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Home Understanding commercial property
April 2, 2026

Redefining the arrival experience at 400 George Street 

At Cromwell, we believe that strategic asset management goes beyond maintaining properties, it’s about anticipating market shifts, understanding tenant expectations, and making targeted investments that enhance long-term value. The transformation of the lobby at 400 George Street exemplifies this approach in action.

Working alongside Shape Australia, Woods Bagot and ADP, we’re proud to deliver a new and refreshed arrival experience at 400 George Street.

Designed to set a new benchmark, the transformation enhances the building’s position as a premium workplace destination. The upgraded lobby complements the building’s existing premium amenities and reflects evolving workplace trends, with a strong focus on wellness, sustainability and connectivity.

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A Design-Led response to evolving workplace trends

The redesigned lobby sets a new benchmark for premium workplace destinations, reflecting how the best commercial spaces now compete. Today’s tenants expect more than efficient floorplates—they’re seeking environments that support wellness, sustainability, and connectivity from the moment they walk through the door.

The transformation delivers on these expectations through several key features:

  • A new street-facing entryway and feature internal staircase that improve flow and create a stronger connection to the surrounding precinct
  • Flexible lobby zones designed for both informal collaboration and formal meetings, recognising that work now happens throughout the building—not just at desks
  • Increased natural light and integrated greenery that enhance occupant wellbeing and bring biophilic design principles into the everyday experience
  • Talwalpin durenma dutta, a newly-commissioned public artwork by Sonja Carmichael, curated and fabricated by UAP, adding cultural depth and a distinctive sense of place

These elements complement the building’s existing premium amenities while signalling a clear commitment to ongoing investment in the asset.

We’ve focused on creating an environment that supports contemporary ways of working, enhances functionality and delivers an elevated experience for tenants.
Karla Bowdler, General Manager at 400 George Street

Karla Bowdler, General Manager at 400 George Street oversaw the delivery of the project. The upgrade positions 400 George Street as a highly competitive destination within Brisbane’s thriving North Quarter.

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Navigating complexity, delivering results

Upgrading a landmark building in a busy CBD environment presents real challenges. The project team successfully navigated a number of challenges, including delivery within a live and busy environment, tenant impacts, and the careful management to minimise disruption to daily operations.

We’re also excited to welcome a new food and beverage offering, set to open later this year, further enriching the lobby experience.

Thanks to collaboration from the wider team including:

  • Landscape Design – Urbis
  • Façade Engineering – Greg Killen Consulting Engineers
  • Certifier – Steve Watson & Partners
  • Signage & Wayfinding – Extrablack

What’s next

The revitalised lobby is just one part of our continued investment in 400 George Street. We’re excited to announce that a new food and beverage offering will open later this year, further enriching the tenant and visitor experience.

Strategic asset management means making decisions today that strengthen an asset’s position for years to come. At 400 George Street, we’re proud to be doing exactly that.

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Home Understanding commercial property
April 1, 2026

Gold medal growth: Australian Commercial Real Estate and Brisbane’s Olympic advantage

Colin Mackay, Research & Investment Strategy Manager at Cromwell

Colin Mackay, recently hosted a roundtable discussion with investors at the Markets Group 7th Annual Australia Investors Forum in Sydney, examining the key forces shaping commercial property returns. The session brought together senior investment leaders for an in‑depth discussion on market fundamentals, emerging trends and opportunities across the sector. Below are the key insights from the discussion.

 

1. Supply and demand remain the fundamental drivers

While higher interest rates have understandably dominated headlines, Colin emphasised that the balance between supply and demand remains the primary driver of unlisted commercial property returns. History supports this view—the asset class has demonstrated resilient performance through previous rate-hiking cycles and periods of geopolitical uncertainty.

 

2. Constrained supply is the biggest story

Perhaps the most significant theme from the roundtable was the severe constraint on new supply. With construction costs elevated and financing conditions tight, most potential development projects simply don’t stack up economically. They’re unlikely to proceed until rents and asset values appreciate meaningfully.

For owners of existing quality assets, this supply drought is supportive of a stronger income growth outlook. Fewer new buildings competing for tenants means greater pricing power for well-located, well-managed properties already in the market.

What matters most for investors is understanding where supply constraints and demand tailwinds intersect.

3. AI and the office: winners and losers, not wholesale disruption

The roundtable addressed a question on many investors’ minds: will artificial intelligence spell the end of the office?

Colin’s view is clear—AI will not be the death of the office. However, there will be winners and losers. Technology adoption will reshape how and where people work, but quality assets in strong locations will continue to attract tenants. Asset selection will be critical to outperformance in this environment.

 

 

4. Brisbane: Australia’s top-performing office market

Brisbane continues to stand out as the country’s strongest office market. The fundamentals are compelling:

  • Low vacancy rates relative to other major capitals
  • Long-term demand tailwinds driven by population growth and favourable industry composition
  • A constrained supply pipeline that supports existing asset values

These dynamics have already delivered results. As we noted in our recent research, prime-grade office assets nationally have recorded demand growth of 11% over the past five years, and Brisbane has been a standout performer within that trend.

 

5. The Olympics factor

Brisbane’s selection as host city for the 2032 Olympic Games adds another dimension to the investment case. The event will catalyse significant infrastructure investment across transport, precincts, and public amenity— improvements that can have lasting benefits well beyond the Games themselves.

For office assets in the CBD, the Olympics provide a clear timeline for urban renewal and an influx of global attention that reinforces Brisbane’s position as a tier-one Australian city.

For office assets in the CBD, the Olympics provide a clear timeline for urban renewal and an influx of global attention that reinforces Brisbane’s position as a tier-one Australian city.

Introducing Cromwell Creek Street Investment Trust

This 24-storey office tower sits on a 1,722 square metre parcel in the heart of the city, leased to a diverse tenant base. The acquisition reflects our conviction in Brisbane’s office market fundamentals and our research-driven approach to identifying opportunities where sentiment has become dislocated from underlying value.

For wholesale investors seeking exposure to a quality Brisbane office asset with strong income characteristics and long-term growth potential, the Trust offers a compelling entry point at this stage of the cycle. Cromwell is now finalising commitments from investors for approximately 75% of the target equity. If you are considering applying, we encourage you to do so soon to avoid potential disappointment.

A prime Brisbane investment opportunity

Cromwell Creek Street Investment Trust for wholesale investors is now open. With a forecast distribution yield of 8.0% p.a. paid monthly.

For wholesale investors only. Minimum $100,000 investment.

Register to access the IM

Disclaimer

This webpage is issued by Cromwell Real Estate Partners Limited ACN 152 674 792 (CREP) as trustee for the Cromwell Creek Street Investment Trust (Fund). It is only being made available to persons who are wholesale clients (as defined in the Corporations Act 2001 (Cth)) (Corporations Act) . It is provided on a personal, private and confidential basis.

This webpage is not an offer to sell or issue you with units in the Fund. This webpage does not take into account your investment objectives, financial situation or particular needs. It is provided for general information purposes only. It is not a prospectus, product disclosure statement or any other disclosure webpage for the purposes of the Corporations Act and has not been, and is not required to be, lodged with the Australian Securities and Investments Commission or the Australian Securities Exchange. It should not be relied upon in considering the merits of an investment in the Fund. Nothing in this webpage constitutes investment, legal, tax, accounting or other advice and should not be relied upon in substitution for your own judgment on the operations, financial condition and prospects of the Fund. Before making an investment decision, you should consider your own financial situation, objectives and needs, and conduct your own independent investigation and assessment of the Fund including the contents of the information memorandum sent to you about the Fund and by obtaining investment, legal, tax, accounting and such other advice as you consider necessary or appropriate.

In making an investment decision in relation to the Fund, it is important that you read the disclosure documents (the Information Memorandum and any Supplementary Information Memorandum) issued by that Fund. The disclosure document for the Fund is available from www.cromwell.com.au or by calling Cromwell’s Investor Services Team on 1300 268 078.

None of CREP or its related bodies corporate or their respective officers, employees, agents or advisors (Cromwell Property Group Members) make any representation or warranty, express or implied, as to the accuracy, completeness, timeliness or reliability of the contents of this webpage. To the maximum extent permitted by law, none of the Cromwell Property Group Members accept any liability (including, without limitation, any liability arising from fault or negligence) for any loss, damage, cost or expense whatsoever arising from the reliance on or use of this webpage or its contents or otherwise arising in connection with it.

This webpage may contain forward-looking statements, guidance, forecasts, estimates, prospects, intentions, projections or statements in relation to future matters (Forward Statements). Forward Statements can generally be identified by the use of forward looking words such as anticipate, estimates, will, should, could, may, expects, plans, forecast, target or similar expressions. Forward Statements including indications, guidance or outlook on future revenues, distributions or financial position and performance or return or growth in underlying investments are provided as a general guide only and should not be relied upon as an indication or guarantee of future performance. Forward Statements are subject to known and unknown risks, uncertainties, contingencies and other factors which may cause actual results, performance or achievements to differ materially from those expressed or implied by the Forward Statements. No independent third party has reviewed the reasonableness of any such statements or assumptions. None of the Cromwell Property Group Members represent or warrant, assure or guarantee that such Forward Statements will be achieved or will prove to be correct or gives any warranty, express or implied, as to the accuracy, completeness, likelihood of achievement or reasonableness of any Forward Statement contained in this webpage. Cromwell Property Group Members assume no obligation to release updates or revisions to Forward Statements made as of the date of this webpage to reflect any changes that occur after the date of this webpage. Past performance is not a guarantee of future performance.

The distribution and use of this webpage, including any related advertisement or other offering material, in jurisdictions outside of Australia may be restricted by law and any person who resides outside Australia or who receives this webpage outside of Australia should seek advice about it and observe any applicable legal restrictions.

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Home Understanding commercial property
March 31, 2026

Five reasons unlisted commercial property is an attractive allocation in uncertain times

In this era of heightened geopolitical and macroeconomic uncertainty, portfolio construction increasingly favours assets capable of delivering durable income, capital preservation, and differentiated return drivers. Unlisted Australian commercial property continues to demonstrate qualities that may support these characteristics.

The immediate backdrop is hard to ignore. On 12 March 2026, the International Energy Agency said the war in the Middle East was creating the largest supply disruption in the history of the global oil market1. At the same time, the IMF has warned that financial stability risks have increased as trade and policy uncertainty remain elevated.

A fractured landscape demands decision-makers weigh risk and resilience more heavily than a decade ago. This note highlights some of the reasons why an allocation to unlisted Australian commercial property is important in today’s uncertain environment, offering attractive returns underpinned primarily by space market fundamentals rather than daily swings in sentiment.

1. Exposure to a scarce, real asset base

Unlike financial securities, commercial property is anchored to land, planning rights and physical improvements. Like residential property, land comprises a sizable proportion of total asset value, typically 30-60% depending on the commercial property sub-sector2. While exposure to land does not eliminate downside, it does mean value is supported by a real, location-specific asset that cannot be readily replicated.

The practical importance of that scarcity is clearest in well-located urban markets. For example, just 4% of Sydney’s serviced industrial-zoned land remains undeveloped3, and Brisbane is expected to run out of developable industrial land in less than five years4. Such shortages limit potential supply, driving land value appreciation and underpinning long-term rent growth.

 

 

2. Inflation protection

The income profile of commercial property further strengthens its position in uncertain environments. Australian commercial lease structures typically incorporate annual rent increases, often linked to CPI (e.g. CPI + X%). This helps defend investors from income erosion in real terms, which is particularly important when price pressures are proving persistent.

Inflation also influences the supply side of the equation. Construction costs have increased by approximately 30-45% across Australia’s major capital cities over the last five years, with further escalation of 20-30% expected through to 20295. This has contributed to higher replacement costs and rendered most new developments commercially unfeasible, constraining the delivery of new supply. CBRE estimates office economic rents have increased by 30-60% across the major CBD markets since 2020, far exceeding market rent growth, with further increases expected through to 20306. For owners of well-located existing assets, this dynamic supports income growth as competing supply is unlikely to be delivered until market rents (and/or valuations) significantly appreciate.

For owners of well-located existing assets, this dynamic supports income growth as competing supply is unlikely to be delivered until market rents (and/or valuations) significantly appreciate.

3. Lower volatility

Income durability is complemented by a return profile that is less exposed to short-term market volatility. Commercial property income is typically contracted over medium to long durations, providing visibility over cashflows. Valuations in unlisted markets are appraisal-based and reflect leasing outcomes and capital market evidence, rather than intraday repricing. This approach can dampen short-term volatility and focus outcomes on underlying asset fundamentals across an appropriate investment horizon, rather than constant sentiment swings. This distinction becomes more pronounced in periods where listed markets are reacting rapidly to geopolitical or macroeconomic developments.

4. Performance driven by space market fundamentals

Interest rates are an important consideration, influencing discount rates, debt costs, and transaction liquidity. However, unlisted property performance is usually more dependent on space market fundamentals – demand and supply levers and the resultant vacancy conditions. Using CBD office as an example, analysis over the last 40 years indicates a strong negative correlation (-0.7) between vacancy rate and total return. Further, analysis of past cycles shows returns tend to outperform during rate hikes compared to the year prior. Similarly, unlisted commercial property has not been consistently impacted by oil price shocks historically.

 

The key underwriting question, therefore, is not the trajectory of the cash rate or the price of oil, but where vacancy is heading and which assets still retain pricing power with tenants. Positively for commercial property, economic expansion and jobs growth remain solid, supporting space demand. At the same time, a dearth of supply, exacerbated by higher-for-longer inflation and rising interest rates, bodes well for a tightening in vacancy and stronger income growth across quality assets.

 

Positively for commercial property, economic expansion and jobs growth remain solid, supporting space demand.

5. Genuine diversification

Unlisted commercial property has different return drivers compared to other asset classes such as equities and bonds – lease structures, tenant covenants, asset quality and local market conditions, rather than interest rates, earnings cycles and risk premia. This differentiation results in largely uncorrelated returns, providing diversification and resilience within a broader portfolio, particularly in periods where equities and other liquid assets are more directly influenced by macroeconomic or geopolitical developments. The relatively stable income component of total return further enhances its role within a diversified allocation.

 

Where to be selective now

Office (quality bias):

Focus on well located, efficient and sustainability aligned assets with strong transport connectivity and credible NABERS and Green Star pathways. The office sector has experienced the sharpest repricing in the recent cycle, and there is emerging evidence of improved leasing conditions in higher quality assets, where active leasing and capital expenditure execution are key differentiators.

Neighbourhood & convenience retail:

Neighbourhood and convenience based centres continue to benefit from their nondiscretionary tenant mix and long dated leases, which can support more predictable rental income. Transaction activity in this segment has remained resilient as investors prioritise income visibility and covenant quality.

Industrial & logistics:

While returns have moderated from the exceptional conditions seen in recent years, occupier demand remains focused on well located, infill assets. Space availability and future supply are both constrained within this segment of the market, supporting positive rent reversion upon lease expiry. Ageing stock and rising obsolescence present an additional opportunity set for active managers with value-add capability.

Conclusion

Over the long-term, Australian unlisted commercial property has demonstrated resilient returns through periods of conflict and oil shocks, with performance supported by income and leasing fundamentals. Unlisted commercial property offers a compelling combination of income stability, inflation linkage, and real-asset backing. When combined with underwriting discipline, discerning asset selection, and active management, these characteristics reinforce its role as a core allocation within diversified portfolios, particularly in periods of heightened volatility.

 

 

 

Footnotes:
  1. International Energy Agency Oil Market Report (March 2026) https://www.iea.org/reports/oil-market-report-march-2026
  2. Cromwell analysis of Victoria Valuer-General 2025 statistics
  3. Sydney Industrial and Logistics Land Supply, CBRE (Feb-25)
  4. No room to grow – Industrial Land Supply & Vacancy Report, Property Council of Australia & SA1 Property (Sep-25)
  5. TPI % Change Calculator and Q1 2026 Construction Market Update, RLB (Mar-26)
  6. CBRE (Feb-26)

 

Disclaimer
This material is prepared for discussion only and should not be relied upon for any other purposes. It has been prepared on a good faith basis but its contents have not been formally verified and no Cromwell entity or person accepts any duty of care to any person in relation to the information it contains. It should not be considered to be investment advice, marketing material or a promotion or offer of any Cromwell fund, product or services. Any person that wishes to invest in any Cromwell fund, product or services should refer to the relevant information or legal documents produced in relation to such opportunity before making any investment or other decisions. This document reflects the views of its author as at March 2026.

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Home Understanding commercial property
November 27, 2025

Tracking the office recovery – five charts that tell the story

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

After a 19-year premiership drought, the Broncos have returned to the top of the rugby league totem pole. Another redemption story, not as long in the making, is underway in commercial real estate. Office was out of favour through the pandemic, weighed down by rising interest rates, subdued liquidity, and concerns that remote work would irreparably damage demand for space. Now, conditions are improving and sentiment is becoming more positive – and the proof is in the total return pudding. Below are five charts that highlight the recovery occurring in the office sector.

1. Asset prices appear to have bottomed

Office asset values across Australia fell -18% from late 2022 to the end of 2024. The devaluation cycle appears to have concluded, with appreciation of +1.2% recorded over the first half of 20251 . The downturn has created a compelling entry point for investors – office is currently providing a larger yield premium over the Australian 10-year Government Bond compared to the 30-year average.

The downturn has created a compelling entry point for investors – office is currently providing a larger yield premium over the Australian 10-year Government Bond compared to the 30-year average.

2. Investment performance is improving

Stable yields and ongoing income growth have contributed to an improvement in total return. Performance has been positive for the last two quarters, leading to the strongest rolling annual total return since early 2023.

3. Tenant demand now exceeds pre-pandemic levels

The income growth side of the ledger has been driven by strengthening tenant demand. Remote work did have a significant impact on occupied space in 2020, however demand has been increasing for nearly five years now. The recovery is even more impressive when split by asset quality – prime grade assets have recorded demand growth of +11% over the last five years, while demand for space in secondary assets contracted by -9%.

4. Rents are growing in most markets

Stronger tenant demand has flowed through to rents. Over the last five years, rents have increased in every major CBD market except Melbourne. Consequently, annual national CBD rent growth has been outpacing inflation since September 2024. Additionally, prime incentives are significantly higher than the long-term average in every major market, suggesting there is scope for them to fall if leasing conditions remain favourable. Decreasing incentives would provide a tailwind for income growth.

5. Future supply risk is lower than average

Construction is prohibitively expensive and new developments are very rarely “stacking up” in the current environment. With few projects breaking ground, the supply of CBD office space is expected to increase by only +0.3% p.a. to 2030, well below the long-term average annual rate of +1.1% and significantly lagging white collar jobs growth. A constrained supply pipeline should put downwards pressure on vacancy rates, supporting the sustainability of the recovery and the outlook for rent growth.

Heading in the right direction

While the turnaround of a real estate sector doesn’t happen overnight, multiple metrics show office is improving. For some, fear of catching a falling knife is turning into fear of missing out on the recovery upswing. With dual levers of stronger demand and weaker supply boding well for a tightening of vacancy and continued rent growth, office has every chance of topping the investment return table over the coming year.

 

 

  1. Cromwell analysis of MSCI data (Jun-25)

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May 14, 2025

Convenience is king: The strengths of neighbourhood retail

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

According to the Property Council of Australia, the typical classification of a Neighbourhood is a local shopping centre comprising a supermarket and approximately 35 specialty shops, with total lettable retail area of less than 10,000 square metres. These assets cater for basic day-to-day retail needs and service the more immediate residential area.

The retail property landscape has faced a number of challenges over the past five years, from e-commerce to pandemic lockdowns, squeezed household wallets, and weak consumer sentiment. But one centre type has stood tall through it all – Neighbourhoods. These convenience-oriented centres are the cornerstones of local communities and offer a compelling investment proposition underpinned by several advantageous characteristics.

Income security

Neighbourhood shopping centres are supermarket-based and heavily weighted to blue chip tenants such as Woolworths, Coles and Aldi. These brands are strong, providing exceptional credit quality and security of income. Their leases are also long, typically 20 years with multiple options to extend, further reducing the variability of income received.

Demand stability

A selection of specialty tenants complements the grocery offer. These smaller shops often span essential categories such as food, services and healthcare, rather than non-essential items such as fashion. This tenant mix means Neighbourhoods are largely focused on meeting basic, long-term human needs rather than fleeting style or brand preferences. As a result, these assets benefit from steady demand and foot traffic, regardless of the business cycle or economic conditions, evident in the lower volatility of grocery sales.

 

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Growth tailwinds

Positively, the lower volatility of grocery spending doesn’t come at the expense of growth. The category has recorded growth of 4.9% p.a. over the last 20 years, behind only Dining and Other (which includes online-only retailers)1. One of the factors underpinning headline grocery trading performance is inflation. Since groceries are essential and demand is inelastic, price increases can be more readily passed on to consumers compared to non-essential items. Deflationary effects from technology advancement or cheaper offshore sourcing also apply to a lesser extent than in the case of categories such as electronics or clothing. Stronger headline sales growth supports sustainable rent increases, which escalate on a nominal basis.

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E-commerce resilience

Growth through physical stores, rather than online, is most relevant for the performance of shopping centres. Over the last ten years, for every extra dollar spent on food (like groceries and dining), 16 cents went to online purchases. Meanwhile, non-food items lost 43 cents to online sales1. In this regard, Neighbourhood centres have a favourable retail mix which is heavily weighted to food spending through supermarket and specialty grocery exposure. They also have a healthy weighting to categories which consumers must shop in-person, such as personal services (e.g. hairdressing). We also believe the shopping experience small local centres provide, underpinned by convenient carparking and wayfinding, further defends against loss of market share to e-commerce.

 

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Bigger investment universe

Larger forms of retail investment, such as Regional shopping centres, can only be sustained in catchments with sizable populations (i.e. major metropolitan hubs). In contrast, Neighbourhood centres are found in cities and towns all across the country. This provides investors with a less constrained and more diverse investment universe which is around 30 times bigger (by number of assets). It allows exposure to a wider range of regions/catchments and their associated drivers of economic performance.

Investment liquidity

The Neighbourhood investment market is broader than other retail centre types, offering increased liquidity and supporting a competitive bidding process (and outcome) regardless of position within the economic or real estate cycle. Over the last decade, an average of 51 Neighbourhood centres transacted each year compared to 15 Sub-Regionals and 4 Regionals. Trading was most constrained in 2020, at the height of the pandemic. In that year, there was still 38 Neighbourhoods sold, while only 5 Sub-Regionals and no Regionals changed hands.

 

Fragmented sector

Ownership of Neighbourhoods is more fragmented than other retail centre types. While Regional shopping centres are typically owned by a small number of institutional investors, private investors are the dominant holders of Neighbourhoods. These private investors have different skills, goals, and priorities, which can affect how well the centres are maintained and managed. In our opinion, this presents opportunities for experienced managers to “add value” to assets through capital projects, leasing and operations, and increases the likelihood that an asset can be acquired and sold at favourable pricing.

Bringing home the bacon

Retail conditions are expected to improve over 2025, with consumer sentiment becoming more optimistic and real disposable household incomes increasing as inflation moderates and rate cuts materialise. Stronger retail conditions are a positive for Neighbourhoods, but these shopping centres will also benefit from their unique characteristics and advantages. The combination of strong, long-term leases to blue-chip tenants, consistent bricks and mortar demand for essential goods and services, and resilience to changing economic and capital market conditions has positioned Neighbourhood centres as a robust and attractive asset class.

Footnotes

  1. Cromwell analysis of ABS data (Jan-25)

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Home Understanding commercial property
February 20, 2025

What’s coming for commercial property in 2025?

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

Santa has come and gone, prawn-induced food comas have ended, and workplaces and schools have started to hum again after the summer break. As the festive cheer starts to dissipate, now is a good time to look ahead at what the balance of the year has in store for us. This article touches on five key macro developments expected to influence commercial property performance and investment over 2025.

 

1. Rate cuts

After hopes of a late-2024 rate cut were dashed in October by resilient labour data, attention turned to 2025 for the turning of the economic cycle and a return of looser monetary policy supportive of stronger growth. Financial markets were pricing a 90% probability of a rate cut prior to the RBA’s decision on 18th February, an expectation shared by most economists. The central bank didn’t disappoint, reducing the cash rate for the first time in over four years.

Governor Bullock’s post-meeting comments struck a hawkish tone, drawing attention to the upside risk to inflation that a tight labour market still poses and appearing to reflect a preference for a relatively measured and cautious cutting cycle. The market now expects two additional cuts this year, with economists generally forecasting a further 1-3 cuts. Because these cuts are expected by the market, instruments like Australian Government 10-year bonds have likely already ‘priced in’ most of the change – and so long-term bond yields may not see significant movement from their current level of around 4.5%1 even as further cuts occur.

Regardless, rate cuts should be a net positive for commercial property by supporting a stabilisation of asset pricing, increasing transaction activity, and easing cost of debt pressures. An ‘easier’ monetary policy environment should also stimulate the economy, which is a benefit for a growth asset class like commercial property where tenants’ demand for space is linked to economic activity such as jobs growth, retail consumption, and trade volumes.

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2. Shifting capital composition

In downturns, nimble private investors tend to trade commercial property more actively than institutional holders. This cycle has been no different, with private buyers making up 45% of acquisitions (by dollar volume) from 2022-23, up from 32% in the five years prior. As 2024 progressed, offshore institutional capital thawed and allocated to the Australian market, becoming the dominant buyer type. Such investors have been involved in some of the headline transactions of the year, including Sydney office towers 55 Pitt Street, 255 George Street and 10-20 Bond Street.

Over the course of 2025, we expect domestic institutional capital to join the party and step up acquisition activity. This expectation reflects the turning of the cycle which appears to be occurring, and the stabilisation of prices that should continue as the cycle enters its next phase.

Deepening of the capital pool and increased activity from institutional buyers will be important precursors to price recovery – with more competition comes more aggressive bidding for assets. This competitive shift will likely be felt in specific asset segments (e.g. premium office) before others, and to differing degrees. While markets and segments that follow the cycle (rather than lead it) may face a slower price recovery, acquirers can benefit from a longer ‘buying window’ where sentiment (and pricing) is yet to align with property fundamentals.

3. Stronger consumers

Consumers have been buffeted since 2022 by various cost-of-living pressures, spearheaded by surging inflation, higher interest rates, and bracket creep. These contributed to a stark fall in consumer confidence, subdued retail sales growth, and tough trading conditions for businesses that cater to households more broadly.

In good news for 2025, many of these headwinds are abating.

  • Headline inflation has slowed from a peak of 7.8% in December 2022 to 2.4% as at December 20242. Lower inflation is benefitting the real (inflation-adjusted) spending power of households.
  • The arrival of rate cuts will lead to a decrease in what is the biggest expense for many Australian households.
  • The Stage 3 tax cuts went live from July and are improving households’ disposable (post-tax) incomes.

With a federal election approaching, we may also see additional assistance for households announced in the first half of the year as politicians try to shore up support before voters head to the polls.

An improved outlook is starting to become evident in stronger consumer confidence measures, setting the stage for stronger retail sales growth. While rising disposable incomes will be welcomed by retailers across all categories, we believe long-term consumption trends will continue to provide outsized benefits to shopping centre assets which are resilient to e-commerce competition and more heavily weighted towards ‘essentials’.

4. Improved market sector

The labour market has been remarkably resilient considering the broader economic slowdown – jobs growth of 2.5% was recorded over the year to September 2024, in stark contrast to GDP growth of only 0.8%3. However, the robust outcome was largely driven by the non-market sector, comprised of industries such as education, healthcare, and public administration, where demand is not determined by typical market forces or the business cycle. During this period, the non-market sector accounted for 94% of the jobs created and market sector jobs growth was a meagre 0.2%.

Demand for office space is correlated with white collar jobs growth, which is largely represented by the market sector. Although headline jobs growth may slow in 2025, market sector jobs growth should accelerate from its low base due to the anticipated rate cuts, which benefit industries exposed to the business cycle. This is expected to contribute to stronger jobs growth in the typical ‘office-using’ industries, positively impacting office space demand, reducing vacancy rates, and enhancing rental growth conditions.

 

While the outlook for office market conditions appears more favourable over the next twelve months, the risk of asset obsolescence remains elevated due to shifting ways of working and amenity preferences. Property selection will be a key driver of outperformance for investors.

5. Geopolitical uncertainty

Geopolitical uncertainty was a key feature of 2024. It was the biggest election year in history globally, with 80 countries heading to the polls and incumbents’ power diminishing in over 80% of the elections held4. At the same time, conflict in the Middle East escalated and the Russia-Ukraine war continued unabated.

 

It looks set to be much of the same in 2025. While most of the election outcomes are now known, implications for the global and domestic economies are yet to become evident. Trade policy is top of mind following Trump’s campaign trail promise of 60% tariffs on Chinese goods, 25% on Mexican and Canadian imports, and 10% on imports from all other countries. While negotiations are underway and such extreme tariffs are unlikely, increased protectionism of some degree is anticipated and could lead to retaliatory measures including counter-tariffs. Similarly, tariffs are typically viewed by economists as inflationary and may stoke cost-of-living pressures once again, particularly if combined with fiscal stimulus. But it’s also possible that disrupted global trade has a deflationary effect if confidence and growth take a significant hit. It is a time of known unknowns.

Whatever occurs, times of volatility and uncertainty often reward quality and security. Assets with strong tenant covenants and stable cashflow are well placed, as are those with enduring location advantages. Shifting trade dynamics are of particular relevance to industrial property and assets which can cater to manufacturing occupiers may benefit from an increased focus on domestic industry.

 

5b. A Broncos premiership

The author is unable to provide supporting data for this prediction.

A year with something for everyone

Economic growth should improve in 2025 as the RBA lifts its foot off the interest rate brake pedal, easing pressures on household wallets and business investment. A stronger economy is a positive for commercial property as increased consumption, jobs growth, and trade volumes underpin leasing demand.

Lower interest rates should also support the continued stabilisation of asset pricing, as capital markets normalise after several years of constrained liquidity and elevated debt costs. A stable price environment will be more conducive to improved transaction activity and subsequently valuation recovery.

There are some potential speed bumps which could sap momentum, not least of which is the geopolitical landscape. Given the environment of uncertainty, flight to quality is a theme which will likely continue to play out over 2025, rewarding assets that can provide investors with stable and secure income.

 

 

  1. RBA (as at 12th February 2025)
  2. December 2024 Quarterly CPI, ABS (29 January 2025)
  3. ABS September Labour Account and National Accounts (Dec-24)
  4. Market Outlook, Westpac (Dec-24)

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Common terms in property investment

Home Understanding commercial property
December 20, 2024

Common terms in property investment

Understanding the terminology used in property investment is crucial for making informed decisions. This section will introduce you to some of the most common terms you’ll encounter in the world of commercial property investment. Whether you’re a seasoned investor or just starting out, having a solid grasp of these terms will help you navigate the complexities of the market and make informed investment decisions.

A trust that uses pooled investor funds to buy property assets, which the trust manages for a profit. A-REITs are listed on the Australian Securities Exchange (ASX), so investors can buy and sell shares in them like any other stock.

A measure used in real estate to evaluate the return on investment of a property. It is calculated by dividing the property’s net operating income (NOI) by its current market value or purchase price. The cap rate is expressed as a percentage and helps investors understand the potential income generated by the property relative to its cost. A higher cap rate indicates a higher potential return on investment, while a lower cap rate suggests lower returns.

In an investment sense, diversification means not investing all your money in one investment, and instead investing across different asset classes (such as shares, property, bonds and private equity), and investing in different options within each asset class. This allows an investor to spread their risk and reduce the risk of the portfolio underperforming as each investment can perform differently in different market conditions. Having a variety of investments with different risks and expected returns will balance out the overall risk of a portfolio.

Also known as leverage or LVR (Loan to Valuation Ratio), is a way to measure how much of an investment is financed using borrowed money (debt) compared to the equity contributed by investors. It is essentially the balance between debt and equity in an investment.

A risk management strategy used to protect against potential losses from unexpected market movements, allowing investors to manage their exposure and maintain more stable returns. With property assets, it usually involves locking in borrowing costs at a certain interest rate over a period of time. A fund might be 50% hedged, meaning that 50% of debt outstanding will be paid at a variable rate of interest, and the remaining 50% is locked in or capped at a fixed rate of interest.

Ready for more?

Sign up for our Essential Guide to Investing in Unlisted Property series to learn the fundamentals of unlisted property trusts.

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IDPS are managed investment schemes for holding and dealing with one or more investments selected by investors. An IDPS allows an investor to invest in a range of investment options across different asset classes, investment managers and investment styles.

The IDPS has custody of the investments with the investor having a beneficial ownership. Investments are legally held by a custodian or trust and not in the investor’s name. This means the investor does not have a direct unit or interest in the managed investments, and instead only has a relationship with the IDPS.

Examples of IDPS like schemes include BT Panorama, Macquarie Wrap, and Netwealth. For a full list of IDPS availability for CFM products see www.cromwell.com.au/invest/advisers/

 

It is an offer document produced for the sale of a product or asset to wholesale investors.

It is a financial metric used to evaluate the profitability of an investment. It represents the annualised rate of return that an investor can expect to receive over the life of the investment. The IRR is calculated by finding the discount rate that makes the net present value (NPV) of all cash flows from the investment equal to zero. In simpler terms, it’s the rate at which the present value of future cash flows equals the initial investment. The higher the IRR, the more profitable the investment is considered to be.

The ratio of a company’s loan capital (debt) to the value of its equity. Also known as gearing or LVR (Loan to Valuation Ratio).

Refers to how easy it is to convert assets into cash.

A unitised portfolio of property assets, listed on the Australian Securities Exchange (ASX). Also known as a REIT (Real Estate Investment Trust).

The ratio of the amount borrowed to purchase an asset (building/property) to the valuation of that asset. LVR’s can change over time as either (or both) debt increases or decreases, or the value of the asset increases or decreases.

It is the National Australian Built Environment Rating System used to measure a building’s energy efficiency, carbon emissions, water consumed, and waste produced, to produce star ratings which can then be compared to similar buildings.

Refers to the total value of a fund’s assets minus its liabilities. It is calculated by subtracting the fund’s liabilities (such as outstanding debts and expenses) from the total value of its assets (such as cash, investments, and other holdings).

For managed funds and exchange-traded funds (ETFs), NAV per share is calculated by dividing the NAV of the fund by the total number of units/shares outstanding. NAV per unit/share represents the value of each unit/share in the fund.

NAV is an important metric used by investors to assess the value of their investment in a fund. It provides insight into the fund’s overall financial health and can help investors make informed decisions about buying or selling units/shares in the fund.

Refers to the percentage of rented or leased space within a property compared to the total space available. It’s a crucial metric in real estate that indicates the level of utilisation and income generation for a property. A high occupancy rate suggests strong demand and stable income streams, while a low occupancy rate may indicate potential vacancies and reduced income.

It is a formal document that serves as a legal offer for a financial product. It provides detailed information about the features, risks, and terms of the product, helping investors make informed investment decisions.

They are pooled investments in real estate typically managed by a fund manager. They allow multiple investors to combine their funds to purchase a property that might be beyond their individual financial reach.

The risk-free rate of return is the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time.

A TMD describes who a product might be suitable for. It sets out the target market for the relevant fund as well as the distribution conditions, review triggers and other relevant information. It helps investors and advisers understand the class of retail investors who the financial product is likely to be appropriate for based on investment objective, proportion of overall investment, investment timeframe, liquidity requirements, and risk/return profile.

It is a type of investment that gives investors the ability to participate in commercial property assets by investing in a fund. Unlike publicly traded funds, unlisted property funds are not listed on stock exchanges, offering a different avenue for accessing property investments. Unlisted property trusts operate similarly to direct investments in commercial property but with the advantages of professional management and diversification. Learn more here.

It is a metric that indicates the average duration until all leases within a commercial property expire. It provides insight into the stability and predictability of income streams from the property’s leases.

A measure of returns to investors that is expressed as a percentage over a set period of time.

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Home Understanding commercial property
November 12, 2024

The Essential Guide to Investing in Unlisted Property: parts 3 and 4

Cromwell continually strives to help securityholders and potential investors better understand the nature of the market – and our business – so that they can make more informed investment choices.

In Insight 47, we explored key excerpts from parts 1 and 2 of Cromwell’s The Essential Guide to Investing in Unlisted Property – a comprehensive series of papers that has been compiled to be a valuable resource for anyone seeking to diversify their portfolio and explore alternative avenues for growth through unlisted property funds and trusts.

In that article, we defined the different property asset classes, and investigated various ways to invest in commercial property. Now, in the second part of this series, we will explore the excerpts from the final two parts of the Guide.

Get the full, unabridged guide for free

Cromwell’s The Essential Guide to Investing in Unlisted Property is comprised of four parts:

Part 1 – The different property asset classes
Part 1 explores the differences between the residential and commercial property and provides an overview of the sub-classes of commercial property – retail, office, industrial, and specialist properties.

Part 2 – Various ways to invest in commercial property
In part 2 we examine different investment methods, ranging from direct property ownership to professionally managed property trusts.

Part 3 – How does an unlisted property trust work?
Part 3 provides insight into the structure of unlisted property trusts; the issuance of units; borrowing arrangements; property management; costs and fees, distributions; tax-deferred income; and the process of exiting your investment.

Part 4 – Reviewing an unlisted property trust
Before investing in an unlisted property trust, it is important to understand and review the provided Product Disclosure Statement (PDS) and Target Market Determination (TMD), particularly the ‘risks’ section, to fully comprehend the nuances of the trust and its assets. In part 4 we provide a summary of what to look out for.

Get the full guide

Excerpt from The Essential Guide to Investing in Unlisted Property: Part 3

How does an unlisted property trust work?

 

Unlisted property trusts can only be offered by licensed managers, who are called the ‘responsible entity’ of the trust. ASIC issues the manager an Australian Financial Services (AFS) licence – and the manager has a fiduciary duty to act in the best interests of investors, including prioritising the interests of unitholders over their own interests.

This section of the Guide explains two key documents that managers must provide to investors:

  1. the Product disclosure statement (PDS); and
  2. the Target Market Determination (TMD) – a newer document introduced as a result of new Design and Distribution Obligations (DDO) introduced by ASIC in October 2021.

A PDS and TMD must be provided for any type of trust you consider investing in, these being:

Fixed-term trusts

A fixed number of units are issued (usually at $1.00 each). The capital raising is completed when the full cost of the property, plus fees and costs less any borrowing, has been raised.

Open-ended funds

An open-ended fund continues to raise funds indefinitely so long as it can keep purchasing properties. Units will be issued based on a unit price, with the unit price based on the value of the fund’s properties and other assets. Unit pricing policies and frequency of issue will depend on the manager and fund.

 

Property management

A significant benefit of investing in an unlisted property trust is gaining access to the multi-faceted expertise of the manager. The best property fund managers have an internal property management division, which looks after the buildings in the trusts it manages. Having this function in-house ensures an alignment of interests between not only the manager and investors, but also tenants who are ultimately responsible for providing unitholders with real income.

Property management includes leasing, ongoing maintenance of buildings, building concierge services, fire safety, and other compliance requirements and – most importantly for you as an investor – making sure rent is collected!

 

Distributions

The trust will receive rental payments from tenants and this is passed on, less any expenses, to unitholders as distributions on a regular basis. Depending on the trust, distributions may be paid monthly, quarterly, six-monthly, or annually.

Tax-deferred distributions

Tax-deferred distributions can be an attractive feature of many property investments and have the potential to increase the after-tax return of an investment. The benefits of tax deferral can be significant, especially for those with high incomes. For many investors, an investment that offers 100% or even 50% tax-deferred distributions can significantly enhance the after-tax returns from that investment.

Cromwell’s The Essential Guide to Investing in Unlisted Property is available to download for free. 

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Excerpt from The Essential Guide to Investing in Unlisted Property: Part 4

Reviewing an unlisted property trust

The manager is critical when choosing a property trust. These are the people and organisations you are relying on – and paying – to carry out appropriate due diligence on the property asset, to build and manage the trust, and usually to physically manage its assets. In reviewing the manager, you should consider their experience and past performance, as well as whether they are financially secure; have good compliance process in place; are forthcoming with information; and more.

Among other elements, it is critical to consider the trust structure; distribution yield; and the property asset/s.

 

Trust structure

It is important to understand the trust structure to ensure the investment is suitable for your needs and anticipated outcomes. The product disclosure statement can be used to help you determine a) whether the trust fixed term or open-ended; b) what happens at maturity of the trust; c) how liquidity is provided (for open-ended trusts); d) how units are priced; e) how are properties valued; and more.

 

Distribution yield

The distribution yield is the income you can expect to receive for every $1 of investment (e.g. a dividend yield of 6% per annum means you can expect to receive 6 cents per year for every $1 invested).

 

The property asset

When reviewing the building(s) in a trust, there are a number of factors to consider and questions to ensure you have answers to before an investment is made. These factors include:

  • Location – is the property in an ideal location; on a major road; has access to public transport?
  • Building quality – what kind of capex is required to bring the building up to the required standard?
  • Capital growth – is there opportunity for capital growth? Is the building in a growth area?
  • Lease team – Ideally, for a fixed-term trust, the lease term will be longer than the term of the trust, as this ensures security of income stream throughout the term of the trust.
  • Lease – Is the rental rate market or is it ‘over-rented’?
  • Tenants – are the tenant blue-chip corporate or government tenants?
  • Weighted Average Lease Expiry – what is the vacancy risk associated with the property?
  • Green credentials – what is the NABERS rating for the property?

Understanding unlisted property trusts

For the full, unabridged version of parts 1 to 4 of the Essential guide to investing in unlisted property, please visit https://www.cromwell.com.au/real-expertise/investing-in-unlisted-property-trusts/

Understanding unlisted property trusts

Read the full, unabridged version of parts 1 and 2 of The Essential Guide to Investing in Unlisted Property, as well as parts 3 and 4 in the series – ‘How Does an Unlisted Property Trust Work?’ and ‘Reviewing an Unlisted Property Trust’. Parts 3 and 4 of the guide explain unlisted property trusts in easy-to-understand detail. Download your copy for free today.

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Home Understanding commercial property
November 11, 2024

Taking advantage of the property cycle

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

Understanding the property cycle can be useful for investors as it enables them to make informed investment decisions and stay focused on their long-term goals.

Commercial property market cycle phases

In our view, the commercial property market cycle includes four phases:

 

Peak: This phase features strong economic growth, rising property prices, and high investor confidence. Demand accelerates and vacancy rates drop well below normal levels. However, it can also lead to overvalued assets as sentiment moves ahead of underlying property performance and prices reach their zenith. Interest rates may also start to rise in this phase as the RBA seeks to take some ‘heat’ out of the economy.

Slowdown: In this phase, market dynamics shift, leading to weaker demand and softening prices. Construction, which typically picks up in the expansion phase, starts to create an oversupply and vacancy rates increase. Interest rates continue to rise, impacting jobs growth and slowing the economy. Sentiment worsens, perpetuating falling prices.

Trough: Characterised by low investor confidence and sometimes widespread despondency, this phase sees prices hitting their lowest point. However, it can also present opportunities for investors to buy undervalued assets at attractive prices. Towards the end of this phase, rate cuts often stimulate activity and lay the foundation for asset appreciation.

Expansion: During this phase, economic and financial conditions improve, boosting investor confidence and supporting asset prices. This is typically the longest phase, underpinned by moderate growth rather than the sentiment-driven extremes of the market peak and trough.

Property market cycles repeat over time, but each one is unique. This is because the intensity and duration of a cycle depends on a multitude of factors such as macroeconomic conditions, geopolitical events, investor sentiment, and unexpected occurrences like natural disasters or global pandemics. Sectors within a market and even different locations can be at different phases of the cycle at the same point in time.

Now that we have the basics covered, let’s take a look at the current property market.

The macro landscape

As mentioned above, macroeconomic conditions play a big role in property cycles. Recently, we’ve seen a significant increase in interest rates – 425 basis points in 18 months, which has significantly impacted commercial property prices. However, many believe that interest rates have peaked for this cycle. Other countries such as the US, Canada, New Zealand, and several across Europe, have already started lowering rates.

Australia’s inflation cycle took hold around six months later than peer markets and rate cuts are also expected to commence a bit later (around early next year). Cromwell expects lower interest rates will boost market confidence, stimulate transaction activity and support property prices.

 

Property pricing

We’re starting to see signs that property prices may be stabilising. The pace of capitalisation (cap) rate expansion (a driver of declining property values) is slowing for retail and industrial properties, an indication that the cycle may be turning for these sectors. It is important to note that because the valuation cycle lags, waiting until market valuation cap rates have started to compress means the best buying (i.e. the bottom of the cycle) has actually already passed you by.

For office properties, cap rate expansion is yet to slow but should follow the example of retail and industrial, in part supported by the emerging cap rate differential to the other sectors, which will boost the relative attractiveness of office investment. Increased transaction activity is another sign that the market cycle might be turning.

 

Office fundamentals

While the macroeconomic and capital cycles appear to be becoming more favourable, they would be of little consequence if office market fundamentals were too far out of sync. Despite some challenges, like high vacancy rates in Sydney and Melbourne, there are still reasons for investors to be optimistic about the office market.

Firstly, rents are at cyclical lows, similar to the levels seen after the early 90s office market blowup. With rents at low levels, occupiers aren’t under financial pressure to reduce their space or avoid expanding if they’re growing. This also means that cutting office space or rent isn’t the first option for saving costs. Companies understand that losing staff or having lower productivity due to a poor work environment is a bigger risk to their profits.

The other cyclical element of office fundamentals is the development pipeline (i.e. supply risk). This is relatively small, with the amount of national CBD stock expected to grow by only 0.9% per year from 2024 to 20281, compared to the 20-year average of 1.6% per year2. It’s not practical to build new offices unless they are already under construction or part of an infrastructure project, due to low rents and high construction costs affecting profitability.

It’s unlikely this dynamic will be resolved any time soon, with construction cost inflation expected to remain elevated3 and state infrastructure pipelines set to continue outcompeting for scarce resources and labour for at least several years. The lack of new development is good for the performance of existing buildings, helping to balance supply and demand and support rental growth.

 

 

The long-term trend

Over the past 40 years, investing in Australian office, industrial, and retail properties has generally paid off, with property values growing steadily despite facing a number of downturns and crises. While looking at a shorter timeframe will accentuate cyclical ups and downs, the market has shown a long-term upward trend.
Adopting a long-term approach when investing in property means investors can benefit from this steady growth. This approach helps avoid the stress of predicting market movements. Sticking to a disciplined, long-term strategy based on solid fundamentals can help investors navigate market cycles, reduce risk, and build wealth over time.

Getting in on the ground floor

It’s hard to know exactly when any market will peak or bottom out, but there are signs that can give clues about the general position of the commercial property cycle – whether it’s falling, stabilising, rising, or peaking.

With rate cuts expected in 2025, financial markets believe the overall economic cycle is close to turning. Similar signs are appearing in commercial property, with slower cap rate expansion in some sectors and increased transaction activity. For office spaces, very low rents and limited supply are reasons for optimism and present a good buying opportunity.

For investors who have the courage and capital to buy now, the benefits can be significant. Attractive prices are available, with buyers able to take advantage of distressed sales and the gap between market fundamentals and sentiment. While choosing the right properties is still crucial for investment returns, getting in early and riding the market upswing can provide a strong advantage for investors. Those who have been patient and held onto their investments through this stage of the cycle are also likely to benefit.

  1. Source: Cromwell (Jun-24)
  2. Source: Cromwell analysis of JLL data (Jun-24)
  3. Source: International construction market survey 2024 (Turner & Townsend)
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Home Understanding commercial property
September 25, 2024

What’s in a Cap Rate

Stuart Cartledge, Managing Director of Phoenix Portfolios

 

Capitalisation rates, commonly known as “cap rates”, are a fundamental metric in Australian property investing. When a commercial property is sold, two pieces of information will be widely reported. Firstly, the amount the property sold for and secondly, the cap rate. Often properties will be compared by their respective cap rates. Reports will often comment on the “implied cap rates” of different property securities. However, this seemingly simple and ubiquitous measure can be far more complex to use when comparing different types of properties.

What is and isn’t in a cap rate

Whilst different market participants may mean different things when referring to a cap rate, the Property Council of Australia (PCA) defines a cap rate as a property’s net operating income (NOI) divided by its property value estimate. For example, if a property generates an annual NOI of $500,000 and is valued at $10 million, the cap rate would be 5%. A purchaser might assume that they would receive a cash flow yield of 5% plus any rental growth that may occur. This isn’t necessarily the case and ignores key considerations.
 

Capital Expenditure (Capex):

Commonly, properties require meaningful ongoing investment, which isn’t reflected in the NOI used to calculate cap rates. This investment is known as capex and comes in many different forms. It may be maintenance capex, which refers to significant replacements or additions to maintain the standard of an existing building. For office properties, this may include replacing lifts or air conditioning units, each of which may need a full replacement as often as every 15 years. For shopping centre properties, capex may include items such as escalators or shared facilities such as bathrooms. Maintenance capex is not directly reflected in increased rent and is commonly used to “maintain” the relevance of an existing building. This amount is often referred to as a percentage of a building’s value. For example, if a building worth $100 million requires maintenance capex of $500,000 per year, it is common to say it requires 0.5% (or 50 basis points) of maintenance capex.
 

Leasing Incentives:

To attract and retain tenants, commercial property owners often provide “incentives” to prospective and renewing tenants. These incentives can take many forms, but are commonly provided as rent-free periods, or contributions to a tenant’s fit-out. The size and form of incentives varies greatly between different property types. Incentives are commonly quoted as a percentage of the total rent to be paid over the tenant’s lease period. For example, if a tenant agrees to a 10 year lease for $100,000 per year, a 20% incentive would mean that $200,000 of benefits are provided to the tenant. Rent, less any incentives is called “effective rent” and in the above example effective rent would be $80,000 per year. Rent excluding incentives is called “face rent”. It is typically face rent that is used to calculate the NOI used in a cap rate.

Whilst not the subject of this article, it is worth noting that lease structures including term and rent reviews, as well as tenant quality are not considered in a cap rate. Buildings with longer leases, higher fixed rent increases and better tenant quality tend to attract lower cap rates than the alternative.

Now and then

In a past generation, institutional grade commercial property primarily consisted of office, retail and industrial property. Approximate leasing incentive and maintenance capex amounts across these subsectors 15 years ago can be seen in the table below:

Property Type A Grade Melbourne CBD Office Building A Grade Melbourne Shopping Mall Modern Melbourne Industrial Facility
Leasing Incentives 20% 0% 5%
Maintenance Capex 0.5% 0.5% 0.3%

Whilst there are some differences between the amount of cash flow leakage, the difference between property types is not enormous. Whilst industrial properties faced limited cash flow leakages, market rental growth had been extremely low for a long period. It may not have been perfect but comparing cap rates across these property types 15 years ago was not a terrible way to assess relative value.

Beyond any changes to leasing incentives and maintenance capex requirements, today’s listed property sector is much broader than it used to be. Alternative property types such as healthcare, social infrastructure, petrol stations and long WALE sale-and-leaseback properties are all part of the institutional investment landscape. Many of these property types are commonly leased in an owner favourable “triple-net” manner. A triple-net lease means a tenant is responsible for property taxes, building insurance and maintenance capital expenditure across the life of the lease.

A revised table approximating today’s leasing incentives and maintenance capex, including triple-net properties, can be seen below:

Property Type A Grade Melbourne CBD Office Building A Grade Melbourne Shopping Mall Modern Melbourne Industrial Facility Triple-net Property
Leasing Incentives 42.5% 15% 10% 0%
Maintenance Capex 0.6% 0.6% 0.3% 0%

Mind the Gap

It is clear when comparing the above tables, that the dispersion in incentives and capex has widened materially. In the case of an A grade office building, the gap between the building’s cap rate and its true cash flow yield is vast. The chart below demonstrates this visually for an office building with a 6% cap rate:

Mind-the-gap-graph-1

As can be seen, the cap rate in no way resembles the true cash flow of owning an office building, with more than half of the NOI received (used in calculating the cap rate) lost to capex and incentives.

Consider the four assets in the above table. In this example, each has a cap rate of 6%. The chart below shows the cash flow yield of each:

Mind-the-gap-graph-2

 

What to do?

Phoenix actively considers the factors affecting cash flows (among others) and explicitly forecasts longer term capex and incentives that property owners will be required to pay. It is these cashflows that determine value, not next year’s dividend or simply observing a cap rate.

A comparison of Dexus (DXS) and Charter Hall Social Infrastructure REIT (CQE) shows the importance of looking beyond headline cap rates and how this affects how Phoenix manages the portfolio. DXS is predominantly an owner of high quality office properties across Australia. CQE is predominantly an owner of smaller properties leased to childcare providers on triple-net leases. CQE’s cash flow is boosted by a lack of incentives and capex. Childcare property rent is also an income stream heavily supported by the government, with support for funding of the sector a politically bipartisan issue. As at period end, DXS’ office cap rate implied by its share price was greater than 8.3%. CQE’s implied cap rate was more than 6.8%. If one were to merely compare cap rates, DXS would be the more attractive investment opportunity. It however faces significant cash outflows (in the form of capex and incentives) beyond what is measured in a cap rate. As such, Phoenix has held no position in DXS for some time and holds an overweight position in CQE.
 

The Detail is Important

Cap rates have the benefit of being simple. In the past they were also a reasonable way to compare property. As incentives and capex levels have diverged between different properties, merely looking at cap rates has become a less appropriate way to consider the relative attractiveness of different properties. By developing a more nuanced understanding of what’s truly “in a cap rate”, investors can make more informed decisions. Remember, the devil is always in the details, and in real estate investing, those details often lie beyond the simple cap rate calculation.
 

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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