Charter Keck Cramer and Precisely Property Podcast respectfully acknowledge the traditional custodians of country throughout Australia. We pay our respects to the elders past, present and emerging.
Richard: Hello, and welcome to another episode of Precisely Property. I’m your host, Richard Temlett. I’m excited to have you with us today. If you’re here for the first time, thank you for joining us. I encourage you to listen to our previous episodes where we discuss all things property, with a focus on dynamic discussions with industry leaders. In this episode, we’re speaking with Benjamin Martin-Henry of MSCI. So, sit back, relax, and let’s get started.
Ben is Head of Real Assets Research for the Pacific Region at MSCI and is responsible for reducing thought leadership for the benefit of MSCI’s clients, covering both the major property sectors and newly emerging ones. Ben has over 15 years of experience in Australia and the United Kingdom across investment analysis, research, strategy and product developments in the property sector. In addition, he has expertise in property sector performance metrics, macroeconomic and financial market data interpretation, and product development. Ben began his career at IPD in London, now MSCI, where he worked predominantly in research. Upon transferring to the Sydney office, Ben took on the role of Client’s Consultant for the Asia Pacific region. Ben then moved to CBRE, where he was Head of Capital Markets, office, and BTR within CBRE research for over five years before moving to RCA to be head of analytics for the Pacific Region, which MSCI subsequently acquired in 2021. Welcome, Ben.
Benjamin: Thanks, Richard. Thanks very much for having me. I’m really looking forward to this. Every time you read my bio, it makes me sound very old.
Richard: Well, I don’t know if it makes you sound old. That’s not my view. What does really impress me is the experience that you’ve got in both various asset classes and various markets over different periods of time and through different cycles. I can’t wait to get into the show today because we’re going to talk about the various asset classes and what you’re seeing on the ground both in Australia and overseas.
Before we get into the show, though, a couple of housekeeping issues. As we were talking offline, I really value our relationship. And just to let our listeners know, we do catch up even though you’re primarily based in Sydney and I’m in Melbourne. We do catch up every quarter. We do share ideas, share notes. I certainly have gravitated to you because I see your research. I listen to you speak as much as I can, and I love we’re both from the research world and the advisory or analysis world. I absolutely love chatting with you and sharing ideas. And today’s session is one of the sessions that we pretty much would have every quarter. It’s just the difference is it’s being recorded. So again, I certainly value the relationship, and I can’t wait to get into discussing all things across the asset classes today and also what our outlook is for the next 6, 12 months, up to two years.
In terms of the agenda, I’d really like everyone to know a little bit more about your background and then also who MSCI is. And then, as I said, we’re going to talk about the various real estate markets, particularly office, retail, industrial, and Build to Rent. And then also, I’m really grateful that you’re going to start sharing your views on what you are doing with the BTR index. I understand that a number of your clients, they already use your different indices from the different other segments, but you’re in the process of doing one for BTR. And I think that’s absolutely fantastic. It’s very proactive. It’ll certainly help finance price the risks, and I think that that’s a gap in the market that does need to be closed. So, I can’t wait to learn a little bit more about that. And hopefully, also, this can be a bit of a shout out to people across the industry that can reach out to you, perhaps give you their ideas or share some of their data with you because, I think it’ll go a long way to helping capital find and price the risk accordingly.
So, let’s get into the show. Could you tell our listeners your background, and then also who MSCI is?
Benjamin: Sure. You’ve covered my background very well, thankfully, so I won’t have to talk too much about that. But, yeah, I have pretty much worked in property my entire career. I find it a fascinating subject that many people probably don’t cover day to day, even though we mostly cover commercial real estate at MSCI, whenever I go to a barbecue or something and tell people what I do, they immediately go, “oh, what’s happening in residential market?” I’m like, I don’t really cover that, but pretty much stick to commercial property these days, but that does cover commercial residential. And as you touched upon before, Build to Rent, that’s certainly a much growing sector that we certainly are looking at. I started covering Build to Rent probably eight years ago, so I’m really looking forward to getting some indices out there, which we’ll touch upon a bit later.
I have predominantly worked in research. I joke with our team that I’m probably the only honest person in the team because I’m surrounded by salespeople and consultants and all that with the research, I’ll just say it as it is, find a personal opinion, but because we have so much data at MSCI, it’s fairly easy for me to just say this is what’s going on and stick to the facts.
About MSCI, I’m sure there’s some blurb I’m supposed to read, but effectively MSCI, we like to provide, what we do provide is critical decision making tools. The company has been around for around fifty years. We have indices covering fixed income, real estate, equities, and we have various analytical tools as well. And many people are familiar with our products. Well, if they’re not familiar with our products, they’re probably in some way, shape, or form their super funds are benchmarked to some of our global indices and local indices as well. So, yeah, and I’ve been at MDCI for a while now. I’ve actually been acquired by the company twice. Firstly, when I was at IPD, and then when I joined RCA a couple of years ago, they acquired RCA. So, yeah, second time around for me here.
Richard: You have mentioned that to me before, and I do laugh. It must have been quite entertaining for you to go, oh my goodness. You’re getting purchased again by them. They can’t seem to get rid of me, or I can’t seem to get rid of them. But I suspect or certainly knowing and chatting with you, you’re a fantastic asset to have. So, I think that they’re very lucky. And your comments talking about what you’re seeing on the ground, in the market and I suppose being independent or talking to the evidence and the data, I think that is why I gravitate to you because we can have very open and honest discussions about what we’re actually seeing on the ground, and that’s been very useful coming out of the pandemic where things have been extremely difficult and there’s a lot of risk floating around, but there’s also a lot of opportunity. And I think there’s not enough people, and you’re certainly one of them when I’ve heard you speak, that do cut through a lot of the noise and get down to the granular level of detail which helps everyone assess the risk, in various opportunities.
Alright. Let’s get into the main part of the show. I saw on The Urban Developer this weekend that you’re talking about the commercial office market, so we’ll start there. I’ve heard in the past about bifurcation. I hope I’m pronouncing that correctly. I’d not heard of trifurcation. I actually had to Google this because I looked and I was like, well, Ben’s talking about trifurcation. I need to learn what that is, and then I need to read his article. So let’s start there. Could you please give us a little bit of your views as to what’s happening in the commercial office market? What is bifurcation? What is trifurcation? And what are you seeing with transaction volumes and then, I suppose, cap rates and prices?
Benjamin: Well, you certainly picked the hardest one to talk about first. So, thanks for that. Really get the brain going. Look, the office sector, it’s been a struggle the last couple of years for obvious reasons. It’s been going through the cyclical slowdown, of course, with the interest rate cycle coming to an end, and then it’s also got that structural shift of the whole shift to hybrid working, and then there’s various supply factors as well that are impacting the various markets. And, yeah, buzzwords for every downward cycle, there’s always buzzwords that come out flight to quality, bifurcation, all those weird and wonderful terms, and then, trifurcation was thrown in with them the other day. I’m like, oh, okay. So I think trifurcation just means talking about A grade, B grade, and C grade offices and the various performances.
I think what we’re seeing at the moment is all offices have suffered during this cyclical and structural downturn. No sort of quality type or market has been unaffected by it. So, if you look at just one of our direct property indices, prime officers have lost around 22-23% of their value since the previous peak. That’s significantly more than what they lost during the GFC where they lost around 15%. It’s the office sector has been impacted worse this time around, and I guess that’s the structural nature that’s also impacting offices as well as that structural shift too. And the whole trifurcation, again, that’s just looking at the various quality of office classes, and yet the performance is much worse in those secondary office grade assets.
We’re seeing new ESG regulations. In fact, I don’t even think you can build C grade or D grade offices anymore, due to the latest regulation. We’re seeing the performance of the secondary grade offices really suffer a lot more than the more prime, the more premium grade offices. And I think partly driving that again is this trying to get people back to work, which is obviously a whole separate topic, which we may touch upon later. But in order to get people back to work, a lot of offices or a lot of tenants are saying we need better quality offices. We need to create quality accommodation for people who are happy to come back to work, better located, much higher indoor environmental quality, which is always a very important one for employees. I think we’re seeing a lot more leases struck on those high-quality offices, particularly given where the rents are at the moment. You’re able to jump up from sort of A grade to premium or B grade to A grade at a lower price point than you had to pay five or six years ago where that jump was quite significant. What this means is that there’s better occupancy, lower vacancy in these high-quality offices, and therefore, investors are looking to buy those ones before they start going down the road of maybe picking up secondary offices.
Richard: Thank you for that fly through. There were a couple of things that I’d like to explore a little bit more with you. One of the most interesting points you made in that article was talking about how historically it seems that the office market and, correct me if I understood this incorrectly. It was more dependent on the point in the economic or the business cycle in terms of how it was performing. Whereas now, there seems to be discussion or the observation that it is a bit more dependent on both the tenants’ preferences or the business preferences, but also structural changes. And I think that that’s really important because I remember coming out of the GFC, a lot of that investment, and it was a much more mature and best understood asset class than, say, residential, certainly in Australia. And, really, you could almost track it with where interest rates were, what’s happening with the growth of employment and wages and so forth. And you could say, alright, well, here’s the demand from white collar workers. There’s a size per square meter of office floor space per employee, and it was much more dependent on the cycle.
But you made a comment about it now being more of those structural changes, whether it is working from home and the requirement for less space or how the space is being used, as well as the ESG credentials. And I think you’re absolutely right with not being able to do the C and the D grade buildings anymore. Could you explain a little bit more? Do you think or I mean, obviously, they’re your comments, which I certainly agree with, but your observation about the structural changes really impacting demand and the size of floor plates, from various tenants moving forward?
Benjamin: Yeah. The whole structural shift to hybrid working, I don’t know if it’s played out yet. I have talked to various investors where they’re heads of asset management, say they’re tired of people saying that the office sector is struggling because of hybrid working and low occupancy. And some of their views were at occupancy levels that were basically the same as pre COVID. And I think that is an important point. An example I always use is there’s not a lot of companies that if they have 100 staff, they don’t lease 100 desks because people are going to be sick, on leave, depending on your business they might be out in there regionally valuing assets, for example. So, they tend to gravitate towards the 65-70% of office space. I am hearing a lot more investors saying that that side is done. We’re back to those pre-COVID occupancy levels, in which case, hopefully, offices will start to recover, but there still are a lot of companies that don’t necessarily have managed to bring people back to work and therefore they need less space. We still are seeing that, and I think there still is a bit of a hangover effect of hybrid working on office sector valuations, but personally, I don’t think that we’ve come to the end of that kind of discussion, that question.
I think there’s a few more things to play out. And the other one is we do have companies that do mandate, which I was talking about before. Sorry. Mandate employees coming back to work, so three days a week. Not a lot of people go into work on Mondays and Fridays. So it’s Tuesday, Wednesday, Thursday. And if you are telling all your employees to come back three days a week and they all come back Tuesday, Wednesday, Thursday, there’s not enough space. So again, we are seeing tenants gravitate to larger space because they can’t accommodate what they’re currently seeing given their mandates, and we are seeing tenants give back space. So, there seems to be, again, this netting off effect. That’s why I keep saying, I think there’s a bit more to run on the whole in the office sector.
Now one thing I’m also hearing a bit more, which may or may not have been mentioned in the article you referred to, is premium offices. Short-term premium offices look okay, doing well. Still within them, there’s different performance levels. But medium-term, I’m getting a few more question marks around premium offices because they’re pretty big floor plates these days or sorry these days, they’re very big floor plates.
And it kind of feels like the era of big offices is over where bigger floor plates aren’t necessarily wanted by many tenants. And the problem with big floor plates, they’re very hard to carve up to redistribute tenancies. So I’m not sure, to be honest, what the future is for premium offices and if what I’m being told by some investors will come out, the premium offices may struggle further down the line in the next couple years. I don’t know, but it’s certainly an interesting point that these bigger floor plates might actually struggle given that there’s a preference for smaller floor plates these days. I don’t know, but it still speaks to all the question marks surrounding the office sector for me.
Richard: Look, I’m inclined to agree with you from what I’ve spoken to various people on the ground, including our people that do the office valuations at Charter Keck Cramer, as well as other people in the industry. There are two things that I was keen to bottom out with you. The first one was the role of the government. Now just for our listeners, we’ve got the Minn’s government in New South Wales, if I’m correct in understanding this. He’s basically said that the public sector needs to come back into the office. On the other hand, you’ve got Melbourne and Victoria, and you’ve got the Allan government who’ve said, well, no, you don’t. You can stay at home. Why does that matter? Well, I was astounded to read, and you can correct me if I’m wrong. In Victoria, the government occupies 30% of the office space in the CBD. If, in fact, that’s correct, and I’m pretty sure it’s correct because it came from the PCA office market report, one third of that floor space, if the government said, look, office employees, please come back into work, it could have a very positive impact on vacancy rates in the Melbourne CBD. Melbourne CBD has probably the highest vacancy rates across the country when I saw the last figures. And I certainly commend the Minn’s government for getting people back into the office. I’m up in Sydney and Brisbane, and I can see the CBDs are very different to Melbourne.
I read that stat and I thought, you can look at the different vacancy rates across the different grades of buildings. And in Melbourne CBD, you’re right. The higher-grade buildings have lower occupancies. Also, there’s different pockets of the CBD that have higher or lower occupancies. But you overlay those with the fact that you could get a significant part of the workforce back into the city. That flows into the retail that is suffering in the CBD, as well as office values and rents. And I suspect a similar thing could play out across the other cities. What are you seeing in that space? What are your views on that space?
Benjamin: I’d say it’s a difficult one, and there seems to be differing views and different opinions out there. And that’s why I keep saying there’s more to run on this. Yes, the Minn’s government did say everyone should come back to it, but I think 65% or 70% of the workforce is frontline anyway. So they were kind of in person type things. So, I’m not sure what impact that’s going to necessarily have.
The other thing is the economy is still doing pretty well. Unemployment is pretty good. People are kind of paying with their feet. We’re seeing a lot more of that that if they are mandated to come back to work, some people are just going somewhere else where they’re not necessarily mandated to come back to work. And you know what human beings are like, we don’t like being told what to do. So even if we love our job and someone tells us to do something we don’t particularly want to do, we might leave. There’s a lot more to run on this, but yes, the government are huge occupiers of office space. They are easily the largest tenants. I think there is a lot of power in the government saying everyone should come back to work, and that will impact CBD retail, as you say.
I think the other point is that we are in danger of having a lot of obsolete offices, particularly those secondary grade offices, and a lot of these secondary grade offices are located in pockets that you touched upon before. Some pockets of cities are doing well. Now the problem is if we don’t get people back to work or back into the offices, some of these offices will sit there derelict, and that’s not great for a city to have derelict areas. So, I think the government does have a lot of control over what they can do and what they can’t do.
And perhaps mandating, look, it hasn’t necessarily worked out too well for some companies, but perhaps the government can do something to get people back to work just to boost the overall CBD. But we’re not trying to suggest that these poor office owners that own $70 Billion worth of assets need help in making money. We’re not, I don’t think anybody’s trying to say that, but it does have significant knock-on effects on cafes, CBD retail, small independent retails within the CBD. They do rely so much on office workers coming to the office.
Richard: Yep.
Benjamin: Interesting, you say that Melbourne’s quiet. Every time I go down there, Melbourne seems pretty, pretty busy. Seems kind of the opposite in Sydney where it’s busy during the day but quiet at night. Melbourne’s quiet during the day but busy at night. I’m going there tomorrow, and we don’t have a dinner reservation. I’m sure we won’t be able to get in anyway because the restaurants are packed, but I mean, Melbourne has obviously struggled to get occupancy rates up after COVID. Sydney is getting there. Brisbane didn’t really struggle too much. Their lockdowns weren’t as severe, so they were okay.
But Melbourne seems to be the hard one. It’s generally the one that’s held up as the most struggling office market in the country. And looking at our performance, that’s exactly what’s going on down there as well.
Richard: Before we jump into some of the other asset classes, do you have any line of sight on the recovery? You say we’ve still got a bit more to play. I’m assuming by that you mean that values probably have not bottomed out yet. What do you think will happen next year? Do you think and when rates hopefully get cuts, will that be one of the triggers? Or what is your thinking there?
Benjamin: I think it’s incredibly hard these days because this is very structural and not cyclical. Generally, in the cycle, everything falls at the same time and comes back at the same time. Now we’re not seeing that this time around because you’ve got that structural element. I believe Sydney prime offices have bottomed out. I think Sydney offices in general have probably bottomed out. Looking out, because we have a transactions database, as well as a valuations database. The cap rates we take from transactions are a leading indicator or forward indicator of valuations. Now at the moment for Q3 numbers for Sydney office in particular, we saw transaction cap rate compression. That looked practically nothing, more like a rounding error, but it does stop seven quarters of expansion. So, to me, I think Sydney offices have on average bottomed out.
Melbourne has a long way to go. There’s still a big gap between transaction and valuation. It’s about 50 bps. In theory, that means that we’re going to see another 50 bps worth of cap rate expansion in the office sector in Melbourne. Again, these are averages. And the reason I keep saying the averages is because I hear too many people saying premium offices will be great. My point is, well, what’s premium offices? Because just looking at the best performing and worst performing premium grade Sydney CBD offices, the worst performing premium grade Sydney CBD offices have lost around 25% of their value. The best have lost around 5%. Now that’s a huge variance. And I think that’s kind of what we’re going to see over the next few years is there’s always a gap between the best and the rest, but I think the gap between some of the top three, top four offices in Sydney and Melbourne, that gap between the next best is going to be getting wider and wider and wider, and that includes premium grade within that premium grade as well.
I think it’s very hard to say if we hit the bottom of this cycle because the performance dispersion between office assets is so vast, but I’m happy to say that I think Sydney has bottomed out. And what happens next year? Now we had a large election over in the US and things have all changed and, rate cuts have been put on hold by the sounds of it and all these kind of question marks around it. It’s hard to tell, but from a cyclical point of view, I think we’re coming out of the office downturn. The pace of the climate is slowing, and I think the next 12 months are going to be much better than the last 12 months for the office.
Richard: Alright. Let’s shift gear and jump into industrial. What are you seeing in the industrial space? I know, certainly, from what I’ve studied, and I’m not as close to it as I am with the residential market, it seemed to be quite flat in Melbourne leading up to the pandemic. Then we had the pandemic, and, basically, there was a huge, again, structural shift. People shopping online, there’s demand for warehouse and last mile delivery and data centers and so forth, and there’s been very strong growth in capital values and then also rents. Although I speak with our Valuers on the ground and the leasing agents, they do seem to say that the price growth is slowing. What are you seeing in this space? What are you seeing in the indices, and what is your view?
Benjamin: Yeah. Industrial is a tricky one. I’m glad you’re seeing your Valuers and leasing agents are seeing price growth slow because every forecast I read for industrial is going to be 10% rental growth for the next 10,000 years, and I just can’t see how that’s going to happen. It’s had its run. We’re seeing 20-25% rental growth in those years during COVID to your point because of things like online retail. I think industrial got very toppy. Some of these assets, particularly down in Melbourne as well, going at 3%-3.25% a year. I mean, they’re extremely tight when bond yields are sort of 4%. I know that there’s a lot of debate about property yields and bond yields moving together, yada yada, but that’s very, very pricey.
So, yeah, it has slowed down. It was always going to slow down. Generally, what goes up must come down. It’s still been an extremely strong performer over the last couple of years looking at our direct property index, we’ve seen industrial returns hit that 25-30% mark, which is very strong. Most of that has been driven by capital growth. So that cap rate compression. Rents have been growing extremely well, but the value increase was so much that that income return component was quite small. Now what we’re seeing is the flip side, we are starting to see a little bit of cap rate expansion, but that has been offset by the strong rental growth, which has kept valuations for industrial pretty solid. Now we have seen some slowdown in industrial, total returns. Like I said, we have seen some cap rate expansion, but I think we only really had one or two quarters of negative total returns for the industrial sector. It’s just been going so strong. And part of the reason for Asia is lack of supply. And I always get laughed at when I tell investors that Australia, we don’t have a lot of land. They’re like, what are you on about? You’re the fifth or sixth largest country in the world. I’m like, yeah I get it. But if you want to build an industrial distribution warehouse or what have you in the middle of the desert, go nuts, up to you. But it’s not serviceable. There’s no water. There’s no electricity. There’s no roads. So, where we have all this industrial, where we need all this industrial, that land is actually quite partly held. So lowlands, limited supply means that demands are going to be still pretty high and it’s going to be still pretty toppy.
I think industrial, you kind of call it bottoming out because it didn’t really go very far. I think that’s already happened and we’ll start to see start to see improvements in the industrial sector. But I think a big difference with industrial compared to say retail and office is that if you compare the one-year returns to the three- and five-year returns, those one-year returns are well below the three- and five-year returns. Whereas on the retail side, it’s the complete opposite. Those one-year returns are well above three and five. So that means they’re both obviously moving at different paces, but it does mean that industrial is coming off a very, very high base and then it’s hitting that bottom. And then it’ll take a couple of years to get back to those elevated levels, even if they do, which I still struggle to see if we’re going to get 25% rental growth again for another few years. That’s a hard one.
Richard: Look, I agree with you, and I thought an interesting anecdote for you, and I’ve never seen this in the 15 years that I’ve been doing residential work. I’m doing a lot of highest and best use assessments. And, basically, for the listeners that’s looking at a site and going, well, what is the highest and best use? And you look at planning, you look at the financial viability, you look at the demand, you look at the supply. And typically, a lot of the sites that I do, residential is the highest you get the best return. What I’ve found, and it’s been remarkable, especially in the greenfield markets in Melbourne and some of them in Sydney, because residential is so weak right now and moving so slowly, especially in Melbourne, and industrial has exploded, the highest and best use has actually flipped from being residential to industrial. And I’ve been working with a few developers where two or three years ago, they were arguing with council trying to get their site rezoned from industrial to residential to do residential housing. They’ve just gone quiet. They’ve gone, well, fantastic, all we’re after is our return on investment, and the return now is actually higher as industrial. And then I’ve had council contact me and go, this is bizarre. These developers have gone quiet, and all of a sudden, they’re proceeding with industrial. Now we are arguing with them. We were hoping we were going to get residential down the line, but now we’ve got this industrial estate. And I do laugh because, obviously, it’s just the developers are being smart with what they’re doing. They have to get a return over a period of time, and they’re basically going, well, I’ve got a greater return, or a risk adjusted return doing industrial right now. But I’ve never really seen that play out, or certainly not consistently. And I think that’s a function of the distortion in the various markets.
And as the residential market starts to recalibrate and perhaps the, and it will start to accelerate and the industrial starts to slow down, they will get that inflection point to that tipping point. And, again, I suspect, especially in Melbourne, the residential will become the highest and best use, based on the various parameters for those different asset classes.
Let’s jump into retail. What are you seeing with retail again that was badly distorted by the pandemic? Although, that being said, I must admit when I was choosing to get into property, it was fifteen years ago, I kind of looked at office, residential, retail, and I always went back. Even back then, I went, people have to have a place to live. So residential occurs to me there’s going to be huge demand. Whereas with retail, I was even worried back then going, well, what can happen with online shopping? There’ll always be demand for bricks and mortar. Certainly, I could never have predicted or estimated what would happen with online shopping and things like that, but I did, even back then, think that it may start to change.
What we’ve seen now is online retail and the penetration rates here, they’re not nearly as high as, say, for example, the US or China or Japan and things like that. But they’ve got much higher, and that’s obviously changed the demand for different types of retail. What are you seeing on the ground right now? And what is your outlook for retail?
Benjamin: I’ve been a huge advocate of retail for the last few years. I think I like to fight for the underdog, and I get fewer retail investors telling me to stop being so positive about retail because it’s increasing their competition for assets. But I’m like, well, I say what’s happening.
Retail was struggling before COVID for sure. And then there’s a massive correction during COVID, just looking at our retail index. I think overall retail values fell around 22-23% as a result of the onset of COVID when all nonessential retail services were shut down, of course. And since then, it only kind of recouped two or three percentage points before this latest slowdown. What that does mean for me is it’s pretty good value retail. And I always say this and people are probably tired of hearing it. We say this, but I think too many investors have this helicopter view of retail, which is big department stores, and they all struggle and they all suck and we don’t want to go into them. That’s not I mean, they might be truly fine, but retail is very varied as an asset class, and I think you need to break it down way more than most people seem to do.
If you look at large format retail, it follows a residential cycle. It’s been pretty bulletproof in Australia for the last15-20 years. It’s probably one of the best performing asset classes we’ve seen for a number of years. Neighborhood shopping centres have been killing it the last few years, again, because people have had to shop more locally, again, because of lockdowns and what have you. Neighborhood shopping centres have done extremely well. Your anchor tenant is a supermarket. Again, pretty good. Supermarkets tend to have, some proportion is turnover linked and a lot of rents are inflation adjusted or linked to inflation, etcetera. So, they’ve obviously done extremely well over the last couple of years, so neighborhoods are doing pretty well.
Subregional, I remember at CBRE we did a report saying, I think my boss called subregional shopping centres the middle child or shopping centres because nobody wanted them. I’m like, yes, but it’s a valid point. Some companies tried to offload massive portfolios of subregions and simply nobody wanted them. Now that kind of flipped again during COVID, you’ve got a supermarket as an anchor tenant and you’ve got discount department store (DDS) Kmart, Big W, as an anchor tenant. It has done extremely well over the last couple of years. This cost of living crisis, of course, means people may be having to adjust their shopping patterns and shop more at DDS as opposed to your Myers and your David Jones. So again, done extremely well. Those are the three that have really boosted the retail numbers of transaction volumes over the last few years.
But more recently, this year, we’ve seen around a 53% increase in transaction volumes for those larger shopping centres. So, your regionals, your majors, and your super regionals. So that’s a big change, and it’s the strongest, I’d say, start to the year, the strongest three quarters of a year since 2018. That’s a long time. Generally, I don’t see stronger since 2018 in any other sector. That tends to me that there’s significant relative value in those larger shopping centres. And if you just go back to basics, the fundamentals of Australia’s pretty good, very high population growth. That’s not necessarily a good thing for some sectors. The population growth by and large is pretty good for retail. We have a very strained retail supply. I’m not an expert on approvals and building construction processes, but we don’t build a lot of retail in Australia. And from what people tell me, it’s very hard to get retail approved. Our retail per head per square meter is like half of that of the US and the UK.
Richard: I saw that. Yes.
Benjamin: Again, pretty constrained supply. Given those fundamentals, shopping centres, and given the blowout in yields for shopping centres. So, for example, back in 2018, regional shopping center yields around 5.5%, and they peaked around 7.8% this time around. That’s a significant value shift, and it looks like investors are really taking advantage of that relative value in retail. And they’re expecting that those fundamentals, those population growth fundamentals was really to boost those shopping centers.
And the other thing is a lot of these large assets, retail assets, don’t trade very often in Australia. They’re very tightly held. The fact that more and more are selling these days means, firstly, some people are trying to offload them and get out for whatever reasons, but it doesn’t mean there’s a lot of demand for them. And what I heard recently from retail investors, they’ve missed out on a couple of deals, but not all shopping centers or retail assets are going to sell. That’s fine. Some have been pulled from the market because there’s no buyers, but sure, fine. But there seems to be more underbidders for some of these retail assets, and that’s a big shift in sentiment then. If you only have one or two bidders, it means, yeah, sure, there’s only a few people in the market. But if you get four or five underbidders, that’s pretty good.
I think retail, it cops a lot of flack. Like you mentioned before, online retail and those increase in penetration rates, but still, I think the US online retails are about 21-22%. You’ve still got an 80% market share for bricks and mortar. It’s pretty good. I think most people would like it. Maybe because Microsoft would like an 80% market share in anything they do.
Richard: Yep. Yep. Very well-articulated. And I must admit, that’s exactly what people look at, that 20% rather than the 80%. The same thing, I see with residential housing, for example, when they look at the proportion of apartments or townhouses and they go, ah, you see it’s only a small amount, or a larger amount, but they don’t always look at the other side of the coin or the other percentages. And I think that’s obviously, it’s what you and I do in terms of the analysis, so we give balanced analysis.
Let’s jump into BTR. I’m keen to understand, and I’ve already asked you this offline, but what are your views on BTR? But particularly, I’m interested to know this BTR index. What are you doing? What have you been asked to do? What’s the end goal? How will it actually help?
Benjamin: I’ve been covering Build to Rent way back eight years now in Australia, when me and our head of client care over at CBRE would try to go around to investors and start talking to them about Multifamily / Build to Rent. Nobody really wanted to talk to us about it. Only very few companies did, but now it seems to have gained a lot of traction. I think it does suffer with one of the worst naming conventions globally. Multifamily is a terrible name. Build to Rent’s a terrible name. We need to cover something slightly better because it’s painful to write and talk about. There’s a heck of a lot of questions over whether or not it stacks up. Will it work, will Build to Rent work in Australia, yada yada. I mean, will every project work? Of course not, you’ll know better than me, you’ve done feasibility studies, not every project will work. Fine. Does Australia have a housing crisis? Obviously. Is it a bad thing to build more residential? Obviously not. I’ve heard so many people say, I don’t know anybody whose dream it is to rent forever. That’s great, but it may be their nightmare. Again, it’s looking at the other side. Some people might not have a choice but to rent forever. Now housing costs are just going through the roof and you look at the percentage of homeowners, it’s touching 60%. The next census will probably show it below 60%. Same as the UK and same as the US. I think there’s going to be a need for more residential accommodation and Build to Rent is just another piece of that puzzle. Will it solve anything? Probably not, but you’re adding more supply to it. You’re giving people more options. Is it expensive? Yeah. It’s not cheap, but then our rents are kind of cheap in Australia. We are incredibly unaffordable.
There’s a joint study between a Canadian University and a California University looking at residential markets, and they came up with a top 10 impossibly unaffordable markets. This is not, these 10 markets are impossibly unaffordable. This is the top 10 of impossibly unaffordable markets. Sydney’s number two, Melbourne’s number seven, and Adelaide’s number eight. We have three impossibly unaffordable markets, and you’re trying to tell me that we shouldn’t have more residential or it’s not going to work.
There’s a lot of Build to Rent in the pipeline, 130-140, maybe some something like that. Not all of them are going to get built. Sure. fine. Some of these things are going to get delayed or pushed over or what have you, because of the construction costs and the like. But what we’re trying to do is create an index to track the performance of these assets. We already have office, retail, industrial indices where we track the performance and people use that to compare asset classes and to benchmark themselves against your future, your super legislation.
And the missing piece for Build to Rent over the last few years has been that performance. Now you get anecdotal performance of this asset is doing this, that, and whatever, but we’re obviously independent. We just track these are the returns. This is what it is. There you go. And people use that to raise capital. That’s effectively what people use indices and benchmarks for is to track their performance so they can tell investors, look, we’re this is much better than these people or Build to Rent is better than the office sector, for example. Give us money and we can do more with it. That’s kind of the point of an index. And, yes, we are desperately trying to get one off the ground because it’s something I’ve been keen on for the last, like I said, six or seven years to get this going, see how these assets perform. Because I still get too many people, I’m sure you’re the same, saying it doesn’t work. It’s not going to work in Australia. I’m not going to do it. Yada yada.
Well, it does work. We’ve seen it work. It’s the largest investment class in the largest market in the world, in the US Multifamily. It does work, but it doesn’t mean every single project is going to work. And the point of us doing an index is to show how it works. Is it bulletproof? Probably not. Will it perform better than certain asset classes over the next couple of years? Potentially. But the other important fact about Build to Rent is if you look at how it works in the US and how it works in the UK, I know it’s pretty young in the UK. Sure. Fine. It’s not the highest returning asset class over the last ten years, but that’s obviously industrial. Because for the last five years it sits in the middle, around those retail numbers, but it’s the least volatile as well because in good times, people need places to live and arguably in bad times, maybe more people need places to rent. It’s always going to be pretty well tenanted. And I think that’s what a lot of investors are simply looking at is that steady stable income stream, which Build to Rent does offer. And that hopefully is what we’re going to be able to track and show the market next year, hoping by mid next year, we’ll have some sort of number to show people. This is how it performs. I’m just very curious myself. I want to know.
Richard: Well, Ben, first of all, as I said to you previously, I’m more than happy to help out and give you my views on what is required. But more importantly to the listeners, what do you need from them? I know you’re probably speaking with a bunch of them, and in fact, I know that you do because they speak very highly of yourself and also MSCI. But what information do you need from them?
Benjamin: So, the way we work is we collect information on your property performance, your valuations, your rents, your tenancy profiles, all those kinds of things. That’s submitted to us, and then we build returns out of it. So that’s how all our other indices work. At the moment, we’re talking with the major players in the industry who have stabilised assets, and they’ll hopefully start to submit this information to us so we can build a series. The problem with…it’s not a problem. It’s a good thing, but the problem with Build to Rent is it’s a small sector and we have very, very strict confidentiality rules that we must adhere to, which is five assets across three fund managers, also three funds or just three players with no asset contributing more than 75% of the return. The point of that is that no one can back out results. We don’t want to be disclosing people’s confidential information. That’s absolutely not what we do. With a small but growing sector like Build to Rent, that’s a bit of a tricky one, which is why we haven’t embarked on this until now, and we’ve probably got 12-15 institutionally managed stabilised assets that we can use to generate a return. So that’s kind of how the process works.
We take all the building blocks and then we aggregate everything up and then we come out with an index number. We’ll definitely keep the market informed as soon as we have a number. Trust me, I’ll be shouting it from the houses. Hopefully sometime this next year. And then if anybody has any questions about it, just drop me a line. We’ll be happy to chat about it.
Richard: Great. Look, I know we’re running a bit short of time. Before I close off, the final question for you, where do you think BTR cap rates are going to sit? I know it’s a hard question, of course, but I’ve got to ask the hard questions. I won’t hold you to it. I can give you my views too. But why I ask is I’ve seen some of your slides where you’ve started to triangulate this with both the US and the UK retail, industrial, and commercial yields or core cap rates, but then also the volatility, which I think is pretty important. So maybe even if we just look at overseas, where do you think it’s going to land?
Benjamin: It’s a tricky one. They are tight. They are definitely very tight in Australia. Residential has always been very tight, 2.5-3%, what have you. I think build-to-rent is going to be around that 4-4.25% on a cap rate basis. Very, very tight. Personally, I think looking at overall return performance is probably a better metric anyway, because that’s what you’re getting in hand. And I think most people are looking at IRRs as well. And on a return performance, like I said, it won’t be the best performing asset class because it is very much that annuity style income return that you’re looking at. You don’t get the volatility of that capital growth that say the office sector does, and that’s why you generate much higher returns. But it does mean that on the downside, it’s not nearly as low either. In terms of volatility, least volatile, pretty sure on that one. But, yeah, those cap rates, if you want a cap rate, let’s say, around that 4%. I still think around that 4.25%. So pretty tight.
Richard: Look, I know that is a difficult question. My views are also when I speak with a lot of financiers, it’ll be around about 4-4.25% for Sydney and Melbourne, slightly higher for Brisbane. There’s a little bit more risk, a less mature market, but that seems to be where it’s roughly landing. And it’ll be interesting to see, obviously, if that actually materialises.
I know there’s been one asset that’s been traded in Brisbane. I don’t know, I wouldn’t be able to talk about what those cap rates were, but it would be interesting when that is made publicly available because that goes a long way. It’s starting to educate the industry a little bit more. Ben, I know we’re out of time, so I’ll just close off. And first of all, thank you so much for coming along today.
The three things that I’ve learned, and I did encourage the audience to keep in mind, is the market has been severely distorted from the pandemic. And when you overlay that with a number of the structural changes, there’s a difference between cyclical changes and structural changes. Some of those structural changes, for example, shopping online or working from home, some of them were happening before the pandemic, but some of them have been expedited because we were forced to either live at home or shop online. That has certainly impacted demand for various real estate asset classes. So that’s the first point, the market distortion.
The second one, just listening to you speak, there’s definitely submarkets within submarkets. And, obviously, you got the different asset classes and there’s different levels of risk, but also different levels of return. And I think that’s important to keep in mind because you can’t judge one without looking at the other. And you’ve got, for example, BTR, which in my mind may have a slightly lower return, and you do need to look at the overall return, not just the yield, but it also has lower levels of risk. And that’s important for different buckets of money to consider in terms of the risk return profiles.
And then the final one is, and I say this all the time, having data and evidence. And I know that you have fantastic data and evidence. That is one of the tools that people need to use to make investments and development decisions right now, especially with so much uncertainty. And I think moving into the future, it is going to be much more relied upon having reliable data and evidence. And I particularly like your benchmarking indexes because it’s really good to start comparing different asset classes and the performance over one, three, five years.
And I wish you all the best in terms of getting the BTR index up and running because I think that that’ll go a long way to help capital price the risk. Before I close off, did you have anything else you wanted to add?
Benjamin: Oh, just thank you so much for having me Richard. I thoroughly enjoyed it. It’s always good to chat and share views, and I look forward to doing it again sometime.
Richard: Well, I was going to say you’re definitely welcome back, and we’ll have to jump into some of the other topics that we discuss, in due course. But thank you so much for coming along. And listeners, I hope that you really enjoyed the session. Thanks very much. Bye.
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