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April 30, 2024

Getting the right healthcare property exposure: why medical centres

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


 

Healthcare property encompasses a range of asset types such as hospitals, medical centres, and aged care facilities. As outlined in the previous article of this series, the healthcare industry is benefitting from several demand tailwinds. However, it’s not all smooth sailing, as evidenced by recent news of private hospital closures1. In this article, we’ll explain why we believe medical centres is the specific property segment investors should prioritise.

 

A necessary care model

As the population ages, the supply of health services is struggling to keep up with demand, resulting in higher costs and longer wait times. Inadequate financial and labour resources are available to improve care standards or wait times under the status quo – a more efficient and cost-effective system is required.

public hospital elective surgery wait times

Part of the required shift includes moving treatment out of hospitals and towards GPs and other primary or secondary care facilities. Focusing on primary healthcare and out-of-hospital care can result in better health outcomes2, reduced risk of infection and improved patient comfort, convenience, and satisfaction3,4. From a funding perspective, out-of-hospital care can be cheaper due to lower overheads compared to when a hospital bed is occupied4.

Avoidable emergency department presentations are clogging the hospital system, with an estimated 1.9 million preventable patient days per annum from those aged 65+ alone5. It would be more appropriate to provide this care in an efficient, fit-for-purpose medical centre environment, saving costs and freeing up hospital resources for actual emergency care and complex cases.

The shift from hospital to non-hospital care is already underway and evidenced by growth in primary healthcare spending outpacing spending on hospitals, as well as government policies putting greater emphasis on primary care and preventive health. For example, the Federal Government has announced a $99m initiative to connect frequent hospital users with a GP to reduce the likelihood of hospital re-admission, and $79m in funding to support the use of allied health services for multidisciplinary care in underserviced communities6.

GROWTH IN PRIMARY HEALTHCARE SPENDING IS OUTPACING SPENDING ON HOSPITALS

Attractive investment characteristics

In addition to demand and funding tailwinds, medical centres offer several attractive investment characteristics:

High quality cashflow
derived from a reliable tenant base
A hedge against inflation
via CPI-linked or fixed rental escalations
Long leases (typically 5-15 years)
sometimes on a triple net basis
Higher rates of lease renewal
compared to traditional office7

Compared to private hospitals, medical centres may be preferred due to deriving income from a typical commercial lease structure, rather than a percentage of operator EBITDAR. Land also typically comprises a greater proportion of asset value, which can provide downside protection and aid long-term development or change of use potential.

 
Private Hospitals
Medical Centres
Lease term 20-30 years 5-15 years
Basis of income Percentage of operator EBITDAR, quoted on per bed basis Typical commercial lease structure, quoted per sqm
Tenant profile Single operator One or several tenants
Capital intensity Very high Moderate to high

Summarised from Exploring Australian healthcare opportunities, JLL (Jun-23)

An increasingly important part of the healthcare landscape

Medical centres are an increasingly important part of the healthcare landscape, representing efficient and fit-for-purpose facilities that can help alleviate the capacity constraints of hospitals and improve the sustainability of the health system.

We believe medical centres’ alignment with demand trends and Government healthcare spending priorities, together with attractive investment characteristics such as CPI-linked income and defensive land holdings, puts them in a favourable position compared to other healthcare property investments.

 

Footnotes
  1. Ramsay Health Care warns of hospital closures as costs blow out, AFR (Feb 29th, 2024)
  2. How much of Australia’s health expenditure is allocated to general practice and primary healthcare?, M. Wright; R. Versteeg; K Gool (Sep-21)
  3. Out-of-hospital models of care in the private health system, Australian Medical Association (Oct-23)
  4. There’s no place like home: reforming out-of-hospital care, Private Healthcare Australia (May-23)
  5. Health is the best investment: shifting from a sickcare system to a healthcare system, Australian Medical Association (Jun-23)
  6. Federal Budget 2023-24, Treasury (2023)
  7. Exploring Australian healthcare opportunities, JLL (Jun-22)

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Home Latest property industry research and insights
April 22, 2024

March 2024 direct property market update

Economy

The disinflation cycle is in the ‘last mile’, where monetary policy is being finely calibrated and market expectations can move month-to-month with each new data release. This was reflected in the RBA’s stance at the March Board meeting, where Australia’s central bank arguably kept a foot in both the tightening and neutral camps. However, much of the market’s speculation is focused on when rate cuts will occur, rather than the genuine possibility of further hikes. As at the end of March, financial markets and the major banks were forecasting the first cut to occur in the final quarter of 2024.

Annual inflation was stable at 3.4% in February (data released March), with rent and insurance inflation remaining stubbornly high, and goods inflation continuing to be moderate. However it is the tightness of the labour market (services inflation) which will likely be the key determinant of the CPI path moving forward. On this front, the unemployment rate fell from 4.1% in January to 3.7% in February1. The magnitude of the decrease is surprising at first glance, but less unexpected when you look at the detailed data which shows a shift in the seasonality of the labour market. It is now becoming the ‘new norm’ for workers to end a job in December and not start a new one until February. Labour data has also shown more volatility month-to-month since the pandemic. Looking at the recent trend rather than the latest monthly print in isolation shows the labour market is gradually softening, with underemployment (people wanting more hours) at its highest level since December 2021 and leading indicators such as job vacancies falling (albeit from high levels).

 

Retail sales provide another indication of a slowing economy. While Taylor Swift’s recent tour boosted February spending on clothing, department stores and dining in New South Wales and Victoria (the locations of the concerts), annual nominal growth of only 1.6% was recorded2. Considering inflation is running above 3% and population growth of circa 2.5%, underlying consumption is very weak, showing that the cost of living is clearly biting. However, consensus expectations are that there should be some relief towards the end of the year as stage 3 tax cuts flow through, inflation continues to moderate, and interest rates potentially ease.

A part of the economy bucking the slowdown trend is housing; reflecting robust demand and constrained supply. CoreLogic’s national Home Value Index recorded its 14th consecutive month of growth in March, rising to new record highs each month since November 20233. There is a risk sustained house price growth may influence the RBA’s view of the appropriate rate path, however as previously stated, the health of the labour market will likely be a much greater focus.

Office

The office market recorded a positive result in the March quarter. According to JLL Research, national CBD net absorption totalled just over +33,000 square metres (sqm), the strongest result since March 2023. Sydney was the top-performing market after three weak quarters prior, while Perth was the only major CBD market which saw demand decline as a result of softening in the non-Premium grades. On an annual basis, net demand is still strongest in the smaller markets of Adelaide, Brisbane, and Perth.

 

The national CBD vacancy rate was flat at 14.7%, with every CBD market except Perth and Canberra recording an improvement in supply-demand conditions. While the softening in Perth was due to both new supply and weaker demand, the increase in Canberra vacancy was entirely driven by the addition of new stock (completion of a refurbishment). Nationally, Premium assets saw the greatest improvement in vacancy rate.

Prime net face rent growth (+1.4%) accelerated further compared to the prior quarter (+0.9%), with the Brisbane CBD and Adelaide CBD the top performers. Prime incentives were largely flat (+0.1%), with half of the markets recording minor increases (Sydney, Melbourne, Perth), offset by the other half recording minor improvements. This meant on a net effective basis, Adelaide and Brisbane recorded the strongest growth, with Melbourne the only market to head backwards.

 

Reflecting the continued softness in conditions, transaction volume for the March quarter ($1.0 billion nationally) was roughly in line with the quarterly average over the prior 12 months but 64% lower than the Q1 average of the previous five years. Having said that, it was the highest number of sales seen since December 2022, highlighting that the smaller end of the market remains more active than larger lot sizes. The lack of transaction activity reflects the sharp increase in cost of capital seen over the past 24 months. This has resulted in national CBD prime average yields softening a further 29bps over the quarter. The national movement in yields may not be directly reflective of individual portfolios or assets, given differences in the timing of valuation processes.

Retail

While annual rental growth remains soft, it is consistent and broad-based. According to JLL Research, across large discretionary shopping centres (Regionals) gross rental growth averaged +0.1% for the quarter and +0.5% for the year, with every market recording a similar result. Growth across Sub-Regionals was slightly stronger at +0.2% and +0.8%, representing nine consecutive quarters of rental increases. Neighbourhood centres also recorded growth of +0.2% for the quarter, taking annual growth to +0.6%. Sydney and South-East Queensland, which have the highest Neighbourhood rents per sqm, recorded slightly weaker growth than the other markets.

It was a very slow quarter for retail property transactions, with volume totalling just over $500 million. No Regional assets changed hands for the first time since September 2022, dragging the dollar value of activity lower. It was quiet across the other centre types as well, with Sub-Regionals the most active relative to the five-year average. While yields did expand further over the quarter, it was to a lesser extent than office and industrial reflecting the higher starting point of retail yields prior to the hiking cycle.

While yields did expand further over the quarter, it was to a lesser extent than office and industrial reflecting the higher starting point of retail yields prior to the hiking cycle.

Industrial

Gross occupier take-up softened materially over the quarter as inventory levels contracted and the broader economy slowed. Transport and Warehousing continues to comprise the greatest share of demand from an industry perspective, with Manufacturing take-up also remaining at a solid level. The big driver of the slowdown was Retail and Wholesale Trade, which saw demand fall by around 90% compared to the five-year average. This may reflect cautiousness from occupiers in the face of weak retail sales and declining global trade volumes, together with a ‘pause’ to expansion after substantial take-up during the pandemic. From a market perspective, Sydney saw the largest slowdown in demand, with South-East Queensland and Perth holding up well.

 

While rental growth is slowing from record highs, it remains well above trend, consistent with tight vacancy conditions. Melbourne saw the strongest growth, with Melbourne West the top-performing precinct nationally (+8.0% QoQ). Brisbane growth was robust in the infill Trade Coast precinct, while the land constrained South precinct was the top performer in Sydney. Rental growth in Sydney’s Outer Central West, where land is more abundant, was not as strong.

Almost 500,000sqm of industrial supply was completed in the first quarter of 2024. A further two million sqm4 of supply is slated for completion over the balance of the year, however construction delays may see timings slip. If all the projected supply is completed in 2024, it would represent the second highest level of completions in a calendar year behind 2022 (2.7m sqm). Projects are heavily concentrated in the land-rich, outer precincts, with 66% of expected 2024 supply to occur in just four precincts (of 22 nationally). Ongoing elevated levels of supply will likely lead to greater availability of space and a further softening of rental growth.

There was a rebound in transaction activity over the quarter, with dollar volumes exceeding the five-year average and hitting the highest level since September 2022. Activity was dominated by Sydney, in particular ISPT and Unisuper’s joint acquisition of a 280 hectare greenfield development site in Badgerys Creek. Consistent with other sectors, prime industrial yields expanded over the quarter along the East Coast, with the smaller markets of Adelaide and Perth unchanged. Sydney saw the greatest degree of softening, but still has the tightest yields nationally.

 

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 remaining resilient. Markets are becoming more confident the rate hiking cycle is at or near its end, which should help ease uncertainty and improve liquidity for property later in the year.

While an economic 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 back 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).

How did the Cromwell Funds Management fare this quarter?

With the Cromwell Direct Property Fund’s property portfolio completely revalued externally in November and December 2023, no external revaluations were completed in the March quarter. With the revaluation process and half-year accounts released, the Fund recommenced accepting applications and offering the Distribution Reinvestment Plan (at a 5% discount) from 25 March 2024.

The Fund continues to experience positive leasing outcomes, especially in its Brisbane based assets. The strategy to build quality speculative fitouts and improving amenity with 3rd spaces has helped improve occupancy metrics, tenant engagement, and improving rental growth.

Both the Cromwell Riverpark Trust’s Energex asset (CRT) and Cromwell Trust 12’s Dandenong asset (C12) had solar panels installed. The installation is awaiting grid approval, and the work will help maintain (for CRT) and obtain (for C12) a 6-star NABERS rating.

Read more about the Cromwell Direct Property Fund: www.cromwell.com.au/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.au/dpf, by calling 1300 268 078 or emailing invest@cromwell.com.au.

 


  1. Labour Force, ABS
  2. Retail Trade, ABS
  3. Hedonic Home Value Index, CoreLogic
  4. Projects with a status of Under Construction, Plans Approved, or Plans Submitted
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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April 22, 2024

An essential and resilient sector: why healthcare property

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


 

The healthcare and social assistance sector is an essential and growing industry, accounting for 8% of the Australian economy1 and 16% of employment2. It is expected to see the biggest increase in government funding from 2022-23 to 2062-63, with government health spending per capita forecast to grow by 2.0% p.a. on an inflation-adjusted basis3. In this short article, we’ll provide a brief overview of healthcare’s key growth drivers, and why healthcare property presents a compelling investment opportunity for income-oriented investors seeking stability and diversification.

Demographic tailwinds

Growth in Australian healthcare is underpinned by several long-term demographic trends, which are spurring demand for care services. Firstly, Australia is forecast to experience the strongest population growth across developed economies over the next decade4. On top of broad-based population growth, there is an even more pronounced “population bulge” now sitting in the 65+ age bracket due to the post-war baby boom. Life expectancy is also rising, up from 78 years (men) and 83 years (women) two decades ago to 81 and 85 today, with the rising trend expected to continue3. These factors mean the number of people aged 65+ will more than double and the number aged 85+ will more than triple over the next 40 years. As we live longer, the proportion of our lives lived in “full” health is slowly declining, meaning a longer period of time where health services and care are needed per person.

People aged 65+ currently account for 40% of government health spending despite being only 16% of the population.

Rising disease incidence

Naturally, an ageing population also means rising disease incidence and complexity. People aged 65+ currently account for 40% of government health spending despite being only 16% of the population3, with 95% of those aged 65+ having two or more chronic health conditions, compared to 59% of those aged 15-444. This is being exacerbated by lifestyle factors, such as poor diets and lack of exercise, and improved medical detection and diagnostics, which are seeing the rates of disease incidence also increase on an age-standardised basis5.

 

Non-cyclical demand

Healthcare is a defensive, necessity service resilient to fluctuations in the economic cycle. Since gross value added data by industry has become available, healthcare has only contracted in 37 of 197 quarters, making it the second most consistently expanding industry behind Education, which has contracted in 25 quarters1. By comparison, cyclical industries such as mining and construction have contracted in 69 and 71 quarters respectively.

Volatility in healthcare demand is lower than in other industries, and growth has also typically occurred even during periods of recession or global economic disruption (e.g. the GFC). In fact, annual growth in gross value added has never been negative for more than one consecutive quarter, with the worst result (-5.0%) recorded during the COVID-19 pandemic when most health services were shutdown. Even during the pandemic, the sector experienced a sharper recovery than the broader economy.

Strong fundamentals

The healthcare sector in Australia is an essential and growing industry. Underlying demand is being driven by long-term demographic trends such as population growth, the ageing population, and longer life expectancy. Rising disease incidence and complexity add further to the growing need for healthcare services and facilities. Demand is non-cyclical and resilient to economic fluctuations, making healthcare property assets a compelling investment for income-oriented investors seeking stability and diversification.

 

  1. National Accounts, ABS (Dec-23)
  2. Labour Force, ABS (Feb-24)
  3. Intergenerational Report 2023, Commonwealth of Australia (Aug-23)
  4. 10-year average growth from 2024-33 based on UN median population projections for ‘More Developed Regions’ excluding Holy See
  5. National Health Survey 2022, ABS (Dec-23)

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Home Latest property industry research and insights
April 22, 2024

March 2024 quarter ASX A-REIT market update

Stuart Cartledge, Managing Director, Phoenix Portfolios


 

Market Commentary

The S&P/ASX 300 A-REIT Accumulation Index continued its march higher in the first quarter of 2024, gaining 16.2%. Property stocks meaningfully outperformed broader equities in the quarter, with the S&P/ASX 300 Accumulation Index adding a lesser 5.4%. This outperformance was predominantly driven by the 33.6% return of Goodman Group (GMG), which is the largest component of the property index, with a weighting of approximately 36%. The median return of stocks in the property index was a lesser 6.2%. Of 33 stocks within the index, only five were outperformers.

During the quarter, companies under coverage reported financial results for the period ended 31 December 2023. In general (with some notable exceptions), financial results were marginally better than expectations, demonstrating the resilience of property income streams. Outlook statements tended to acknowledge uncertainty, as the future path of interest rates remains a key input into likely outcomes.

Retail property was one of the stronger subsectors in the March quarter. Results released in February’s reporting season showed solid sales growth within shopping centres and even more impressive were the much-improved re-leasing spreads. Owner of Australian Westfield shopping centres, Scentre Group (SCG) led the way, gaining 16.2%, whilst foreign owner, Unibail-Rodamco-Westfield (URW) also moved sharply higher, adding 14.8%. Peer, Vicinity Centres (VCX) underperformed the index, but performed strongly, up 7.3%. Owners of smaller neighbourhood shopping centres didn’t keep up with their larger competitors, with Region Group (RGN) lifting 5.8% and Charter Hall Retail REIT (CQR) finishing the quarter 2.8% higher.

Once again it was office property that was the laggard as elevated vacancy and incentives continue to create concern about the prospects of office ownership. Dexus (DXS) materially underperformed the index, up 3.0%. Centuria Office REIT (COF) was weaker still, adding only 1.9%, whilst GDI Property Group (GDI) lost 5.4%. Large capitalisation office owner GPT Group (GPT) also had a tough quarter, losing 1.5%.

Returns of property fund managers were mixed through the quarter. As previously discussed, it was GMG that dominated all comers. HMC Capital Limited (HMC) outperformed, finishing the quarter 17.7% higher, but much of its performance was tied to non-property funds management targets. Charter Hall Group (CHC) also performed solidly, gaining 14.2%. Centuria Capital Group (CNI) couldn’t keep up with peers, losing 0.3% whilst Elanor Investors Group (ENN) gave up 12.2%.

For some time, we have highlighted the disconnection between private real estate valuations and public real estate equity share prices. It is inevitable, given time, that this gap closes. This can occur through private market devaluations, share price appreciation or M&A transactions serving to close the gap (or some combination of those options). During the quarter we have seen a combination of all three, with valuations moving marginally lower, share prices moving meaningfully higher and we have also begun to see some M&A activity. Each of Newmark Property Group (NPR), Eureka Group Holdings (EGH) and Hotel Property Investments (HPI) received takeover bids or had strategic parties acquire large stakes in the companies. Each of these companies were amongst the few outperformers in the quarter. Should small capitalisation securities continue to underperform, we would expect M&A activity to be an ongoing feature of the market.

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 February reporting season saw stocks providing solid updates, with cautiously optimistic outlooks, based on the assumption that interest rates may have peaked. Long term valuations are driven by “normalised” interest costs, meaning the impact of short term hedges maturing is mostly immaterial. Should the forecast decline in interest rates eventuate, recent 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 remain elevated.

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 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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Research and Insights

Home Latest property industry research and insights
March 8, 2024

The power of AI in real estate: a paradigm shift

AI has the potential to profoundly change the real estate industry in coming years, and is projected to add up to $275 billion to market values. Indeed, understanding shifts in occupier markets from AI is crucial to optimising allocation decisions and maximising investment returns. This month, Cromwell’s Research and Investment Strategy Manager, Colin Mackay, takes a close look at the utilisation of AI, including how to best understand the risks and ethical concerns around the topic.

View the full report here.

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Home Latest property industry research and insights
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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Research and Insights

Home Latest property industry research and insights
January 4, 2024

Biodiversity: a fundamental part of our natural capital

Consideration of the environmental impact of real estate is usually focussed on greenhouse gas emissions during construction and operations. However, another critical aspect is the impact of the built environment on biodiversity. In this briefing note we explore the connection between biodiversity and real estate. We explain why investors that align their strategies to accommodate new regulations will also enhance their asset financially, socially, and environmentally.

View the full report here.

 

 

 

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Home Latest property industry research and insights
November 28, 2023

Large format retail: Sticking to the fundamentals

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


While most property types have experienced a performance slowdown this year on the back of rising interest rates, retail has been comparatively resilient. The sector was already being viewed with some caution pre-COVID due to the impacts of e-commerce, contributing to less substantial cap rate compression through that phase of the cycle – over the last five years, retail saw a cap rate low of 5.2% compared to 4.8% for office and 4.1% for industrial1. This different starting position has meant the negative valuation impact from cap rate expansion has been less pronounced.

The sector has also benefitted from strong fundamentals, namely strong consumption growth and a muted supply pipeline. Incomes have risen, retail spending’s share of wallet has increased, and population growth has surged. These drivers have seen Australian retail trade grow by 28% since Feb-20, with spending levels sitting 16% above the pre-COVID growth trend2.

One of Cromwell’s preferred exposures to retail is Large Format, a sub-sector that isn’t often in the limelight. These assets don’t have the scale or luxury brands of a major shopping centre. It’s a no-frills, back to basics retail proposition – but that’s not a bad thing. While underwriting assumptions do have to account for a weaker consumer outlook over the next 12 months, Large Format is expected to benefit from resilient fundamentals, offers an attractive yield and “clean” income, and is better positioned to leverage e-commerce as an opportunity rather than a challenge.

Population growth is a powerful driver of demand

 

Nominal retail consumption growth can be boiled down to three buckets:

  1. People paying more for the stuff they buy (retail price inflation)
  2. People buying more stuff (real growth per capita)
  3. More people buying stuff (population growth)

Of the three, population has been the most significant driver of retail growth over the last decade, averaging 1.4% p.a3. It has strengthened further post-COVID, with Australia recording population growth of +2.2% in the year to March3 and preliminary indicators of net overseas migration suggesting the pace hasn’t dropped off over the course of the year. The growth tailwind is expected to persist, with population forecast to grow by 1.4% p.a. from 2022-23 to 2032-334.

 

Positively for Large Format and its typical occupiers, Australia’s population growth skews to younger families. Around 60% of growth is due to net overseas migration, of which circa 80% comprises those aged under 35. This demographic is central to household formation and the retail activity that comes along with it, which is more heavily represented in Large Format assets (e.g. furniture/appliances).

Another boost to demand is the changing nature of dwelling composition. Australia is seeing the number of occupied dwellings increase faster than the population, as single person households become more common5. This has resulted in a lower average household size, or thought of another way, more dwellings required per person. While people are increasingly living in smaller dwelling types (e.g. apartments versus houses), we expect the net result to be greater demand for household goods and furnishings.

 

The growth of the under 35 demographic is central to household formation and the retail activity that comes along with it, which is more heavily represented in Large Format assets (e.g. furniture/appliances).

Clean income and an attractive yield

 

In a time of slowing growth and elevated inflation, the ability to generate stable, growing income is an important driver of investment returns. Large Format’s yield nationally is 6.1%6, higher than many commercial and residential property sectors. We also consider the yield to be “cleaner” – what you see is what you get. Compared to major shopping centres for example, which are complex structures with substantial plant and equipment, often less capital expenditure is required to maintain a Large Format asset. This means the post-capex yield, or the money that actually ends up in your pocket, may be more attractive than a simple comparison of headline yields suggests.

The income underpinning the yield also grows over time, in contrast to the fixed nature of bonds. Like the broader retail sector, Large Format leases typically stipulate rent escalation each year of 3-5% or a CPI-linked amount, usually providing growth in excess of inflation. The income stream is dependable, with the majority of Large Format income derived from 5–10-year leases to ASX-listed or national retailers, such as Bunnings, The Good Guys and Freedom.

We believe the runway for rental growth in Large Format is sustainable, given the lower starting level and attractive economics for retailers. Mosaic Brands recently announced plans to open 40 “mega stores” through to Jun-24, as the larger format is 3x more profitable than their normal store size7. For some assets, further growth can be derived from intensification – development of unutilised land, car parks, or air rights into income-generating improvements.

 

Omnichannel-ready

 

Online’s share of Australian retail trade has increased from 5.1% five years ago to 10.7% today8. The rise of e-commerce has dampened demand for physical retail space relative to household consumption, particularly across discretionary shopping centres with large exposures to categories such as clothing and department stores. Cromwell forecasts online’s share of spending to increase to 20% by 2030, however there are several reasons why Large Format can view the shift as an opportunity, given its role in omnichannel retailing.

From consumers’ perspective, Large Format minimises much of the friction associated with a traditional shopping centre experience – friction which turns shoppers towards e-commerce. Convenience is the number one reason for purchasing online9,10, as large multi-level shopping centres provide a frustrating car parking11 and navigation experience. In contrast, Large Format assets are often a simple rectangular layout with large on grade or basement car parks. These assets can provide the benefits of a physical shopping experience, such as better customer service8 and the ability to touch and trial products12, while minimising the painpoints. In-person shopping is particularly valued across Large Format’s typical retail categories such as homewares and home improvement.

For retailers, Large Format facilitates an improved omnichannel proposition in a number of ways. Rents are typically in the range of $300-600 per square metre, much lower than traditional shopping centres and closer to levels being seen across industrial assets today. Sites are generally large, flat, and designed to be accessible to the heavy vehicles delivering bulky goods to occupiers. Assets are also often well-located, with ample arterial and motorway connections servicing significant population catchments. These attributes make Large Format assets well suited to the full suite of omnichannel product “delivery” options, including buying in store, click and collect, and ship from store, while also offering reasonably cost-effective inventory storage – Nick Scali for example stores 55% of inventory in its showrooms13. In this respect, Large Format can offer investors a quasi-industrial exposure spanning warehousing and fulfilment, with the added fillip of revenue generation (making sales).

The physical store presence also aids in reducing last mile reverse logistics costs14 and processing times15, and provides retailers with an additional opportunity to engage with customers and generate a sale when products are being returned. By offering a seamless omnichannel experience, retailers can drive customer engagement and loyalty.

Customers’ preference for omnichannel is evidenced in trading outcomes, with “Bricks & Clicks” retailers winning online market share at the expense of “Digital Native” retailers16, and multichannel customers spending 2-3x more than single channel customers17. Omnichannel is important to customers and retailers alike, and Large Format’s characteristics can make it a preferred component in that proposition, particularly as e-commerce increases its share of sales and industrial rents reach higher levels.

Large Format is an omnichannel hybrid of retail and industrial, offering consumers a “touch and trial” shopping experience and retailers a cost-effective shopfront and inventory storage.

Supply is constrained, good news for existing owners

 

One of the reasons retail in Australia has avoided the “dead mall” phenomenon seen in the US is sensible planning policy and constructive relationships between developers and councils. In the US, developers have taken advantage of lax policy to build more than double the shopping centre floorspace per capita than Australia18, causing supply to considerably outstrip demand and leading to significant space handbacks and store closures. Australia, by comparison, has restricted development to more sustainable levels, raising barriers to entry and lowering the likelihood of value-destroying competition impacts for both landlords and retailers. While there are more land zones where Large Format is permissible compared to traditional shopping centres, the lack of excess shopping centre space more broadly means a better supply-demand balance across the whole spectrum of retail typologies.

In addition to the above, Large Format supply has been constrained more than normal by rising construction costs, labour and material shortages, and a lack of suitable sites, exacerbated by competition from industrial uses. The characteristics which make a site compelling for Large Format (size/configuration/access/location) are also desirable to industrial facilities. With industrial vacancy below 1%19 and yields remaining tighter than other sectors1, developers are prioritising industrial over other uses such as Large Format. A recent example is Goodman’s 2022 acquisition of Alexandria Homemaker Centre with the intention of future conversion to logistics, which will result in the withdrawal of Large Format space from the market (a positive for existing asset owners). Such transactions also highlight how Large Format centres can be used as a way to land bank large sites in tightly held corridors, with the benefit of income generation over the hold period.

Large Format Outlook

 

The outlook for demand is robust with retailers continuing to look for space – Super Retail Group for example is looking to open an additional 61 stores by Jun-26, while the likes of Baby Bunting, Bedshed, Nick Scali and Plush require a combined 125+ locations to reach their target store networks20. The vacancy rate has tightened to 3.2%21, its lowest level since at least Jun-17, meaning limited space is currently available and future availability will be constrained by the muted supply pipeline. These dynamics are expected to create conditions conducive to rental growth, which CBRE forecasts will run at +3.0% p.a. nationally from 2023 to 202622.

Stock selection is key, with Large Format performance closely linked to location, the strength of the surrounding catchment (i.e. income/population growth), and impacts from competition. Metropolitan sites in land-poor markets are preferred given the protection that scarcity (and lack of competition) provides to valuations over time – acquiring at attractive pricing is a key challenge for these types of assets. Dominant assets in fast-growing non-metropolitan markets can also be attractive if the risk of future competition can be adequately priced.

 

 

 


  1. The Property Council of Australia/MSCI Australia Annual Property Index, MSCI (Jun-23)
  2. Retail Trade August 2023, ABS (Sep-23)
  3. Based on analysis by the Centre for Population, National population projections in the 2023-24 Budget; Cromwell (May-23)
  4. National, state and territory population, ABS (Sep-23)
  5. ABS 2021 Census; Cromwell
  6. Australian Retail Figures Quarterly Market Report, 2Q 2023 (CBRE)
  7. FY2023 Market Update, Mosaic Brands (Aug-23)
  8. Rolling 12-month basis as at Jul-23. ABS Retail Trade (Aug-23)
  9. IAB Australia and Pureprofile Australian Ecommerce Report 2023
  10. Shopping Pulse, Klarna (Q2 2023)
  11. Bricks & Clicks, UBS (2019)
  12. Retail Monitor, Australian Consumer and Retail Studies, Monash Business School (Nov-22)
  13. FY23 Results Presentation, Nick Scali (Aug-23)
  14. Wallenburg, Einmahl, Lee & Rao (2021)
  15. McKinsey (2021)
  16. Inside Australian Online Shopping, Australia Post (2023)
  17. Myer (Sep-23); Coles (Feb-21); Accent Group (Aug-18); Pallant et al (2020); KPMG (Dec-22)
  18. SCCA (Sep-23)
  19. Australian Industrial and Logistics Figures Q2 2023, CBRE (Jul-23)
  20. Company reports; Cromwell (Sep-23)
  21. JLL Research (Jun-23)
  22. Large Format Retail Australia, CBRE (May-23); Cromwell. Rental growth refers to Prime net face rents (AUD/sqm).

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Home Latest property industry research and insights
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.

Performance commentary

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