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January 23, 2024

December 2023 direct property market update

Peta Tilse, Head of Retail Funds Management


Economy

Over the December quarter, interest rates were reasonably volatile both in terms of short and longer-term rates. The RBA increased interest rates by 25 basis points (bps) in November, taking the cash rate to 4.35%; its highest level since the end of 2011. The justification for the move was to bring inflation to target within a reasonable timeframe (i.e. by end-2025), rather than risk a prolonged overshoot and upwards shift to inflation expectations.

Subsequently, softer than expected inflation offshore and in Australia, together with dovish comments from central banks, helped take some of the heat out of bond yields through to December. Australian government 10-year bond yields decreased by 52bps over the quarter to 4.0%.

More recent data has shown Australia’s annual inflation pace slowing quite materially from 4.9% in October to 4.3% in November1. While there could be an uptick in Q1 2024 due to base effects and government subsidies rolling off, there was little in the latest data which would give the RBA cause for concern. Goods inflation continued to slow, and services inflation appears to have peaked. While dwelling and rental costs and insurance premiums rose further, dining out and household services eased. Overall, inflation is on track to undershoot the RBA’s forecast for the quarter, decreasing the likelihood of a hike in February.

cpi_forecast

While expectations of further cash rate hikes have diminished, 10-year bond yields remain approximately 40bps higher than a year ago2, putting pressure on debt costs and access to capital. The macro impact of interest rates continues to be the main challenge facing commercial property, despite bottom-up demand drivers remaining relatively resilient. This is being reflected in higher capitalisation rates (effectively the earnings multiple for property), and in turn putting downward pressure on asset valuations.

In further economic data, the labour market remains tight, however there are signs of softer conditions emerging. Unemployment increased to 3.9% in November (latest available data), the highest it has been since May 2022 and slightly above consensus expectations (3.8%)3. Hours worked was flat over the month leading to a higher underemployment rate, job ads declined, and there were more applicants per job – all signs of slowing. Positively, the increase in the unemployment rate has been orderly and driven by strong population growth (i.e. supply), rather than job destruction. In fact, annual jobs growth increased to 3.2%, with 104,000 jobs created over the quarter-to-date (65% being full-time), a positive for office space demand.

Office

There continues to be mixed demand readings between the major CBDs, largely aligned to the different industry compositions of the markets. According to JLL Research, national CBD net absorption totalled -59,000 square metres (sqm) across the quarter, the weakest result since March 2021. The resource-based markets of Brisbane (+9,000 sqm) and Perth (+7,000 sqm) both continued their run of positive demand, recording the strongest results of the quarter. Melbourne CBD recorded the weakest net absorption on a quarterly and annual basis, due to a couple of substantial A-Grade contractions in the Parliament precinct. It was the first quarter since March 2021 where Prime net absorption was weaker than Secondary net absorption.

net_absorp_dec23

The national CBD vacancy rate increased from 14.2% to 14.9% over the quarter, with the result following a similar pattern as net absorption. Brisbane CBD (-0.4%) recorded the biggest improvement in vacancy rate, while Melbourne CBD (+2.0%) deteriorated materially, due to the occupier contractions seen in the Parliament precinct. While headline vacancy remains elevated compared to the historical long-term average, particularly across Prime stock, the majority of CBD assets remain well-occupied (<10% vacancy).

total_vac_dec23

Prime net face rent growth (+0.9%) accelerated slightly compared to the prior quarter (+0.6%), with the Sydney CBD and Canberra the biggest improvers. Prime incentives were relatively stable across every CBD market except Melbourne (+1.0%) and Canberra (+0.3%). This meant that on a net effective basis, Melbourne and Canberra were the only markets where rents headed backwards over the quarter. Adelaide (+2.7%) recorded the strongest net effective rental growth, as Brisbane slowed after two quarters of very strong growth. Adelaide joined Brisbane and Perth as CBD markets where net effective rents are higher today compared to pre-pandemic.

rental_growth_dec23

Transaction volume for the quarter ($1.8 billion nationally) was roughly in line with the quarterly average over the rest of the year but was 66% lower than the Q4 average of the past five years4. The lack of transaction activity reflects the sharp increase in cost of capital seen over the past 18 months, and the gap between bidder and vendor price expectations which is taking time to align. It also reflects a lack of large transactions, with only one asset greater than $250 million changing hands during the quarter. This has been reflected in the total expansion of national CBD prime average yields to 120bps from peak pricing, with further expansion possible given the inherent lags in the valuation process.

Retail

There was a large rebound in retail sales in November (+2.0%), following a slow start to the quarter in October (-0.4%)5. November’s monthly growth was the strongest result since November 2021,when activity was boosted by post-lockdown reopening. It is important to note that Black Friday sales had a large positive impact, with spending surging across household goods, department stores and clothing. A decent portion of this spending was likely ‘brought forward’ from December, so Christmas data (due 30 January 2024) may be weaker.

Consumers remain under pressure, with Westpac’s measure of sentiment up in December but still at very pessimistic levels. While real disposable household incomes should improve in the latter half of 2024, elevated inflation and interest rates are expected to dampen per capita discretionary spending for some time yet.

retail_growth_nov23

Rental growth at large discretionary shopping centres continues to underperform though is positive. Large Format Retail was the top-performing sub-sector over the quarter, with rental growth benefiting from a lack of new supply across 2022 and 2023. This positive supply-demand dynamic saw Large Format vacancy decline over the quarter, while the other retail sub-sectors recorded slight increases.

It was a slow quarter for retail transactions, with volume totalling less than $1 billion. No large assets changed hands, following the sales of Stockland Townsville and Midland Gate Shopping Centre last quarter. As seen across most commercial property sectors, retail capitalisation rates expanded further over the quarter.

Industrial

Australia’s industrial market remains the tightest in the world, with a national vacancy rate of 1.1%6. The city-level figures are book-ended by Melbourne (1.6%) and Sydney (0.5%), while Brisbane saw the biggest increase in vacancy rate (+0.8%) over the second half of 2023. Vacancy has been rising in most offshore markets across the year and the trend has now reached Australia, reflecting ongoing supply and a softening of demand. While vacancy is increasing, it remains well below long-term average levels.

Softening of demand is consistent with a slowing global economy (hence lower trade volumes) and an unwinding of some of the e-commerce gains made through the pandemic years. However, net absorption continues to be positive, particularly in Sydney and Melbourne where newly developed stock is being readily taken up by occupiers whose expansion in prior quarters was constrained by limited availability. While the demand cycle is starting to slowly turn, low vacancy helped generate national super prime net face rental growth of 15% year-on-year as at 4Q23 (preliminary data)6. Prime incentives remain low compared to historical levels at around 10-15%.

Supply delivered in 2023 was elevated at around double long-term levels. Higher levels of supply are earmarked for completion in 2024, however delays due to planning, infrastructure servicing, and construction will likely see some of this development pushed into the following year (as was seen in 2022 and 2023). Ongoing supply will likely put upwards pressure on the vacancy rate, however solid levels of pre-commitment (already almost 50% across the East Coast) limit the risk of a blowout.

While investors remain relatively positive on the industrial outlook, as with other sectors, transaction activity was nevertheless muted. Volume over the course of 2023 was soft compared to recent record highs, but roughly in line with levels seen in the three years prior to the pandemic.

 

Outlook

The global economy is slowing but at a relatively measured pace, engendering optimism that a “soft landing” can be achieved. Australia’s economy is in a similar position, with inflation slowing but employment conditions softening but remaining resilient. Similarly, household consumption has slowed without falling precipitously. Markets are becoming more confident that the rate hiking cycle is at or near its end, which should help ease uncertainty and improve liquidity for property over the coming months.

These factors put the Australian commercial property market in relatively good stead from a demand perspective. While a slowdown is expected over 2024 and early 2025, a more significant contraction (i.e. recession) is looking less likely. Businesses will continue to review their space requirements as they adjust to hybrid working, though the balance between in-office versus remote is expected to shift towards the office over 2024. Location continues to be an important driver of occupier preferences, combined with amenity and building quality (at a given price point).

Capital continues to view Australia as a favourable investment destination given its attractive demographic profile, growth prospects, and relative social and political stability. As uncertainty abates and liquidity improves, transaction activity should increase. The best opportunities will present where sentiment has become dislocated from market fundamentals.

How did the Cromwell Direct Property Fund fare this quarter?

On 27 October 2023, Cromwell announced the termination of the proposed merger between the Cromwell Direct Property Fund (the Fund) and Australian Unity Diversified Property Fund, as a result of deteriorating market conditions.

Given market dynamics for Australian real estate markets, and in particular potential movement in office asset valuations, the Board decided it appropriate to externally revalue the Fund’s assets to identify if any values may have moved materially owing to the nature of the assets and market circumstances. The Fund’s gross asset value experienced an 8.9% decrease. While partially offset by rental growth, this decline is mainly attributed to elevated interest rates and a softer capital market in the second half of 2023, which led to a 72bps expansion of the Fund’s weighted average capitalisation rate, which now stands at 6.87%.

Despite the valuation decline, the Fund’s asset portfolio continues to experience positive leasing activities, particularly in Brisbane. The Fund has improved occupancy (on a look-through basis) to 96.4% as of December 31, 2023.

Effective 14 November 2023, the Fund temporarily suspended new applications and ceased to offer the Distribution Reinvestment Plan (DRP). These measures will be in effect until the valuation process concludes and the audited financials for the half-year ending 31 December 2023, are released. It is anticipated that applications and DRP will be reinstated in early 2024 as this process completes.

During the quarter, the Fund implemented new hedging which lifted the hedge ratio to 51.7% against drawn balance, and produced a weighted average hedge term of 1.85 years as at 31 December 2023.

Cromwell remains committed to unlocking property value through proactive asset management, aiming to navigate the cyclical downturns in the commercial property market.

Read more about the Cromwell Direct Property Fund: www.cromwell.com/dpf.

Past performance is not a reliable indicator of future performance.

Cromwell Funds Management Limited ACN 114 782 777 is the responsible entity of and issuer of units in the Cromwell Direct Property Fund ARSN 165 011 905.

Before making an investment decision in relation to the Fund it is important that you read and consider the Product Disclosure Statement and Target Market Determination available from www.cromwell.com/dpf, by calling 1300 268 078 or emailing invest@cromwell.com.au.

 


  1. Monthly Consumer Price Index Indicator, November 2023 (ABS, Jan-24)
  2. Capital Market Yields – Government Bonds (RBA, Jan-24)
  3. Labour Force, Australia, November 2023 (ABS, Dec-23)
  4. Real Capital Analytics, Jan-24
  5. Retail Trade, Australia, November 2023 (ABS, Jan-24)
  6. Australia’s Industrial and Logistics Vacancy Second Half 2023 (2H23), CBRE (Dec-23)
About Cromwell Direct Property Fund

Read more about Cromwell Direct Property Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS and TMD in deciding whether to acquire, or to continue to hold units in the Fund.

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January 9, 2024

December 2023 quarter ASX A-REIT market update

Stuart Cartledge, Managing Director, Phoenix Portfolios


 

Market Commentary

The S&P/ASX 300 A-REIT Accumulation Index moved substantially higher in the final quarter of 2023, gaining 16.5%. Property stocks meaningfully outperformed broader equities in the quarter, with the S&P/ASX 300 Accumulation Index adding a lessor 8.4%. This outperformance was driven by a large move in bond yields. After hitting a peak of approximately 5.0% during the quarter, the 10 Year Australian Government Bond yield dropped materially, finishing below 4.0%.

Property fund managers earnings are particularly leveraged to movements in bond yields. Given this it is unsurprising that they were major outperformers during the quarter. Charter Hall Group (CHC) had previously materially underperformed as bond rates rose, however recovered strongly, gaining 29.2% over the quarter. Centuria Capital Group (CNI) followed a similar path, rising 32.7% for the quarter. Goodman Group (GMG) as only a marginal outperformer for the period, lifting 18.6%, however had performed stronger earlier in 2023, finishing with a total return of 47.5% for the calendar year. In contrast, despite having a productive period from a business development perspective, property debt fund manager Qualitas Limited (QAL) only added 3.1% as its investment products will not directly benefit from a reduction in interest rates.

Those with exposure to residential property, particularly smaller capitalisation securities, were major underperformers across the December quarter. AV Jennings (AVJ) lost 9.1%, propelled lower by a heavily discounted, and somewhat surprising equity raise. Aspen Group (APZ) underperformed the index, only up 1.9%, with Peet Limited (PPC) similarly gaining only 4.5%. Performance was more robust for large capitalisation residential property developer Stockland (SGP), up 15.6%, just below the index’s strong result.

Office property owners had very mixed results during the period. Leading the way higher was GPT Group (GPT) which rose 22.2% for the quarter. Centuria Office REIT (COF) was also an outperformer, recovering some of its recent underperformance, adding 20.2%. On the other side of the ledger, Australian Unity Office Fund (AOF) lost ground in an absolute sense falling 16.2%, whilst Dexus (DXS) gained only 8.9% after announcing current Chief Investment Officer, Ross Du Vernet will take over from Darren Steinberg as Chief Executive Officer of the company in 2024.

Retail landlords were very strong performers to finish off the year. The major outperformer was Unibail-Rodamco-Westfield (URW), who’s share price shot 47.5% higher. As one of the more financially leveraged stocks in the sector, it is a relative beneficiary of lower global interest rates. Scentre Group (SCG) and Vicinity Centres (VCX) were also outperformers, up 21.5% and 20.4% respectively. Both are beneficiaries of more resilient consumer spending than anticipated, with initial indications of spending across the key Christmas period appearing robust.

In general, smaller capitalisation, non-benchmark property owners were substantial underperformers during the quarter. Each of Desane Group Holdings (DGH), 360 Capital REIT (TOT), Newmark Property REIT (NPR) and Gowings Brothers Limited (GOW) had negative absolute returns despite the movement in the Index and bond yields. In many cases this may be more representative of shorter term supply and demand dynamics for shares rather than underlying business underperformance.

Market outlook

The listed property sector is in good shape and provides investors with the opportunity to gain exposure to high quality commercial real estate at a meaningful discount to independently assessed values. While share market volatility may be uncomfortable at times, the offset is liquidity, enabling investors to rebalance portfolios without the risk of being trapped in illiquid vehicles.

Rising interest rates have been a headwind for many asset classes, with property, both listed and unlisted, a particularly interest rate sensitive sector. The August reporting season saw a number of listed stocks come under pressure as short term interest rates hedges are beginning to roll off and higher interest costs are impacting earnings growth and distributions. Long term valuations are driven by “normalised” interest costs, meaning the impact of short term hedges maturing is mostly immaterial. Should the sharp decline in interest rates seen in December 2023 be sustained, these headwinds may dissipate and possibly reverse.

The industrial sub-sector continues to be the most sought after, given the tailwinds of e-commerce growth, the potential onshoring of key manufacturing categories and the decision by many corporates to build some redundancy into supply chains to cope with current disruptions. All of these factors are contributing to ongoing demand for industrial space, which is evident by rapidly accelerating market rents and vacancy rates at historic lows of around 1% in many markets.

We remain cognisant of the structural changes occurring in the retail sector with the growing penetration of online sales and the greater importance of experiential offering inside malls. Recent performance of shopping centre owners has however been strong, with consumers showing resilience. It is interesting to note the juxtaposition of very high retail sales figures despite very low levels of consumer confidence, no doubt impacted by rising costs of living. Importantly, we are also now seeing positive re-leasing spreads in shopping centres, indicating strengthening demand from retail tenants.

The jury is still out on exactly how tenants will use office space moving forward, but demand for good quality well located space remains. Leasing activity is beginning to pick up, and there has also been some transactional activity, albeit at prices typically at discounts to book values. Incentives on new leases do remain elevated and some vacancy in the market is becoming apparent.

We expect to see further downside to asset values in office markets, but elsewhere expect market rent growth to largely offset cap rate expansion, particularly in industrial assets. Listed pricing provides a meaningful buffer to such movements.

About Stuart Cartledge

Stuart is the Managing Director of Phoenix Portfolios and the portfolio manager for each of the company’s property portfolios. Prior to establishing the business in 2006, Stuart built a strong track record in the listed property security asset class and has been actively managing securities portfolios since 1993. Stuart holds a master’s degree in engineering and management from the University of Birmingham and is a Chartered Financial Analyst.

The content above is taken from the Cromwell Phoenix Property Securities Fund quarterly report. Sign up here to be the first to access the latest report and to gain a deeper insight into the Fund’s performance.

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January 9, 2024

Build to Rent – an emerging asset class in Australia

Stuart Cartledge, Managing Director, Phoenix Portfolios


SC_mirvac

In October 2023, Phoenix participated in an Investor Day, hosted by listed REIT, Mirvac Group, that focussed on “Living Sectors”. Aside from the joy of wearing a high-vis jacket, those with an eye for detail will notice the badge, clearly indicating that the occupant of the jacket is a “Young Worker”.

In this article we share with you some of the lessons learned by that young worker from the day.

Australia has a housing crisis. We may have had an inkling of this one before the tour, but with an estimated 1,000,000 new immigrants expected to arrive in Australia over the next 3 years, requiring approximately 400,000 dwellings, we’re going to have to get cracking with the government’s new housing targets.

The chart below puts these figures into the context of what has been delivered in the past. The key takeaway for us, is that the Australian Government may well be having another Utopia moment.

With demand likely to remain robust, and rental markets as tight as a drum, the opportunity for an entity such as Mirvac Group to deliver product into this environment is compelling.

Built-to-rent

What is “Build to Rent”?

Build to Rent (BTR) is the creation of residential dwellings, typically apartments, which instead of being strata titled and sold to individuals, remain institutionally owned, professionally managed, and represent high quality rental accommodation, often including a higher level of amenity than competing product. Furthermore, a resident has security of tenure, not just through a lease, but because the entire building forms part of a long-term residential community.

An investor in BTR benefits from typically high occupancy rates, with multiple tenants delivering low volatility of income and stable valuations. Well-designed buildings should certainly benefit from relatively low maintenance capital requirements, at least initially, and certainly do not suffer from the requirement to incentivise tenants with expensive fit outs that plague the office leasing market.

While BTR may be a relatively new concept in Australia, it is a mature property sub-sector in offshore markets, particularly in the US, where it is referred to as “multi-family”.

 

Mirvac is pioneering BTR in Australia

The BTR sector is embryonic in Australia, representing less than 0.5% of housing stock across the country. This compares with a ~12% penetration in the US and around 5.4% in the UK. The opportunity set is therefore large.

For MGR, the BTR sector capitalises on the company’s 50-year residential track record of asset design and creation and has facilitated MGR to pioneer the sector in Australia. MGR has branded its BTR product with the “LIV” name, and delivered LIV Indigo, its first project in Sydney Olympic Park back in September 2020. That project is now 94% occupied. LIV Munro, opposite Queen Victoria Market in Melbourne’s CBD is the second completed project which opened at the end of last calendar year and is now 70% occupied. LIV Munro is pictured below.

Mirvac-pioneering-BTR-Australia

The tour showed investors around LIV Munro enabling us to get a feel for the amenity, including pool, gym, dining areas, podcasting rooms and rooftop BBQ and relaxation facilities and to meet the on-site staff responsible for the community experience. We were impressed.

We also visited LIV Aston, a project under construction on the corner of Spencer Street and Flinders Street West, also in Melbourne’s CBD. Hard hat required! With a total of 474 apartments, the construction project was on time and budget and is expected to compete before the end of the current financial year. This project is almost adjacent to another, yet to be competed, BTR project currently being developed by Lendlease. It will be interesting to see these projects go head-to-head when they are both operational.

Alongside the three projects referred to above, MGR has another 2 projects under construction, one in Melbourne and the other in Brisbane, which will bring their collective exposure to BTR to approximately 2,200 apartments across 5 projects.

Financial metrics are interesting

Financial modelling for BTR is made a little tricky by some big movements in construction costs over the last few years, which ordinarily would lower returns, combined with some offsetting and also significant market rental increases in the residential sector. For MGR, the end result is a stabilised yield on cost of 4.5% – 5.0%. Along with rental growth, maintenance costs and ancillary income, the investment return (Internal Rate of Return) is estimated to be around 7% – 7.5%.

MGR’s investment in the sector is structured in a joint venture as shown in the diagram below.

External investors sit alongside MGR, and enjoy investment returns that benefit from MGR’s active management and can take comfort that MGR’s interests are very much aligned with theirs.

In addition to the returns on capital invested in the joint venture, MGR also earns funds management, development management and asset management fees across the platform. This fee stream is more volatile but adds to the returns that MGR shareholders enjoy.

Mirvac-summary_btr

Phoenix assumes that MGR is able to build out its current pipeline of BTR opportunities and will be able to identify future projects to reach its medium term target of 5,000 apartments on the platform. Importantly, we also assume that the company will be able to continue to partner with external investors to deliver a solid outcome for all stakeholders.

We expect the BTR market to get more competitive, but with penetration rates so low and the demand for housing so high, we forecast a solid runway for the foreseeable future. The only sad thing about the day, was the discovery that BTR is typically targeting the affluent renters, aged between 25 and 39. The “young worker” on this tour is more likely a target for the over 55 land lease portfolio, which we will write about in subsequent articles.

About Stuart Cartledge

Stuart is the Managing Director of Phoenix Portfolios and the portfolio manager for each of the company’s property portfolios. Prior to establishing the business in 2006, Stuart built a strong track record in the listed property security asset class and has been actively managing securities portfolios since 1993. Stuart holds a master’s degree in engineering and management from the University of Birmingham and is a Chartered Financial Analyst.

The content above is taken from the Cromwell Phoenix Property Securities Fund quarterly report. Sign up here to be the first to access the latest report and to gain a deeper insight into the Fund’s performance.

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October 20, 2023

September 2023 quarter ASX A-REIT market update

Stuart Cartledge, Managing Director, Phoenix Portfolios


 

Market Commentary

The S&P/ASX 300 A-REIT Accumulation Index moved lower in the September quarter, losing 3.0%. Property stocks underperformed broader equities in the quarter, with the S&P/ASX 300 Accumulation Index giving up a lessor 0.8%. This underperformance is unsurprising considering the 10 Year Australian Government Bond yield increased meaningfully over the quarter, finishing at approximately 4.5%.

Despite the property index underperforming over the period, the headline result masks the weak performance of most property stocks. Only 8 out of 32 index constituents outperformed the index. This result was mostly driven by the outperformance of the index’s largest stock, Goodman Group (GMG), which rose 6.9%, despite the weakness seen elsewhere. Many investors became excited about the opportunity in data centre investment that GMG referenced in their result. For more on GMG, see the performance commentary section of this report.

During the quarter, most property stocks reported their full year financial results to 30 June 2023. A key feature of results was increased interest costs and the impact they are having to short term profitability and distributions. Phoenix normalises for mid-cycle interest rates when considering the valuation of a stock, so the impact was minimal to our valuations, however, was seen as very significant by those focussed on short term distribution outcomes.

Stocks with exposure to office property were particularly weak during the quarter. Incentives to secure office tenants remain elevated and vacancy is beginning to creep into office portfolios as existing long-term leases come to their end. Growthpoint Properties Australia (GOZ) lost 20.8%, whilst Cromwell Property Group (CMW) gave up 29.3% and Centuria Office REIT (COF) dropped by 14.6%. Large capitalisation office owner Dexus (DXS) also lost ground, off 6.4%. Charter Hall Group (CHC), whilst a diversified manager of property funds, has a meaningful exposure to office property and was also weak, giving up 11.4%.

Owners of large regional shopping centres broadly reported solid results in August’s reporting season. Specialty sales were strong, supported by elevated inflation and resilient consumer spending. All-important specialty re-leasing spreads were positive for both Scentre Group (SCG) and Vicinity Centres (VCX). There is some concern that cyclical factors such as weakened consumer sentiment will weigh on future results despite the recent strong performance. SCG and VCX marginally underperformed the index, losing 4.1% and 4.7% respectively. Owners of smaller neighbourhood shopping centres were weaker during the period as their rental outcomes are not as directly tied to inflation, but their costs are rising sharply. Region Group (RGN) gave up 11.0% and Charter Hall Retail REIT (CQR) finished the quarter 13.0% lower.

Developers of residential property showed resilience during the period as the undersupply of housing in Australia came into focus. All else equal, a sharp increase in interest rates should have a cooling effect on residential house prices and sales, however the impact of interest rates is offset by an acute shortage of both rental and stock for sale. Peet Limited (PPC) outperformed, up 1.2%, AV Jennings Limited lost only 1.9% and large capitalisation developer Stockland (SGP) dropped 2.7%.

Market outlook

The listed property sector is in good shape and provides investors with the opportunity to gain exposure to high quality commercial real estate at a meaningful discount to independently assessed values. While share market volatility may be uncomfortable at times, the offset is liquidity, enabling investors to rebalance portfolios without the risk of being trapped in illiquid vehicles.

Rising interest rates have been a headwind for many asset classes, with property, both listed and unlisted, a particularly interest rate sensitive sector. The August reporting season saw a number of listed stocks come under pressure as short term interest rates hedges are beginning to roll off and higher interest costs are impacting earnings growth and distributions. Long term valuations are driven by “normalised” interest costs, meaning the impact of short term hedges maturing is mostly immaterial.

The industrial sub-sector continues to be the most sought after, given the tailwinds of e-commerce growth, the potential onshoring of key manufacturing categories and the decision by many corporates to build some redundancy into supply chains to cope with current disruptions. All of these factors are contributing to ongoing demand for industrial space, which is evident by rapidly accelerating market rents and vacancy rates at historic lows of around 1% in many markets.

We remain cognisant of the structural changes occurring in the retail sector with the growing penetration of online sales and the greater importance of experiential offering inside malls. Recent performance of shopping centre owners has however been strong, with consumers showing resilience. It is interesting to note the juxtaposition of very high retail sales figures despite very low levels of consumer confidence, no doubt impacted by rising costs of living. Importantly, we are also now seeing positive re-leasing spreads in shopping centres, indicating strengthening demand from retail tenants.

The jury is still out on exactly how tenants will use office space moving forward, but demand for good quality well located space remains. Leasing activity is beginning to pick up, and there has also been some transactional activity, albeit at prices typically at discounts to book values. Incentives on new leases do remain elevated and some vacancy in the market is becoming apparent.

We expect to see further downside to asset values in office markets, but elsewhere expect market rent growth to largely offset cap rate expansion, particularly in industrial assets. Listed pricing provides a meaningful buffer to such movements.

About Stuart Cartledge

Stuart is the Managing Director of Phoenix Portfolios and the portfolio manager for each of the company’s property portfolios. Prior to establishing the business in 2006, Stuart built a strong track record in the listed property security asset class and has been actively managing securities portfolios since 1993. Stuart holds a master’s degree in engineering and management from the University of Birmingham and is a Chartered Financial Analyst.

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October 20, 2023

Australia’s housing battle: Interest rates versus supply and demand

Stuart Cartledge, Managing Director, Phoenix Portfolios


 
Residential property occupies much of Australia’s news coverage and much of the brain space of Australians in general. Everyone seems to have an opinion on house prices and housing policy and not all of it seems to be based on fact. This article will try to provide an analysis of the current factors influencing residential property and in dealing with those facts, provide some examples of how Phoenix is making investments that are supported by the current environment.

Interest rates

It seems all of us have heard comments like “house prices always go up”. Anyone with a basic understanding of maths and economics have told those people they cannot be correct. With that, let’s look at the median house price in Sydney since 2002:

Looking at the chart above it almost does seem like house prices always go up. But wait: what happens when interest rates go up, surely house prices will crash? Let’s zoom into the chart above and look at the effect of recent interest rate rises on the value of homes in Sydney:

Despite interest rates on new home loans more than doubling off their lows, it is clear that house prices have been stunningly resilient, growing once more after marginally decreasing when rates began to increase.

Those concerned about the sustainability of current house prices will correctly point to just how much it costs to own a home. Approximately 75% of home purchases are supported by the use of a mortgage. Obviously, those making the purchase can only do so if they can service the payment on that mortgage. To show this, the chart below looks at the monthly cost of servicing a new mortgage (Loan to Value = 90%) on the median home in Sydney and how it has changed over the same period.

The cost of servicing a mortgage has clearly risen dramatically. A mortgage obtained on the median home in Sydney now costs more than $7,400 per month to service. This has increased by more than 50% since December 2021, less than two years ago. Common sense suggests that this must have a limit. Surely at some point people can’t afford to service their mortgage anymore and surely even the ~25% of people who buy a home with cash won’t have enough cash to buy the home they want. That all has to be true, but house prices prove that at this stage we have not reached that breaking point.

How can we afford this?

Basic economics states that in a market economy, the price of a good or service is a function of its supply and demand. Housing is no different. The demand for housing should be simple to understand. All Australians have demand for a place to live. To support “elevated” house prices and increased mortgage servicing, there has to be a capacity to pay monthly costs. This capacity is most commonly tied to a person’s income. When entering into a 30-year mortgage, someone’s view of their job security is also front of mind. In this context, a chart of long-term and more recent unemployment rates in Australia is presented below:

As can be seen, unemployment rates are at multi-generational lows, serving to add to demand for housing at ever-increasing prices.

Housing demand

In the most basic sense, the quantum of dwellings needed in Australia is related to the amount of people in each dwelling and the population of the country. The Australian Bureau of Statistics (ABS) and Reserve Bank of Australia (RBA) have compiled the nation’s historic average household size and recent trends as shown below:

While perhaps a controversial figure, former RBA Governor Phillip Lowe summed up recent changes astutely, saying:

“During the pandemic, the average number of people living in each household declined. People wanted more space. They were working from home. Rents actually declined for a while. People said, ‘Rather than have a flatmate I will just have an office at home,’ so the average number of people living in each dwelling declined and that increased the demand as a result for the total number of dwellings”.

So, we have less people living in each dwelling and the other component of household requirements, populaion, is also increasing strongly. Again, the RBA and ABS help by showing both the impact of population growth (in light blue) and change in household size (dark blue) over time in the chart below:

Again, Phillip Lowe sums up the situation:

“The other thing that is now happening is a big increase in population. The population is increasing by two per cent this year. Are there two per cent more houses? No. The rate of addition to the housing stock is very low. We have a lot of people coming into the country.”

This comment touches on the other key element to home prices in Australia. Namely, the supply of new property.

The other thing that is now happening is a big increase in population. The population is increasing by two per cent this year. Are there two per cent more houses? No. The rate of addition to the housing stock is very low. We have a lot of people coming into the country.
Phillip Lowe

Housing supply

So there clearly is a need to build new houses. Given the voracious demand for residential properties at elevated prices, one would think that residential developers would address this demand and supply the properties the population clearly want. Two major factors are holding back the supply that would otherwise naturally occur.

Firstly, the cost of building new homes is a major factor. A residential property developer will require approximately a 20% profit margin on top of their costs to put new housing supply into the market. The costs of developing that property comprise:

  • the cost of the land on which it is built,
  • the hard costs of the materials used,
  • finance costs,
  • architectural and planning costs and
  • the cost of labour to physically build the property.

In recent times, all of these costs have been increasing. Materials costs increased significantly with supply chain disruptions during the COVID-affected period and only now is the “rate of growth” slowing. Labour costs are also ever increasing, as even the availability of workers is a significant challenge in many cases (see unemployment rates). Each of these increased costs place downward pressure on the supply of new properties.

 

The real issue

Arguably the biggest factor limiting new supply however is simply being allowed to build new properties. New building requires a myriad of approvals, principally development approvals, from local councils or state governments. Local constituents tend to be against development in their area, often known as NIMBYs (Not In My Backyard). Local councils and members of parliament are voted in by existing residents of a geographic area and hence are incentivised to block the building of new houses.

To provide one such blatant example, one member of parliament (MP) made the comment: “Housing in Australia is in crisis,” describing the cost of housing forcing “families [to sleep] in their cars”. This same MP has vehemently opposed the development of more than 800 dwellings on an unused site in their electorate. Going further, in an attempt to justify the position, he argued that such development activity “drives up the cost of rent and house prices.” This is demonstrably false and fails to pass even the most basic test of common sense. We are not referencing it to call out an individual, but rather providing an example of just how difficult it is to obtain approval to address the housing supply shortage, even from those aware of the need. To see how dire this supply issue has become, see the chart below, provided by the ABS, showing the trend in approvals for dwelling units despite the obvious need for housing.

What are we doing about it?

Amending the long-held planning practices, incentives of government and fixing global supply chains is above our pay grade. What we can do is observe and acknowledge the situation and make investments that benefit from the realities of housing undersupply. This can be done by investing in companies that either have development approved housing projects, or a history of working with planning authorities to obtain approval, despite all the complexities inherent in residential development.

One such investment in the portfolio is Mirvac Group (MGR). Most of MGR’s development takes place in urban infill locations. These projects often increase density and at times have included iconic projects across Australia. MGR is currently developing the old Channel 9 headquarters in Willoughby in Sydney’s North, which will deliver 417 lots, with a total development value of $800 million. Existing iconic projects completed by MGR include The Melbournian, and The Eastbourne in Melbourne. MGR has also been a pioneer in the embryonic “build to rent” property sector. This involves building large apartment buildings, with all lots held for rent on an ongoing basis as opposed to being sold on completion. Those in Melbourne can inspect LIV Munro, adjacent to Queen Victoria Markets, which was recently completed and has 490 apartments available for rent. In the midst of record low rental vacancy, this business both addresses a need and provides low risk returns to investors.

Another investment in the portfolio is Peet Limited (PPC), which specialises in master planned communities across the country. These tend to be extremely large plots of land on the urban fringe of major cities and will effectively be new suburbs and in some cases almost new cities. PPC’s largest project is Flagstone, located between Brisbane and the Gold Coast in Southeast Queensland. It will take a generation to complete, however once built will house 120,000 people and become Australia’s 20th largest city, a similar scale to Cairns. It will include a 100-hectare town centre, with a regional shopping centre similar in size to Chatswood Chase and will have a bigger town centre than the Brisbane CBD. This project has all relevant approvals. It is projects such as this that will go a small way to addressing Australia’s housing undersupply.

A closing note

The current balance in Australian housing is a bit like an unstoppable force meeting an immovable object. Interest rates are having a meaningful impact on the affordability of housing and clearly are putting downward pressure on housing prices. Fighting against this, ever increasing demand and insufficient supply are supporting home values. Over time, these factors should find an equilibrium. Investing in those who are helping to address this undersupply is prudent both from an investment perspective and for the benefit of the nation.

Flagstone-Citys-Future-Town-Centre
Peet Limited’s Artist Impression of Flagstone City’s Future Town Centre

About Cromwell Phoenix Property Securities Fund

Read more about Cromwell Phoenix Property Securities Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS and TMD in deciding whether to acquire, or to continue to hold units in the Fund.

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October 19, 2023

September 2023 direct property market update

Peta Tilse, Head of Retail Funds Management


Economy

pf_quarterly_oct2023_cpiThe quarter started off on positive footing, with inflation across advanced economies edging down to 4.4% YoY in July1. Central Banks’ continued focus on inflation outcomes saw data moderate, helping to ease pressure on rates. However toward the quarter’s end, it was rising energy prices (in part driven by a supply halt by OPEC+) which posed some risk to the inflation outlook and therefore increasing interest rate expectations once again

In Australia, the pace of annual inflation slowed in July from 5.4% to 4.9%, before picking up in August to 5.2%2. While services inflation does remain sticky, the August increase is unlikely to be seen as cause for concern by the RBA, namely because it was driven by volatile items such as automotive fuel (up from -7.6% to 13.9%) and holiday travel (5.3% to 6.6%).

Australian bond yields were dragged higher over the quarter by the US, as markets grappled with comments from the Federal Reserve’s Chairman Powell suggesting the Fed’s job is not done, and higher-than-expected Treasury debt issuance.

While the cash rate in Australia did not change over the quarter, market pricing in early October suggested a 34%3chance of a hike. The October meeting of the RBA Board saw a new Governor (Michele Bullock) in charge. The Board elected to leave interest rates on hold (at 4.1%) which was welcomed by the market. Market pricing (as at 9th October) has all but removed the prospect of another move, only ascribing a 5% chance of another 25bps, and signalling that the central bank is almost at the end of the cycle.

While expectations of further cash rate hikes have diminished, longer term interest rates (proxied by 10-year bond yields) remain ~40bps higher than a year ago4. This is continuing to put pressure on debt costs and is the main macro driver challenging property valuations, despite resilience across demand drivers.

The labour market remains tight, with unemployment staying unchanged at 3.7% in August5 and the number of employed people increasing by 50k over the first two months of the quarter (September data still to come). However, the “quality” of jobs growth was poor, with the number of full-time jobs decreasing by -15.9k over the same period. Leading indicators such as job vacancies and applicants per job advertisement point to slowing jobs growth ahead. Population growth is running at a far stronger pace which should cause unemployment to move beyond 4% before the end of the year, providing support to the view that the RBA hiking cycle may be complete.

On the consumer front, the impact of higher mortgage rates continues to be the primary concern. The RBA recently released its biannual Financial Stability Review which provides an updated assessment of household resilience and loan serviceability. The fixed-rate “cliff” is generally being managed well, with 45% of fixed loans originated during the pandemic having already rolled off onto higher rates and 90 days arrears rates remaining below historical averages. While risks are clearly most elevated for borrowers with high loan-to-value ratios (>80%), around two-thirds of fixed-rate mortgage holders have liquid savings equivalent to at least 12 months of scheduled mortgage payments6.

 

 

Office

dpf_quarterly_chart_netAbsorptionThere continues to be mixed demand readings between the major CBDs, largely aligned to the different industry compositions of the markets. According to JLL Research, national CBD net absorption totalled around 1.5k square metres (sqm) across the quarter. The resource-based markets of Brisbane and Perth both continued their run of positive demand, which has now extended to over a year for each. Adelaide recorded the strongest CBD result with positive net absorption of 37.5k sqm, underpinned by the completion of a 40k sqm Prime office building at 60 King William St anchored by Services Australia. Sydney CBD recorded the weakest result on a quarterly and annual basis, with all precincts except the Core contracting over 3Q23. Prime net absorption was stronger than Secondary net absorption for the tenth consecutive quarter, with Sydney and Canberra the only CBD markets recording weaker net absorption across Prime stock.

The national CBD vacancy rate decreased slightly from 14.4% to 14.2% over the quarter, with the result following the same pattern as net absorption. Brisbane CBD (-1.1% pts) and Perth CBD (-1.2% pts) both recorded lower vacancy rates, particularly across A Grade stock. Sydney CBD and Melbourne CBD were largely unchanged, with Sydney in particular benefitting from minimal large occupier space handbacks and exits which have impacted previous quarters. Premium stock continues to have the highest vacancy rate compared to the long-term historical average, although much of this vacancy is concentrated in a handful of buildings outside occupiers’ preferred precincts.

 

dpf_quarterly_oct2023_chart_totalVacancy

Elevated vacancy and soft demand have caught up to Sydney and Melbourne, with the major CBDs recording weak Prime rental growth outcomes for the quarter. While net face rents continued to grow modestly, incentives increased to record highs (Sydney 35%, Melbourne 41%), dragging net effective rents backwards. The strong demand conditions which have persisted across Brisbane and Perth for some time pushed rents higher again, with Brisbane CBD in particular recording both higher face rents and lower incentives. They are the only CBD markets where net effective rents today are higher than pre-pandemic levels.

dpf_quarterly_oct2023_chart_rentalGrowth

Transaction volume ($1.2b nationally) increased significantly from the very weak previous quarter ($0.6b) but remains well down on typical levels. This lack of transaction evidence resulted in average CBD Prime yields expanding by only 9bps, however industry feedback regarding bid-ask spreads for assets currently on market point to further softening ahead. A more substantial expansion of yields is expected in the December quarter when a greater proportion of assets are revalued.

Retail

dpf_quarterly_oct2023_chart_retailTradeThe impact of higher interest rates is being felt by consumers, with retail sales rising by a modest 0.7% over July and August combined. This was despite positive effects from warmer than normal weather and the Women’s World Cup boosting clothing and dining spending. Annual growth has slowed to 1.5% and with population growth running above 2%, real growth per capita is firmly in negative territory. On an annual basis, dining continues to record the strongest growth, followed by groceries. Tasmania is the worst performing market with nominal sales heading backwards year-on-year, while the ACT has been the top performer with annual sales growth of 5.5%.

Positively for retail real estate, income growth continues to recover from COVID impacts. Retail sales are still 16% above the level implied by the pre-COVID trend, and leasing activity reflects the outperformance which accrued to tenants over the pandemic period. Retail has not been immune from yield expansion. However, a higher starting yield means the movement is less impactful to valuations on a percentage basis.

While income recovery is strongest across discretionary-focused assets, investors continue to prefer centres underpinned by a strong convenience offering. Assets with a high proportion of income derived from supermarkets or dominant national chains (e.g. Bunnings) are proving attractive.

Industrial

Industrial continues to generate face and effective rental growth, albeit at a slowing pace. All markets except Perth recorded growth for the quarter, led by Melbourne (+6.9%)7. Prime incentives increased slightly by 1%, and now average 10%. Space take-up continues to be hampered by a lack of available space, but higher pre-lease activity in Sydney and Melbourne lifted demand to slightly below the 5-year quarterly average. From an industry perspective, Transport and Warehousing, Retail Trade, and Manufacturing continue to drive demand, with Transport and Warehousing accounting for 51% of gross take-up over the quarter.

Supply is expected to reach a record level in 2023, with a new record expected to be set in 2024. However, it’s important to note these records reflect delayed completions from previous quarters due to planning, construction, weather, materials, and labour issues. Delivery delays are most likely in Sydney, which together with Melbourne comprised 74% of completions for the latest quarter. There is currently around 900k sqm of stock under construction due for completion in 4Q23, but some of these projects may be pushed into 2024.

Investors continue to pursue allocation to the sector, but transaction activity is being constrained by higher cost of capital and a lack of available stock. There is a clear preference for the more established East Coast markets, which accounted for all income-producing asset transactions greater than $10 million over 3Q23.

 

Outlook

The Australian economy remains in a solid position despite global headwinds. Inflation is slowing, employment is solid and population growth will provide support to demand over the course of the year. The rate hiking cycle appears to be nearing its end, financial stability has been maintained, and distress remains contained.

These factors put the Australian commercial property market in good stead from a demand perspective. Businesses continue to adjust size requirements for occupancy as they live with hybrid working, although in certain markets this is now largely known. Experiential workplaces with clever refurbishments and amenity continue to attract and retain quality tenants; something we continue to see within our assets. Location has emerged as the biggest driver of occupier demand and asset performance.

Powerful megatrends such as the need for more sustainable, energy efficient real estate, demographic shifts, and rising demand for segments serving the modern economy such as urban logistics, healthcare and highly amenitised offices will create income growth opportunities.

With the Israel-Hamas conflict adding further uncertainty to geopolitical risks and a soft Australian dollar, capital continues to view Australia as a favourable investment destination. This is because of its attractive demographic profile, growth prospects, and relative social and political stability. However, elevated interest rates, wide bid/offer spreads, and limited transactional evidence have all put pressure on valuations.

How did Cromwell Funds Management fare this quarter?

Reflecting the good leasing activity in Brisbane, it was a busy quarter for 100 Creek Street, Brisbane with the leasing of speculative suites helping to fit the asset’s occupancy to 88.4%. The Fund’s current WALE (on a look-through basis) is 4.3 years, and occupancy sits at 94.4%.

There were no valuations updates in the quarter for the Fund given the entire portfolio was independently revalued last quarter. With higher interest rates and softer valuations weighing on the Fund, and understanding regular income is important to all unitholders, the Cromwell Funds Management Board made some financially prudent changes in September. These included ceasing to offer redemptions for a period of 6 months, and reducing distributions to 5.75cpu p.a; bringing it in line with expected profit from operations. Other important changes included the addition of a 5% discount to the Distribution Reinvestment Plan. Further details are listed here.

Performance (%) p.a as at 30 September 2023

Year Cash (AU) Bonds (AU) Shares (AU) Cromwell Direct Property Fund
1 3.56% 1.61% 10.9% -11.0%
3 1.36% -3.92% 8.55% 2.31%
5 1.28% 0.34% 5.08% 3.48%

Past performance is not a reliable indicator of future performance. Source: Lonsec and Cromwell Funds Management


1. The Forward View – Global, NAB (Sep-23)
2. Monthly Consumer Price Index Indicator, ABS (Sep-23)
3. RBA Rate Tracker, ASX (Oct-23)
4. Capital Market Yields – Government Bonds, RBA (Oct-23)
5. Labour Force, ABS (Sep-23)
6. Financial Stability Review, RBA (Oct-23)
7. Australia Industrial and Logistics Figures Q3 2023, CBRE (Oct-23)

About Cromwell Direct Property Fund

Read more about Cromwell Direct Property Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS and TMD in deciding whether to acquire, or to continue to hold units in the Fund.

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September 14, 2023

Industrial: Still delivering the goods

Colin Mackay, Research & Investment Strategy Manager, Cromwell Property Group


Industrial has been Australian real estate’s star performer for a decade, notching up an annualised 10-year return of 14.2%1. While the rate of new supply has increased, the availability of space has been unable to match pace with surging demand. Australia has become the lowest vacancy industrial market in the world2, contributing to record rental growth of almost 25% in the year to March 20233. The sector’s strong momentum continues, and the outlook is bright, as several long-term tailwinds drive demand.

 

E-commerce

The shift in retail activity from physical stores to digital channels drives demand for industrial space in several ways:

  • warehouse space is needed to store inventory which would have otherwise sat in a store;
  • e-commerce tends to offer a wider range of products, rather than the curated selection that a specific retail store might be limited to, necessitating more storage space; and
  • goods purchased online have higher rates of return, and space is needed to handle the reverse logistics.

Increased storage and space needs mean pure-play e-commerce requires three times the distribution space of traditional retail4. Customer preferences are primarily driving the shift to online, particularly as demographic change sees ‘digital natives’ become the dominant consumer segment. As scale and investment lead to greater efficiencies and profitability, the shift may gain another momentum boost.

E-commerce in Australia is following a similar trajectory to Great Britain – it is on track to hit a market share of 20% of all retail sales by 2030 despite growth slowing from pandemic peaks. With 70,000sqm of logistics space needed for every incremental $1 billion of online sales5, e-commerce alone could generate industrial space demand of almost 600,000sqm p.a. over the next seven years6.

Supply chain resilience

As explained in last year’s Supply Chain Adaptation paper, one of the most immediate and lasting impacts of the pandemic has been supply chain disruption, with erratic swings in demand exacerbated by congested ports and border restrictions. The pendulum is now swinging from the prevailing ‘Just-In-Time’ supply chain philosophy, where goods are shipped on demand and arrive just before they are needed, back towards a ‘Just-In-Case’ approach. Under this approach, higher volumes of inventory and production are stored and undertaken locally, where it can be better guaranteed.

Supply chain experts estimate the majority of Australian occupiers are currently holding approximately 30% more inventory compared to pre-pandemic levels7. While this degree of buffer will likely decrease as supply chain disruptions ease, a full return to previous inventory levels is unlikely, meaning more warehouse space will be needed on an ongoing basis for storage.

Online-share-article

 

Infrastructure

Infrastructure development is a key priority in Australia as we contend with ongoing urbanisation and densification, along with surging population growth. Across the 2022-23 Budgets, $255 billion in government expenditure was allocated to infrastructure for the four years to 2025-26, an increase of $7 billion or 2.7% compared to 2021-229. In dollar terms, NSW has the highest allocation to infrastructure ($88 billion), while QLD saw the largest increase on the previous year ($5.7 billion). The three East Coast states of NSW, Victoria, and QLD account for 83% of the committed infrastructure funding.

Budget-infrastructure

Infrastructure investment stimulates demand for industrial real estate in a couple of ways. As new infrastructure is built, congestion and connectivity improve, lowering transport and operating costs and allowing more efficient movement of people and goods. This helps businesses to grow and increases the supportable population base. More activity and more people, mean more demand for industrial space to power the ‘engine room’ of a bigger economy. The more direct source of infrastructure-related industrial demand occurs during a project’s construction phase, as space is needed to manufacture, assemble, and store materials and components.

Customer proximity

The time it takes to reach the customer is of critical importance in modern supply chains. Customers increasingly expect products to arrive faster, more flexibly, at the time promised, and with lower delivery costs. While not a driver of aggregate space demand, the focus on customer proximity does contribute to stronger rental growth for well-located properties.

Transport accounts for 45-70% of logistics operator costs compared to 3-6% for rent10. This low proportion of cost means well-located industrial assets with good transport access and proximity to customers have long runways for rental growth, as occupiers prioritise lower (cheaper) transport times – an up to 8% increase in rent can be justified if a location reduces transport costs by just 1%.

Share-logistics

 

But what about supply risk?

While the demand drivers for industrial are clear, the supply-side response is just as important in determining asset performance. In previous cycles, downturns have arisen from excess speculative development creating too much stock and dampening rental growth. But there are several reasons why the sector is insulated from a supply bubble this time around. Firstly, labour and materials shortages are making it challenging to physically build new assets, even though development is commercially attractive. Secondly, there is a lack of appropriately zoned, serviced land available for development. While land is becoming available farther out from metropolitan centres (e.g. Western Sydney Aerotropolis), this land is not appropriate for many occupiers or uses which require closer proximity to customers. It will also take time for this land to become development-ready, due to planning, infrastructure (e.g. road widening), and utility servicing (e.g. water connection) delays. Finally, the sector has matured and become more ‘institutional’ over the current cycle, with a shift in ownership from private capital to large, sophisticated owners and managers. Institutional owners take a more cautious approach to development, contingent on higher levels of tenant pre-commitment, reducing the risk of a speculative supply bubble. These factors will make it difficult for supply to keep pace with – let alone surpass – demand.

 

Demand story remains intact

Industrial has been the “hot” sector in recent years, and it’s reasonable to question whether it’s been squeezed of all its juice. The pandemic provided a boost to many of industrial’s demand drivers (e.g. e-commerce) and introduced new ones (e.g. supply chain resilience). While these tailwinds have abated somewhat from their pandemic highs, they continue to contribute to a positive demand outlook. Arguably more importantly, the supply response remains constrained by shortages (e.g. labour/materials/land) and delays (e.g. planning), and it will take several years for the sector to return to a more normal supply-demand balance. As a result, Cromwell expects healthy rental growth to be a key driver of industrial returns, and for the sector to remain attractive despite expansionary pressure on cap rates.

Footnotes

1. The Property Council-MSCI Australian All Property Digest, June 2023 (MSCI)
2. Australia’s Industrial and Logistics Vacancy 2H22, December 2022 (CBRE Research)
3. Logistics & Industrial Market Overview – Q1 2023, May 2023 (JLL Research)
4. What Do Recent E-commerce Trends Mean for Industrial Real Estate?, Mar-22 (Cushman & Wakefield Research)
5. Australia’s E-Commerce Trend and Trajectory, September 2022 (CBRE Research)
6. Projection based on historical 15-year retail sales growth of 4.0% p.a. (Cromwell, Jun-23)
7. Is ‘Just-in-Time’ a relic of a time gone by in Australia?, March 2023 (JLL)
8. Global Reshoring & Footprint Strategy, February 2022 (BCI Global)
9. Australian Infrastructure Budget Monitor 2022-23, November 2022 (Infrastructure Partnerships Australia)
10. 2022 Global Seaport Review, December 2022 (CBRE Supply Chain Consulting)

About our managed commercial property funds

Our suite of funds offers access to unlisted property trusts, ASX-listed Real Estate Investment Trusts and internationally listed small cap securities, providing different methods of investing in commercial property and diversifying your portfolio.

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September 14, 2023

An office space evolution

George-street-final

We know the office space landscape is changing. It’s up to Cromwell, as a real estate investor and fund manager, to a listen to the modern requirements of tenants and invest in upgrading our assets to meet these needs while also adding value for investors.

In Edition #42 of Insight, Cromwell’s Research Investment Strategy Manager, Colin Mackay, examined how the office is increasingly becoming a place for collaboration and social connection, rather than focus work, meaning a greater need for meeting, gathering, and collaboration spaces. There is also a need to lower density and make workplaces more comfortable from an employee wellbeing and retention perspective.

Earlier this year, Insight examined ‘The physical office in a hybrid world’ – how white-collar employees divide their working week between home and office, and how the role of the office space has changed forever, largely due to work from home requirements during the COVID-19 pandemic.

The conclusion reached was that, as demand continues to concentrate on the minority of space suitable for modern occupation, the supply-demand mismatch will widen. It was proposed that investors who own or can acquire or create the space occupiers want, where they want it, are well positioned for future rental growth – and, importantly, are more likely to retain and attract tenants.

So, what do tenants want?

 

Spaces occupiers want

Understandably, tenant requirements can be as diverse as the building occupiers themselves. However, there are a number of reoccurring modern office space requirements that require attention.

A May 2023 research paper by global real estate services firm JLL revealed that incentives being offered by landlords to either encourage tenants to stay, or entice them to new premises, remain at historically high levels across many markets1.

According to the research, upgrades to the base building, including end-of-trip facilities, improved ground entry and reception areas, improved lifts and amenities, event spaces, health and wellbeing facilities, business lounges, and cafes are high on the agenda for landlords seeking to keep their occupancy levels stable.

Sustainability is also increasingly a consideration for tenants, including requirements to source all power from renewable sources, or undertake capital upgrade works to the building infrastructure.

In addition, research from Swinburne University of Technology and Third-Place.org in January announced that “working from cafes and pubs will be a 2023-defining trend”2. These kinds of work environments have been termed ‘third spaces’ – or ‘third places’.

That is, if ‘home’ is categorised as a ‘first space’, and the traditional office workplace is categorised as a ‘second space’, ‘third spaces’ can be best described as communal, multi-purpose areas that people can utilise as they desire – including for work. The desire for third spaces has increased significantly since the end of the COVID-19 pandemic, as office building owners and employers look for ways to encourage more workers to return to the office.

 

The Swinburne-Third-Place research found that almost half of remote workers now spend time each week working from cafes or other third places. The trend continues to be particularly popular with Gen Z workers (loosely defined as people born between 1995 and 2010), ten percent of whom say third places are now their preferred place to work.


The researchers found that, on average, people who work in third places will typically do so between two and three times each week. These workers will stay anywhere between 15 minutes and four hours – most of the time, they’ll go to a third place on their own.

The top three benefits to working in a third place were reported to be mental reset, community and social connection, and great food and coffee. When asked to what extent working from a third place positively contributes to their overall wellbeing, the average response was 86%. By extension, 98% of respondents said they’d continue to use a third place for work in the future.

Meeting market desires

Cromwell has a strong track record of adapting office spaces to meet tenants’ requirements. Our exceptional in-house property development, project management, and technical capabilities allow us to identify and deliver value for our tenants, our investors, and capital partners through innovative development and construction projects, whole- of-building refurbishments, and adaptive re-use and asset transformations, all of which incorporate market leading sustainability initiatives.

In response to our tenants’ changing needs – highlighted in the 2022 Tenant Engagement Survey – Cromwell rolled out the successful design and delivery of a new purpose- built wellbeing and third space at our 400 George Street building in Brisbane.

 

Brisbane-based architectural firm nettletontribe was engaged to design a space that would meet the needs of our current and future tenants; and experienced national Indigenous accredited fitout and refurbishment company Rork Projects was tasked with delivering the vision.

 

The result is a superbly integrated indoor-outdoor shared meeting area; a training room and larger boardroom; a multi-faith/wellness room; and a 200 sqm breakout or function space.


High ceilings and earthy floor tiles are complemented by polished timber entranceways and olive-green feature walls. Concertina (bifold) doors allow much of the area to be opened to the bustling city below.

The space is already being utilised by tenants as a break- out area; a space for meetings, yoga classes, and wellbeing classes. In this instance, Cromwell was able to repurpose a vacant and difficult floor space to provide an outcome that benefitted tenants, enhanced the building amenity, and increased marketability of the asset. Cromwell will apply the lessons learned through this process to upgrade works at our other assets.

Our experienced property managers continue to liaise with tenants regarding every workplace requirement, including lease disposal, lease negotiation, space planning, workplace design, change management, cost of construction, technology solutions or transitioning to net zero.

The office market latest

Vacancy rates in Australia’s capital cities have increased modestly over the last six months, driven by an uptick in new office supply, according to fresh data from the Property Council of Australia (PCA).

The July 2023 edition of the ‘Office Market Report’, which is released twice a year, showed overall CBD vacancy increased from 12.6 to 12.8% nationally3. Non-CBD areas saw an increase from 15.2 to 17.3%.

PCA projects that the supply of office space in CBD markets is expected to remain close to the historical average throughout 2023, with an anticipated increase above the average in the second half of 2024.

Encouragingly, the office market in Brisbane – where Cromwell owns a number of assets – is particularly robust, with tenant demand outpacing available supply, decreasing the vacancy rate from 12.9% to 11.6%.

“Notably, the results show Premium and A Grade stock remains in high demand, reinforcing businesses’ desire to provide attractive and enjoyable workplaces for their people,” Property Council Chief Executive Mike Zorbas said as part of the July Office Market Report launch.

“These organisations recognise that maintaining a physical office presence in our cities is vital for conducting business effectively. We know that face-to-face teamwork supports deeper team relationships and brings about positive outcomes for organisations, the economy, and society
at large.”

 

Continuing to improve our spaces

Attracting Government and blue-chip tenants on long-term leases continues to be a key focus for Cromwell. As with our George Street property, works have been undertaken at several other assets to retain existing building occupiers – and attract new tenants.

Cromwell has actively completed a number of property upgrades of this kind already in 2023, including the recent completion of several speculative fitouts.

Speculative fitouts are new office fitouts built by the landlord or building owner, designed to accommodate a broad range of new tenants. If building owners can show potential tenants a functional, modern space that requires no further work, it makes the property a much more attractive prospect.

Recent completed works include:

 

207 Kent Street, Sydney
Cromwell’s Projects Team has successfully concluded construction activities on levels 18, 19, and 20. These enhancements are in preparation for the upcoming occupancy of new tenants in the forthcoming months.

The tenancy areas have undergone upgrades, featuring environmentally conscious carbon-neutral flooring and energy-efficient LED troffer lighting. Additionally, significant improvements have been made to lift lobbies and amenities across various floors. Both cold shell and warm shell office spaces have been prepared for future fitouts.

These recent endeavours build upon the substantial base build refurbishment that was previously undertaken in 2022. This refurbishment included a lobby refresh inspired by a First Nations Indigenous design, with the addition of end-of-trip facilities. These facilities encompass a spacious bike storage area, expanded shower amenities, and the installation of numerous new storage lockers.

95 Grenfell Street, Adelaide
Cromwell Direct Property Fund’s Chesser House property, located in the heart of Adelaide, has recently seen the completion of speculative fitouts in two tenancies.

The suites boast neutral colour palettes, highlighted by gentle blues and calming green tones, contributing to a serene ambience. The layout of the 360sqm and 200sqm spaces has been strategically planned to maximise functionality. This includes dedicated areas for meeting rooms, quiet spaces, and collaborative zones.

475 Victoria Avenue, Chatswood
Cromwell’s Projects Team has successfully managed the realisation of six speculative fitout tenancies spread across three levels. The sizes of these tenancy floors span from 100sqm to 520sqm, with each suite thoughtfully adorned with a distinct colour palette, instilling a sense of individuality to every area.

 

Space planning was thoroughly conducted in collaboration with both internal and external leasing teams. This strategic approach responds to the growing demand for collaborative spaces while underlining the importance of design flexibility to facilitate enhanced reusability.

 

Furthermore, sustainability remains a paramount focus. A notable achievement in this regard is the recycling of 52% of construction waste, which includes repurposing existing furniture items.


100 Creek Street, Brisbane
Three speculative fitouts, completed in December 2022, were well received by the market; prompting the building of a further four speculative fitouts, across two floors, this year.

The design of these suites focused on breakout areas and collaboration zones to address market requirements in addition to providing quiet rooms to those wishing to concentrate on tasks or avoid distraction.

To enhance the value of the space, carbon-neutral flooring inspired by First Nations Indigenous culture was carefully selected and incorporated.

 

Continuing to improve our strategy

In response to market dynamics, Cromwell is reshaping our speculative fitout approach. Our primary goal is optimising financial efficiency, particularly during periods when tenants are yet to be secured.

As part of this process, we’re introducing a fresh concept: pre-lease design concepts – that is, potential tenants can influence final touches after pre-commitment. By addressing tenant preferences, we enhance experiences and minimise post-move changes. This strategy balances financial prudence, tenant engagement, and functional design, exceeding expectations consistently.

Our designs offer lasting allure, catering to diverse needs. Easily upgradable components reduce major modifications. Further, ESG considerations remain paramount to our business decisions – we integrate eco-friendly practices and repurpose elements to cut waste.

In essence, our approach emphasises sustainability, functionality, and tenant satisfaction. Adaptable designs create appealing, eco-conscious spaces.

 

In conclusion

As the office market continues to evolve, Cromwell is committed to ensuring that our assets adequately meet current and future tenant requirements – we will adapt office spaces to meet tenants’ needs, improving our vacancy rates in a highly competitive market.

By developing our approach to improve the occupancy of our assets, we will deliver favourable outcomes for investors now and in the future.

Footnotes

1 Choosing the best fit for your organisation, May 2023 (JLL Research)
2 Third Places – A health alternative to working from home?, January 2023 (Swinburne University of Technology and Third-Place.org)
3 Office Market Report, July 2023, (Property Council of Australia)

About Cromwell Direct Property Fund

Read more about Cromwell Direct Property Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS in deciding whether to acquire, or to continue to hold units in the Fund.

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September 14, 2023

In conversation with… Rob Percy

A native Glaswegian, Rob Percy has lived in Australia for almost 20 years. He’s an avid swimmer and AFL convert – and has adapted to the life of a Sydney Swans supporter in his adopted hometown.

Skilled in asset management, mergers and acquisitions, financial structuring, financial services, and valuation, Rob has been with Cromwell for just under 12 years – serving as the Group’s Chief Investment Officer since mid-2018.


 

1. You’ve been the Chief Investment Officer at Cromwell for the past five years, Rob – what does the role involve? What are some of the key responsibilities you take on daily?

The role has changed somewhat since I was first appointed, but the current role is responsible for Group Strategy, our Australian Funds Management business, Investor Relations, and Research. I also represent Cromwell on the Boards of our joint venture companies (Phoenix and Oyster) and, in the case of Oyster, I chair the Investment Committee.

On a day-to-day basis, I’m focused on thinking through what’s next for Cromwell Property Group and our suite of Funds Management products, while ensuring our existing balance sheet and retail products are appropriately and effectively managed.

 

2. You hold a Master of Science, focused on chemical physics, from The University of Glasgow – how did you transition from that field to the finance industry? Are there any transferable skills
between the two vocations?

I always enjoyed studying the sciences through school so, when it came to choosing what degree to do, I decided to choose something that clicked with me; something I enjoyed learning about. I had a great time at university, but never intended on becoming a professional scientist. In the summer before my final year, I spent two months in London with a large investment bank, working in their derivatives team – and I was hooked.

I applied to a number of investment banks to join their graduate programmes, and ultimately accepted an offer to join NM Rothschild & Sons for their 1998 intake.

I joined the bank around September that year, along with my fellow graduate programme members – which included geographers, linguists, and historians, among others. We embarked on a four-month on-the-job training programme, where I was taught financial analysis, presentation skills, basic legal skills, project management skills, and spent time on secondment across the various parts of the business. From then on, I spent eight years in investment banking in London and Australia before moving into property funds management.

There are a huge number of transferrable skills between science and finance. At Uni, I was taught how to independently think and motivate myself – the days of being chased and reminded by a teacher to complete an assignment were over. No-one else was going push me, I had to do that myself.

A science-based education teaches you strong analytical and problem-solving skills that can be used across any number of careers. I was taught how to observe, research, and think critically, all kills which can be used when approaching any task, be it in a laboratory, at an office desk, or in a boardroom.

 

3. There’s been considerable media attention given to the current state of the commercial property market over the past six months – how do you see the market in August 2023?

There is no denying that times are challenging and uncertain. The current volatility in interest rates and valuations is making investment decisions hard for investors, which is flowing through to low transaction volumes worldwide.

Recent data is looking more promising for Australia, but I think we still have some way to go until markets can settle down, interest rates become more stable, and investors have more confidence in deploying capital that is not just looking for opportunistic returns.

The other key focus is on leasing and maintaining our buildings to ensure we are keeping our occupancy high and that our buildings are attractive and relevant to existing and new tenants.

 

4. Given the environment, how does Cromwell navigate the uncertain market conditions to keep generating income for our investors?

A key focus for us in this environment is to protect our balance sheet. We have undergone a programme of noncore asset sales, the proceeds of which have been applied to reduce our outstanding debt balance and reduce gearing. These sales continue, particularly in Europe, where we are looking to return capital to Australia for investment locally.

The other key focus is on leasing and maintaining our buildings to ensure we are keeping our occupancy high and that our buildings are attractive and relevant to existing and new tenants.

 

5. In your opinion, what opportunities exist for Cromwell over the next twelve months?

With uncertain and volatile markets also comes opportunity. A key strategic goal for us in the short-to-medium-term is to expand and grow our Australian Funds Management business. We are looking to create a number of new products in the short-term to take advantage of some thematic trends we are seeing domestically.

We will be looking to expand our sector horizons outside of office and take advantage of our repositioning skills to look for opportunities where we can add value and additional life to existing assets.

We also see great opportunity to boost our funds under management and skill base through platform and portfolio acquisitions, much like our recently announced transaction between Cromwell’s Direct Property Fund and the Australian Unity Diversified Property Fund.

We have a great platform, loyal investors, and a broad skill set within Cromwell, which I think places us well to take the business to the next stage of its strategic plan.

We have a great platform, loyal investors, and a broad skill set within Cromwell, which I think places us well to take the business to the next stage of its strategic plan.

 

6. The merger of Cromwell’s Direct Property Fund with Australian Unity’s Diversified Property Fund was seen as a bright point for the business in 2023 – can you expand on the work that was put into the deal?

It’s a big deal for both funds, and one that took a lot of people to get to this point.

We’ve been working on the transaction for close to 12 months, working with multiple advisors across all disciplines. It has already involved every team within Cromwell and will continue to as we move towards the unitholder meeting and hopefully completion and integration into our platform.

It’s a great illustration of what can be achieved together, working alongside our colleagues, and being aligned to a common goal.

 

7. What are some changes or shifting attitudes/trends/practices that you currently see playing out in the commercial property market?

As businesses adjust to the post-COVID-19 environment and work practices, we are seeing tenant attitudes to office shifting. We are seeing larger occupiers, which traditionally fill Premium buildings with large floorplates, contract – while smaller tenants are expanding.

This is changing the adage of “flight to quality”. Historically, “quality” would have been synonymous with Premium – top grade, large floorplate office buildings with high rents, but this ignores the needs of most office occupiers, particularly those that are growing.

The majority Australian businesses (and employment) are small and medium-sized enterprises. These SMEs are in the market for a new ‘Toyota’, not a ‘Rolls-Royce’. They want the highest quality office, in the best location, within their price bracket. So “high quality office” is really the space that meets the needs and preferences of its target audience.

We are also seeing a shift to “experiences”, with tenants now increasingly focused on the whole package of location, local amenity, on floor experience and fit-out, natural light, third spaces and wellness, and proximity to transport. We are seeing this play out particularly in the city fringe areas where rents are growing strongly, given the lack of availability.

 

8. What do you enjoy most about your role?

I think it’s the variety of the role and being central to the growth of the business, helping to set and drive the strategy, creating new products, and building new relationships.

When I was in investment banking, we would move from one transaction to the next, but at Cromwell I can follow through on ideas and new opportunities, helping to build out the business and develop the culture.

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September 14, 2023

Initial ‘green’ loan secured under new Sustainable Finance Framework

In a milestone for the business, Cromwell Property Group transitioned to our first ever green loan in July, as part of the rollout of our new Sustainable Finance Framework. Developed in consultation with the Commonwealth Bank of Australia and French-based multinational financial services company Societe Generale, this framework will see Cromwell apply best practices in energy efficient real estate and sustainability to our portfolio – and support the transition to a more sustainable economy more broadly.

 

What is a ‘green’ loan?

According to the Climate Bonds Initiative, an international organisation working to mobilise global capital for climate action, green loans are defined as any type of loan instrument used to finance or re-finance projects, assets, and activities with environmental benefits.

Green loans are based on ‘use of proceeds’, with borrowing proceeds transparently earmarked for eligible ‘green’ assets1. It is global best practice for green loans to be arranged in line with the Green Loan Principles, the Climate Bonds Standard (to the extent of available criteria), as well as several country specific guidelines.

The Climate Bonds Initiative anticipates that green loan markets are poised for growth in the coming decade, as lenders and borrowers cooperate and leverage market development to support local economies to transition to become net zero and climate resilient.

It’s better being green

The inaugural transaction under Cromwell’s new Sustainable Finance Framework involved transitioning the existing $130 million bilateral loan on the Cromwell Riverpark Trust – with Commonwealth Bank of Australia – to a green loan certified by the Climate Bonds Initiative. The debt facility for the Cromwell Riverpark Trust was extended for a further two years, with all other terms remaining the same.

Obtaining this type of loan requires issuers, like Cromwell, to embed transformative steps, not incremental improvements, for rapid decarbonisation across all three scopes of their footprint.
Lara Young – Group Head of ESG, Cromwell Property Group

 

Cromwell’s Group Head of ESG, Lara Young, said a huge team effort, and considerable work, went into securing this type of loan for the Cromwell Riverpark Trust, which is underpinned by Energex House in Brisbane.

 

“The Climate Bonds Low Carbon Buildings Criteria was designed with an ambition of a zero-carbon future in 2050. Obtaining this type of loan requires issuers, like Cromwell, to embed transformative steps, not incremental improvements, for rapid decarbonisation. Only the top 15% most emissions-efficient buildings in a city can qualify for green loans certified by the Climate Bonds Initiative(1)” said Ms. Young.

 

“Energex House is an industry leading Green Star 6 star, and 6-star NABERS Energy rated, building. By extending the term of the facility for a further two years under a green loan, we will continue to improve its sustainability performance.”


Framework to safeguard the future

Cromwell has developed its Sustainable Finance Framework to support, and provide transparency to, our commitment to fund low-carbon, sustainable, efficient, and resilient buildings that meet our ESG ambitions, as well as those ambitions of our people, our tenants, and our suppliers.

Moving forward, the framework will further optimise the Group’s borrowing practices through the use of sustainable debt instruments, including green bonds and loans – like those outlined above – as well as sustainability linked bonds and loans. A copy of the document is available on the Cromwell Property Group website.

Lara Young explained that Cromwell would continue to refine its Sustainable Finance Framework over the next few years, in line with the evolving sustainable finance market and the latest legislation, standards and best practices.

“By leveraging green or sustainability linked debt, Cromwell Property Group can move significantly closer to meeting our current and future ESG responsibilities, including a Cromwell portfolio Net Zero Scope 1 and 2 target for 2035, and Net Zero across all 3 scopes by 2045.”

 

Initial-green-article-1

 

The new framework was developed following in-depth consultation with issuers and financial institutions to ensure that a best practice methodology could be deployed. The Commonwealth Bank of Australia and Societe Generale acted as sustainability coordinators throughout the development process.

Commonwealth Bank of Australia General Manager Corporate Finance and ESG, Jane Thomson, said sustainable finance was a rapidly growing market.

“We have partnered with many high-profile clients through their first sustainable finance transactions, and we’re thrilled to support Cromwell to develop a framework that reflects their business objectives and sustainability strategy,” Ms. Thomson said,

“One of our priorities is to play a leading role in supporting Australia’s transition to a modern, resilient, and sustainable economy, and key to that is supporting high quality green buildings in the commercial property sector.

There are enormous benefits for an organisation in accessing the vibrant sustainable finance markets and we are pleased to have supported Cromwell’s inaugural green loan under the new framework for the Energex House asset.”

Tessa Dann, Head of Sustainable Finance for Australia & New Zealand at Societe Generale, said: “as a global bank with strong focus on supporting the transition to a more sustainable economy, we are pleased to have worked as a sustainability coordinator for Cromwell Property Group to develop a Sustainable Finance Framework with a global perspective that reflects Cromwell’s presence across 14 countries.”

“The Sustainable Finance Framework adds another dimension to Cromwell’s sustainability strategy by enabling all Cromwell funds and related entities to utilise the Framework by aligning debt funding needs with sustainability outcomes.”

Benefitting our investors

As outlined in the ‘ESG and Investment Strategy’ white paper by Cromwell’s Research Team, ESG and financial performance are inherently interlinked. The report demonstrated that investments which maximise positive ESG outcomes also maximise long-term performance given their contribution towards ensuring stable, well-functioning and well-governed social, environmental, and economic systems.

There is no trade-off between ESG and financial return, the report found – they go hand-in-hand. That is why it is prudent that investors seeking to protect, create, and grow long-term performance ensure that ESG is central to investment strategy decisions.

Strong ESG credentials attract high calibre tenants, helping to safeguard stability of income.

Strong ESG credentials attract high calibre tenants, helping to safeguard stability of income. For example, the Australian Government has minimum energy performance standards for all government office buildings. Australian Government tenants are only allowed to occupy office building spaces that have a 4.5 stars NABERS Energy, or equivalent, level of energy efficiency.

State governments around Australia similarly have strict energy requirements for the spaces they occupy. For Cromwell, given the large volume of government tenants we cater for, ensuring that we nvest in ESG is critical to ensuring ongoing long- term government leases.

Accountability: delivering on what we promise

Cromwell formalised an overarching ESG Strategy in early 2023, the process for developing which was one of consultation and collaboration, and we have sought to achieve a globally harmonised approach.

The new ESG Strategy includes targets that are crucial to our future, including decarbonising our business toward net zero and setting new baselines for areas such as energy consumption, waste management, and carbon in each of our operating regions. We have also developed region-specific targets to ensure we are addressing local concerns, such as the development and registration of an Australian Reconciliation Action Plan, with further progress and meaningful reflection occurring constantly.

As a capital light fund manager that focuses on the acquisition and uplift of existing buildings, we have a lower carbon footprint compared to organisations focused on new developments as our embodied carbon is largely limited to maintenance and refurbishment. That said, even Cromwell still strives to ensure embodied emissions are addressed. During our buildings’ lifecycles, we aim to act as responsible stewards – we generally acquire existing buildings, identify and implement the most relevant opportunities to improve their environmental efficiency and ensure they are performing well, before divestment.

In FY23, we developed a comprehensive Scope 1-3 emissions baseline and Marginal Abatement Cost Curves across all regions to understand where our major emissions sources lie in our value chain, and determine and prioritise locally appropriate and cost-effective emissions reduction activities.

We have now developed an ambitious Net Zero Strategy that encompasses our Scope 3 emissions, including our tenants’ emissions and embodied carbon, and we are excited to share updates on our progress.

Footnotes

1. Green Loans Australia & New Zealand, 2020 (Climate Bonds Initiative)

Explore our Sustainable Finance Framework

Read the full Sustainable Finance Framework and find out more.