Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 242

The hot spots in commercial real estate

Seven years into an upcycle, Australian non-residential (commercial) real estate returns have stabilised according to the latest PCA/IPD Australian Property Index published by MSCI. The Index, which tracks the performance of more than 1,470 institutionally owned office, retail, industrial, hotel, and medical properties, generated a total return of 11.9% in the year to December 2017. This is below the peak of 13.7% recorded in the year to 31 March 2016 but is still above the 5- and 10-year averages of 11.5% and 8.3% respectively (Figure 1).

Figure 1: Non-Residential Real Estate Total Returns: 2007 – 2017

Source: MSCI

Non-residential real estate, like most asset classes, has been buoyed in recent years by bond yields falling to record lows. Most of the returns from real estate in the past few years has been due to capitalisation rate (yield) compression (as cap rates go down, values go up) rather than income growth (Figure 2).

Figure 2: Drivers of Non-Residential Property Investment Returns: 1995 – 2017

Source: MSCI

Direct real estate (returning 11.9%) and unlisted real estate (12.8%) typically have gearing between 20% and 50%, and they outperformed infrastructure (11.1%), listed real estate (8.5%) and bonds (5.8%), but underperformed equities (13.1%) during calendar 2017 (Figure 3). Investors hunting for yield were well rewarded if they invested in infrastructure and direct real estate with income returns of 8.6% and 5.8% respectively.

Figure 3: Asset Class Returns: Year to 31 December 2017

Source: MSCI

Sub-sector performance highlights demographic trends

Drilling down into the various sub-sectors shows a wide variation in performance. The best performing sector was ‘Other’ (medical, health, seniors living, and car parks) with a total return of 19.8% in the year to December 2017 followed by hotels at 14.5%. Notably, both these sectors were also the best performers in 2016.

Health and medical assets are now well and truly on the radar of institutions, as are the other alternate assets like childcare, seniors living, student accommodation, and data centres. Medical and health centres are benefiting from the aging population, changes in the delivery of medical services, and their higher yield relative to office, retail, and industrial assets, although the re-rating of the sector has seen the yield gap narrow in recent times.

Hotels, particularly in the gateway cities of Sydney and Melbourne, are booming. Strong growth in international and domestic tourism and buoyant business conditions in both cities has occupancy levels and room rates at near-record levels. Sydney’s average occupancy in 2017 was 85.9% (on some nights it was near impossible to find a room) and the average daily rate increased by 4.7% to $230 per night. Melbourne’s average occupancy in 2017 was 83.1%.

Figure 4: Non-Residential Real Estate Sectors: Total Returns 2016 and 2017

Source: MSCI

Retail real estate was the worst-performing sector with a total return of 10.1%. Given the challenges facing the retail sector, both structural (Amazon, on-line retailing) and cyclical (high household debt, low wage growth), many would be surprised that retail generated a double-digit return in 2017.

One explanation is that Super and Major Regional Centres (the mega retail centres) comprise almost 60% of the market capitalisation of the Retail Index, and those centres generated an average total return of 10.3% for the year (Figure 5). Globally, institutions are lining up to buy these so-called tier one ‘fortress malls’. The rationale: they dominate their trade area and are perceived to create a community destination (retail, entertainment, restaurants, medical etc.) rather than just a shopping experience. Therefore, they are best placed, of all the retail centre types, to withstand the onslaught of on-line retailing.

Figure 5: Retail Centre Total Returns: 2016 and 2017

Source: MSCI

In November 2017, the AMP Capital Shopping Centre Fund and the AMP Capital Diversified Property Fund each acquired a 25% stake in Indooroopilly Shopping Centre in Brisbane with management rights, in a deal worth more than $800 million on a yield of 4.5%. This was the biggest single-asset retail transaction and represented the first super-regional shopping centre to be sold via an on-market campaign since 2010. Other notable transactions in 2017 include GPT acquiring the 25% interest they didn’t already own in the 153,000 square metre Highpoint Centre in Melbourne for $680 million from their JV partner, the Besen Family, on a yield of 4.25%. GIC, the Singaporean Sovereign Wealth Fund, exchanged a 50% stake in Queen Victoria Building, The Galleries, and The Strand Arcade, all in the Sydney CBD, for a 49% stake in the ASX-listed Vicinity’s Chatswood Chase. The $562 million deal was struck at a yield of 4.75%.

The easy money has been made

Overall, at Folkestone we are underweight retail as we believe the headwinds will continue and there are better opportunities in other sectors. Deploying capital at this point in the cycle requires patience and discipline. With real estate yields across most sectors at record lows, the easy money has been made.

We expect the pace of cap rate (yield) compression to slow and the focus to move to asset-level income generation as the primary driver of non-residential real estate performance. Investors should recycle out of assets that have limited capacity to grow the cashflow and retain or buy assets where there are opportunities to actively manage, refurbish, or reposition to drive income growth. Asset specific factors will be critical including landlord tenant relationships, quality of tenants, lease expiry profile, location, and the active management of the building’s facilities. With record high electricity prices and electricity being one of the major costs of operating a building, efficient operating of the building will be crucial to optimising the bottom line.

 

Adrian Harrington is Head of Funds Management at Folkestone, a sponsor of Cuffelinks.

RELATED ARTICLES

Offices will live on in a post-COVID world

Not all non-residential real estate performs the same

Strong capital flows support non-residential real estate

banner

Most viewed in recent weeks

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

Latest Updates

Investment strategies

Charlie Munger and stock picks at the Sohn Conference

The Sohn Australia Conference brings together leading fund managers to chose their highest conviction stock in a 10-minute pitch. Here are their 2021 selections with Charlie Munger's wisdom as the star feature.

Interviews

John Woods on diversification using asset allocation

All fund managers now claim to take ESG factors into account, but a multi-asset ethical fund will look quite different from a mainstream fund. Faced with low fixed income returns, alternatives have a bigger role.

SMSF strategies

Don't believe the SMSF statistics on investment allocation

The ATO's data on SMSF asset allocation is as much as 27 months out-of-date and categories such as cash and global investments are reported incorrectly. We should question the motives of some who quote the numbers.

Investment strategies

Highlights of reader tips for young investors

In this second part on the reader responses with advice to younger people, we have selected a dozen highlights, but there are so many quality contributions that a full list of comments is also attached.

Investment strategies

Four climate themes offer investors the next big thing

Climate-related companies will experience exponential growth driven by consumer demand and government action. Investors who identify the right companies will benefit from four themes which will last decades.

Investment strategies

Inflation remains transitory due to strong long-term trends

There is momentum to stop calling inflation 'transitory' but this overlooks deep-seated trends. A longer-term view will see companies like ARB, Reece, Macquarie Telecom and CSL more valuable in a decade.

Infrastructure

Infrastructure and the road to recovery

Infrastructure assets experienced varying fortunes during the pandemic, from less travel at airports to strong activity in communications. On the road to recovery, what role does infrastructure play in a portfolio?

Economy

The three prices that everyone should worry about

Among the myriad of numbers that bombard us every day, three prices matter greatly to the world economy. Recent changes in these prices help to understand the potential for a global recovery and interest rates.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.