Market Views: Is Australian real estate overheated?
Australia's commercial real estate market has always offered comfort to investors because of its enduring growth potential and sound legal framework as one of the most mature markets in the Asia-Pacific region.
But Australian asset owners, such as Future Fund and the City of Brisbane Investment Corporation, have started rebalancing their real estate portfolios and recently sold their domestic real estate assets.
Australian house prices are also falling and expected to fall further – and sharply – according to some prognoses. But then Melbourne and Sydney are among the least affordable housing markets in the world, according to an annual global real estate study by PwC.
Some commercial property sectors, notably retail, are feeling the pinch due to “structural changes” as sales increasingly move from physical stores to online, noted M&G's last Asia real estate outlook.
But others, such as distribution centres and last-mile delivery hubs, are benefiting. Investment allocations to Australian logistics assets are among those singled out by PwC in the Asia-Pacific region as having risen significantly in 2018 in Australia.
Another study projects that the Australian logistics and warehousing sector will be worth $133.8 billion (A$187 billion) by 2021.
But questions remain. Is the Australian real estate market about to reach the peak of the cycle? What opportunities and pitfalls should investors take note of if they consider allocating capital to Australia’s commercial real estate market?
AsianInvestor asked three industry experts to share their thoughts.
The following extracts have been edited for brevity and clarity.
Mark Coster, senior managing director for capital markets for the Pacific region
CBRE
Many of the commercial property sectors in Australia are in the longest sustained growth cycle this country has experienced. The market is now nearing its peak, but there is little to suggest a correction.
Commercial real estate assets in Australia remain highly sought after by both local and international investors. Indeed, a recent CBRE Investor Intentions survey highlighted that Australia continues to be a favoured global destination for real estate capital. This is due in part to the potential for rental growth across many of the markets, something not available at present in some major global destinations.
We are also seeing strengthening demand for logistics assets in Australia. This aligns with a global trend for investors to target this sector and capitalise on the increasing need to provide fast and effective logistics solutions to meet the ever-increasing consumer demand for online delivery...
Debt remains available and accretive to returns ... For some international investors, the Australian dollar dropping to around $70 cents has also been beneficial.
Domestic funds, on balance, are positive on the commercial real estate sector, with most indicating their intention to be net buyers in 2019. Asset sales are being driven by a variety of factors, including redemptions, end-of-fund sell-downs and the strategic disposal of non-core real estate. However, in many cases those same investors are re-investing in the traditional core markets of office, retail and logistics or looking to alternative real estate assets such as childcare, student housing and, more recently, build-to-rent residential.
Andrew Ballantyne, head of research for Australia
JLL
Transaction volumes in 2018 were A$33.1 billion – one of the strongest years on record. Domestic investors were active on both the sell and buy side of the ledger and so far in 2019, a number of large domestic investors have increased their Australian real estate exposure. DXS/DWPF acquired a 50% stake in the MLC Centre at 19 Martin Place, Sydney for an estimated A$800 million, while GWOF purchased a 50% stake in Freshwater Place at 2 Southbank Boulevard, Melbourne. Both these acquisitions took their economic interests in those assets to 100%.
Real estate asset pricing and return expectations are intrinsically linked to the outlook for bond yields ... The [10-year] Australian government bond yield has trended lower, starting the year at 2.32% and currently sitting at 1.89%. Furthermore, medium-term bond yield projections have been revised lower. So although this real estate cycle has lasted seven years (from 2012), the spread between return expectations and the risk-free rate still makes real estate attractive.
Australia is the beneficiary of two major investment themes. We believe that these themes remain relevant ... The first major theme is the re-rating of real assets and higher allocations by pension funds and sovereign wealth funds to real assets. The second is that the Asia Pacific region is projected to be a larger part of the global real-estate investable universe over the next 20 years as it has stronger long-term economic growth prospects, more favourable demographics and increasing urbanisation rates.
One of the challenges for investment into the Asia-Pacific region is a lack of transparency. The JLL Global Real Estate Transparency Index has highlighted a strong relationship between transparency and transaction volumes. Australia is ranked as a highly transparent and the second-most transparent real estate market in the world. Transparency has improved across the Asia-Pacific region with Singapore (No. 12) and Hong Kong (No. 13) ranked as transparent, while China (No. 33) and India (No. 35) are ranked as semi-transparent.
Australia has a diverse commercial property market with opportunities depending on the geography, sector and stage of the cycle. The office and retail sectors are the largest and most mature commercial property sectors. The Sydney and Melbourne office markets have very low vacancy [rates] and the potential for significant income reversion. Brisbane and Perth have shown tangible signs of a leasing market recovery ...
The headwinds in the retail sector are similar to other mature economies. However, Australia’s demographic profile is more favourable and planning restrictions limit retail floorspace per capita ...The logistics sector is a favoured sector as funds seek to increase their allocation to the asset class. The challenge in Australia is the ability to build a portfolio with scale ...
Alexander Cousley, investment strategy analyst
Russell Investments
It’s fair to say there are signs that Australia is nearing the peak in some markets and past the peak in other markets (namely residential). The commercial market in Australia has become bifurcated in a number of different ways. By sector, the residential and retail sectors are under some pressure, while the office space is being supported by continued jobs growth in the services sector. In the Sydney and Melbourne office sector we are seeing solid market fundamentals. However, over the next two or three years we are likely to see vacancy rates tick up given there is a pipeline of new supply. Pricing in the second-tier cities (Perth, Brisbane) are more attractive in our view, and we are seeing solid demand from some investors.
Given how much valuations have risen in some parts of the market, we think part of the reasoning for putting domestic assets up for sale is taking profits along with rising concerns about how the Australian economy is going to absorb the decline in the housing market.
The Australian commercial real estate market is a bit more expensive than opportunities that can be found in other Asia-Pacific markets, although the risk is also lower (and quality is higher). Some of the developing Asia-Pacific markets provide significant potential capital appreciation, with Southeast Asia economies, in particular much earlier in the cycle than Australia or Hong Kong, for example. Surveys of investor intentions show that Sydney and Melbourne continue to be the preferred investment markets, followed by Tier 1 China [cities] and then prime markets in Japan.
... We would look to allocate capital towards the office space (rather than the retail or residential offerings), and think there are better opportunities in off-prime markets given some of the high valuations in the prime markets. In terms of pitfalls, the big question for us at the moment is the risk surrounding the timing of the next recession. Our models show recessionary risks will be rising in the second half of 2020 in the U.S. While Australia has avoided the last two U.S. recessions (2001 and 2008), it is less clear whether the domestic economy will be able to weather the storm again.