I suppose

4:30

a challenge of focus coming up there. What do you

4:33

make of that?

4:34

Phil, look I have always been a

4:36

fan of quality and liquidity and

4:38

so I think the Sydney market will

4:40

continue to sort of command that premium.

4:43

We've typically seen that at 25 to

4:45

50 bps of better

4:47

yields in Sydney. It's a very safe

4:49

choice for investors, particularly when they're dipping their

4:51

toe for the first time. But in

4:54

consumer-facing sectors, like residential,

4:57

in retail, in hotels, you

5:00

can afford to extend your horizon and look

5:02

at those cities, Phil, that you mentioned here, Brisbane and Perth

5:04

are indicating sort of better returns.

5:07

Okay. Well let's dive into the core

5:09

asset classes. I'd like to do something

5:12

a little bit different here, Sameer, and just

5:14

tackle one question in each of them if I may

5:17

which really gives us a moment to ask

5:19

the simplest question so that we can get to the real

5:22

fundamentals. So let's start with retail. There's been

5:25

fresh interest in retail and shopping centres,

5:27

particularly from the private market. And

5:29

of course, we all know that retail was a sector

5:31

that went through a period of real pressure

5:34

through 2017 to 2021. We

5:37

were concerned about the post pandemic

5:39

changes in customer behaviors, leakage

5:41

to e-commerce, and of course legacy asset

5:44

composition. But retail has

5:46

really weathered that storm. So what's happening

5:49

in the fundamentals in retail that's making

5:51

us fall in love again?

5:54

Well, there's actually quite a lot to like about

5:56

the current outlook for shopping centres. Firstly

5:59

we've got this booming population and retail

6:01

spend is expected to grow

6:04

to about 500 billion by the end of this decade,

6:06

sitting at about 420 billion right now.

6:09

So you've got this

6:11

very strong demand. And then secondly, new supply for

6:14

shopping centres is around half

6:16

of what it's been historically and this

6:19

drives up the productivity of shopping centres, which

6:21

is a big reason why my US

6:24

colleagues turned positive on the sector.

6:26

And when you say productivity Sameer, what

6:28

do you mean? Elaborate on that.

6:30

Phil, we measure productivity through

6:32

a metric called GLA per

6:34

capita, which is basically space per person.

6:37

And that GLA per capita for

6:39

shopping centers has dropped from 0.8

6:42

to 0.65, which is

6:44

quite a sizable move. And just along these

6:46

lines, vacancy rates have now dropped below

6:49

5% nationwide. It should

6:51

continue to keep falling as city

6:53

centre shopping centres get filled up. Our historic

6:56

low in vacancies being 3%. So

6:58

that would be a nice target for us.

7:01

Yes. Trending that way. So what else

7:03

supports retail?

7:04

We’ve got this increasing

7:07

return to work rates, but the real big reason here

7:10

in Australia is Australian

7:12

shopping centres are underpinned

7:14

by daily need supermarkets,

7:17

which is a real draw card for repeat

7:19

visitation by customers. Our own

7:21

analysis shows that about 94% of shopping

7:24

centres in Australia have at

7:26

least two supermarkets in them. And so

7:28

it means, people are always visiting these shopping centres.

7:31

That's been a real hallmark of the resilience for sure.

7:34

So three really solid themes supporting retail.

7:36

I'll chip in with one more and that's really that occupiers are

7:39

continuing to evolve their e-commerce strategy

7:42

so they have a more omnichannel approach. Again,

7:44

that's not necessarily new, but certainly a

7:47

continuing theme and companies are rediscovering this

7:49

need for in-person interaction with clients,

7:51

whether that's a showroom, a try before

7:53

you buy, returns, you name it. Or

7:56

even a shift towards direct to customer business models.

7:58

So one final question on retail, Sameer,

8:01

what about leasing spreads they've been looking

8:03

pretty positive?

8:06

Phil, one of the things that really got

8:08

me more constructive on retail is that these

8:11

releasing spreads have now swung into

8:13

positive territory. So the occupancy

8:15

costs were lowered during the

8:18

last three years, with some categories, for occupiers,

8:20

where we saw about 15% lower rent to turnover

8:23

ratios. We saw that with

8:25

mini majors, we saw that with women's fashion.

8:28

And as vacancy has tightened,

8:30

rents can be rebased higher,

8:32

much higher.

8:35

Well it's a good outlook for retail. Alright,

8:37

so we've covered that off. Now let's tackle office.

8:40

As we all know, this is the sector that really

8:42

is in the eye of the storm right now. So

8:45

I've got a fundamental question for

8:47

you Sameer. So you and I have always been

8:49

constructive on Australia core office, but

8:52

investment sentiment remains really,

8:54

really challenged. So as you think

8:56

about office, why do you think we have this sort

8:58

of yawning gap between the fundamentals

9:01

and the sentiment? Is it differing views on the fundamentals

9:03

or is it just price?

9:06

I'll tackle both. We'll tackle fundamentals

9:08

and then pricing. So just on the fundamentals,

9:12

return to work has seen a strong

9:14

uplift in the early part of

9:16

2024. If you recall last year we were talking

9:19

about CBD visitation sitting at about

9:22

71%, almost three quarters of the pre-Covid level.

9:25

And that was Australia wide. Sydney was in the mid-seventies,

9:27

Melbourne was at 56%. And now

9:30

what we're seeing is that there's good

9:32

momentum in Melbourne. Melbourne has improved to

9:35

early-sixties, maybe mid-sixties and this should

9:37

continue to increase as the year progresses. The other

9:39

positive has been jobs growth in

9:42

Australia. So the Australian economy

9:45

added about 1.3 million jobs since the

9:47

start of 2020. And nearly a

9:50

third of these jobs have been

9:52

your traditional white-collar workers. So

9:54

people in professional services, financial services and

9:57

government. So

10:01

there should be this continuing good demand

10:04

for office space. So the fundamentals are good.

10:06

Let's maybe just look at pricing. Cap

10:08

rates in office expanded

10:11

and I'd say we're

10:13

getting close to sort of cycle high in Australia. Cap

10:16

rates went up by about 50 bps in that

10:18

second half of '23. And the latest

10:20

conversations we've had with our own

10:23

CBRE brokers and valuers suggest that we're

10:26

getting close to stabilisation for that

10:28

prime CBD stock. And in the

10:31

US cap rates for office expanded by

10:34

a little bit more, by 50 to 75

10:36

bps in that second half of '23. And now

10:39

when we ask our US investors whether they expect

10:42

further expansion, that percentage

10:45

is starting to trend down. It

10:47

used to be about 70% thought

10:49

there's more cap rate expansion coming, now

10:52

it's less than half and so it seems

10:54

like we're getting near the trough of

10:56

the office valuation cycle. Having

10:58

said that, getting capital to

11:01

actually take an active position in office is

11:03

a whole different matter.

11:04

Yes. I think what you're saying is

11:07

very supportive and undeniable fundamentals

11:09

around return to office, population

11:12

growth, white collar jobs growth.

11:15

You didn't mention the transport infrastructure,

11:17

but I think that's something that is a real tailwind

11:19

for Australian office, pretty hard to match

11:21

that. So I think what I'm hearing you say it's bright

11:23

and we're on our way there. Okay,

11:26

let's turn our attention to the living sector Sameer.

11:29

As we've covered in our previous editions,

11:32

living is probably the most vexed sector

11:34

in that we have this unprecedented set

11:36

of demand conditions that would

11:38

have any investor constructive on the opportunity to

11:41

serve multiple types of housing in Australia.

11:44

But we have equally unprecedented supply

11:46

side barriers in planning,

11:49

taxation, construction costs and labour shortages.

11:52

So the one question I have for you for

11:54

this sector is how do we keep the faith

11:56

in the living sector knowing these supply

11:59

side challenges?

12:00

It's a very attractive market, Phil, in

12:02

my view. We just cut

12:04

our future supply pipeline

12:07

forecast by 9%. So in

12:10

2023 and 2024 we see around

12:12

50,000 apartments delivered, which

12:14

is around half of cycle

12:16

peak rates. And supply over

12:18

the next five years will hover around 50,000 to

12:21

70,000 apartments, demand is running

12:24

at 75,000. Much, much higher than

12:28

supply. So, at least on our numbers, vacancy

12:30

will remain below 1% for the next five years.

12:36

Well it's interesting isn't it, sub 1%

12:38

vacancy is very similar to what we experienced in industrial

12:41

through 2022 and 2023, right? So

12:43

rents increased in Sydney and Melbourne by

12:46

about 70% during those two years. So

12:48

practically, if you think about it in

12:50

dollar value rent growth, what

12:52

could we expect these tight conditions to create?

12:56

Our number is about $155

12:58

per week growth in the median

13:00

rent for a two-bedroom apartment between

13:03

2023 and 2028. So,

13:05

the average apartment’s rent is going

13:07

to increase by about $155 per

13:10

week. It's a bigger number, it's

13:12

a much bigger number in markets where

13:14

rent is already elevated. So

13:17

if you think about, say the Lower North Shore of Sydney,

13:20

I'm expecting rents will sit around $1,250

13:23

to $1,300 per week for a median

13:25

apartment.

13:27

Well it's pretty aggressive rent growth and

13:29

income levels are not growing at that

13:31

pace, right? So how do you reconcile

13:33

that with affordability?

13:35

It's an unfortunate situation in a tight market

13:38

because vacancy is likely to remain

13:40

at these very ultra-low levels. And these

13:43

high prices are needed Phil in some ways to

13:45

encourage supply. And my

13:47

view is that this annual demand-supply mismatch

13:50

is not going away anytime soon and consumers

13:52

are just going to need to navigate these higher

13:55

rents through a lot of

13:57

different avenues. A larger share

14:00

of many people's income is going to

14:02

go towards rent, in some cases there'll be

14:04

subsidies from the government. Some people will

14:06

need to make a choice around location or around

14:09

the type of dwelling or dwelling

14:11

structure that they're in or maybe even the

14:14

number of people that are contributing towards the rent

14:16

or mortgage. We're constructive on both

14:19

rents and prices. In rents, I've got

14:22

about 28% rent growth over the

14:24

next five years and potentially, a similar

14:27

level of improvement in pricing, higher prices,

14:29

but over a much, much shorter

14:31

timeframe.

14:34

Alright, well look extending the chat on sectors with

14:37

low vacancy let's have a look at industrial. 2023

14:40

saw takeup of 2.9

14:42

million square metres, which was down on 2022,

14:45

but in line with 2019 and

14:47

close to historical average. Actual

14:50

takeup in Q1 of this year was

14:53

400,000 square metres. So a lower number, something to

14:56

track and maybe an early indicator there

14:58

Sameer. So can we see some

15:01

space come back onto the market as the strength of demand

15:04

from occupiers starts to moderate?

15:06

Phil, we were expecting that there could

15:08

be a lot more sort of sublease space coming

15:10

back into the market in late

15:12

2023, but this never

15:15

eventuated. So it was a risk, it was something we were

15:17

worried about. It just hasn't eventuated

15:20

maybe at a scale where it causes

15:22

market disruption and even

15:24

as we speak today, our rent numbers are moving

15:27

in a flat to mid-single digit type

15:30

growth rate for 2024. There

15:32

is a sense right now that supply

15:35

chains destocked quite considerably during

15:37

last year, in anticipation of

15:41

soft consumer demand. We saw inventory levels

15:44

come down by about 2% through the course

15:46

of last year, but we've had these recent issues

15:48

Phil with Australian ports getting

15:51

blocked and global shipping and this

15:54

is making clients rethink whether they should

15:56

have more inventory sitting in Australia.

15:59

Alright, well there's some food for thought across our

16:02

traditional asset classes. Sameer, before we

16:05

wrap up, I just have one final question for you and

16:07

that's just, zoom out a little bit and give us

16:10

your overall view on the investment market.

16:12

Phil, I’d say I'm constructive on

16:15

three things. On rents we've been raising our

16:17

rent growth forecast now for the past six

16:19

months and I expect that this'll continue.

16:22

I'm more bullish on asset

16:25

pricing, partly because we don't have too

16:28

much distress selling in Australia.

16:30

And the third one is, I

16:32

expect more and earlier interest rate cuts

16:34

over the next two and a half years.

16:37

I'd say I'm more bearish on two things.

16:39

Whether any of this mooted

16:41

supply, whether it's office, residential,

16:44

retail, whether any of this mooted supply will

16:47

eventuate and just the pace of recovery and

16:49

transaction volumes. How about you Phil,

16:51

your thoughts?

16:52

Well, you know listening to you, it sounds like

16:54

you're coming around to my pick on the timing of rate cuts.

16:56

So I'm looking forward to that bottle of Coleraine Sameer, but look,

16:59

I think we're through the toughest part of the cycle and the re-rating

17:03

has largely taken place and you

17:05

can see that in, in the listed space, but

17:07

it's going to take some more time, another quarter or

17:10

two before we see confidence improve and

17:12

pricing starting to align. What you touched

17:14

on before but when we do, I certainly

17:16

expect volumes to increase pretty quickly.

17:20

Alright , well thank you Sameer. In our next

17:22

house view in July, we'll look to revisit our

17:25

bold predictions from the first quarter and

17:27

give you our views on where we see the market heading into

17:29

the second half of the year. So be sure to

17:31

tune in. I hope you've enjoyed this latest edition

17:34

of The House View. A quick little plug though

17:36

that we'll be continuing to release new

17:38

Talking Property episodes each fortnight.

17:41

So be sure to subscribe through your favorite

17:43

podcasting platform. And of course

17:45

if there are any topics you'd like to hear more about,

17:47

you can email us at talking [email protected].

17:51

Until next time.