Rebecca Kent
I’m Rebecca Kent. You’re listening to JLL’s Perspectives podcast.
Cautious but confident is how you might describe the way investors are approaching commercial real estate as they navigate a sector hit by huge economic and social changes over the past year.
JLL Research predicts the values of some of Australia’s best city office buildings will fall by anywhere from four to seven percent in some areas, while older buildings could see their values drop even lower, by 20 percent. The same goes for some regional shopping centres.
There’s promise on the horizon though. Various coronavirus vaccine announcements appear to be shifting sentiment, causing share prices to jump for some office and retail landlords as investors hold out hope for a speedy return of workers back to the office, and shoppers back to malls.
One type of property that is thriving regardless, is warehouses. On the back of an ecommerce boom, investors seemingly cannot get enough, and for the first time ever, industrial assets are in the same league as shiny city offices in terms of their value.
Here’s Andrew Ballantyne, JLL’s head of research in Australia, commenting, on a JLL webinar, on the making of a new hierarchy among the core asset classes of office, retail and industrial.
Andrew Ballantyne
The next area that I wanted to discuss this morning is what we've called the great convergence. This chart shows that story of the great convergence that we're seeing across the office, retail, and industrial and logistics sector. And it's really the industrial and logistics sector that is driving this convergence at the moment.
A lot of people have talked about how resilient the sector has been through COVID-19. I actually believe the defensive characteristics of the sector first started to be recognised to a greater extent coming through the Global Financial Crisis. What we saw through that crisis was the resilience of income and rent collection. We've seen that come through again very strongly. So we can see that those defensive characteristics are very much valued by investors.
And the big question: could we actually see an inversion of some of those relationships and a new hierarchy between the sectors? Because this convergence story that we're seeing here in Australia is very much replicated around the region.
If you look at Shanghai as an illustration, the spread seven years ago was about 250 basis points between office and industrial, it's now sitting at just under 100 basis points. I think that great convergence story is going to be a thematic that we discuss moving forward over the next 12 to 18 months.
Rebecca Kent
Andrew Ballantyne there was speaking on a JLL capital markets webinar titled ‘The truth about the impacts of COVID’.
For this podcast, I’ve extracted a few really good other bits from that webinar. You’ll hear from Leonie Wilkinson, senior vice President at Brookfield Asset Management, who talks about the opportunistic investments that are interesting Brookfield right now; and Dave Roberts, head of global real estate strategy at Macquarie Group, who looks at how investment in Australia is stacking up against its global rivals.
You’ll also hear from Fergal Harris, JLL’s head of capital markets in Australia, who was moderating.
By the way, if you’d like to watch the whole webinar, or if you have a question for any of the panellists, drop us a line at jll.com.au/perspectives-podcast.
First of all, Fergal kicks off here talking about rising property yields and low interest rates and the opportunity this presents for investors prepared to withstand the risk of uncertainty in the short term.
Fergal Harris
One of the things that has been on my mind has been the increase in cap rates, and also the historic low risk-free rate. You'd have to think that given where historically cap rates trend towards a risk free rate, that there would be a natural convergence in the offing over the next two to three years - notwithstanding the short term risk.
Leonie, from Brookfield’s perspective and your own perspective, that presents opportunity, clearly. Not that it's a given. And that it’s just going to buy a property over time and over time it pays for itself because there's a convergence. But it must offer an opportunity for the less risk-averse, or the more risk-savvy. Would you agree with that?
Leonie Wilkinson
The current spread in the yield on property and the yields that you can receive on bonds are very high. That supports down pressure on cap rates in real estate. But the caveat to that, is that investors do need to see high quality income coming from those real estate assets to justify that tightening in yield. So I think your point around an opportunity for a risk-averse investor is there if they can do their work on the quality of income coming off that asset and be comfortable that there's a long-term lease in place with the covenant, then, yes, absolutely, strong demand from investors that have focused on that yield and are risk averse.
Equally, on the other side of the equation, if we have less resilient income, or a shorter WALE (weighted average lease expiry), or income in place from a tenant that may be vulnerable post-COVID-19, then as the income has more risk associated with it, they're the kind of contrarian, opportunistic investments that we're quite interested in at Brookfield. This is where we're starting to see some opportunities come in to play now. We think they'll start to emerge six to 12 months post the trough of the downturn.
I think generally, high quality assets are owned by high quality institutional investors who are rational and thinking long-term and are continuing to invest into those assets. So I completely agree, it's unlikely that we'll see distress in the high quality assets across all sectors of real estate in Australia.
But we're keeping a really close eye on perhaps lower-quality assets within those sectors that might be owned by a group that perhaps doesn't have the appetite to continue to invest capital into that asset, so it's attractive to occupiers going forward.
And also in some of the sectors that are unloved by the listed market in particular. So there are good fundamentals that we believe in over the long term, in sectors like tourism, hotels, generally, student accommodation, even retail if we believe in the long-term fundamentals, where we're seeing those prices come off already and a lot of vulnerability in the income, we're very interested in looking at those over the next little while.
Fergal Harris
If we go back even a short time ago, we were saying distress would naturally follow an event like COVID-19, with the softening of the economy that we're in at the moment. And we talk about this euphemism of ‘dry powder’.
Dry powder is a combination of government stimulus, the underleverage in the debt markets, and the foreign capital that pre-existed before COVID. Andrew, what's your sense of that? Is it a significant amount of capital that will also fund acquisition if there's product? But also stave off potential distress or wholesale distress in the market? It's significant.
Andrew Ballantyne
The treasurer said that the budget is underpinned by a vaccine towards the end of 2021, so let's use that as a sort of figure coming through.
If that starts to come through, the thematic that we're talking about at the moment, in terms of wide spreads between cap rates and risk-free rates start to become interesting across the board.
And arguably, it becomes more interesting for those assets that have seen some distress, that is, pockets of retail, pockets of hospitality, where the spreads are significantly wider. So there will be little pockets of distress, but I don't think it's going to be a repeat of what we saw back in the Global Financial Crisis.
I'm a big believer in looking at who I consider the big global investors, who are thematic investors. I think they're already positioning themselves around what it means as we start to come out of COVID.
Because I think everyone's fairly comfortable that we're going to be in an ultra-low treasury yield environment for an extended period of time. I think it was one of Dave's colleagues who first said to me “I think this is lower for longer forever”. It was the adding on of “forever”, that is going to have significant implications for asset pricing moving forward.
Fergal Harris
Dave, just in terms of the relative yield story between the region and Australia, which I think we saw in the middle of a recovery post-Global Financial Crisis. We're going to touch a little bit on that, and what your what your view is.
Dave Roberts
On a relative basis, investors with an allocation of real estate are looking across the Asia Pacific region. If the comparison is, ‘I've got an allocation to core real estate across Asia Pacific, and I look at CBD (central business districts) in Tokyo, Central 5 Ward - cap rates at 3 percent. Similar in Singapore, similar in Hong Kong, Shanghai is at 4 percent.’ On a relative basis, Australia's cap rates really stack up against those competing markets.
Then if you overlay the political stability, the way the government has been able to control COVID-19 relative to other developed markets. I think the long-term fundamentals of Australia's safe institutions, and stable political outlook, will continue to support capital flowing into the Australian market.
I think the other thing that we can't overestimate is economically Australia's exposure to China. China has done well to recover out of COVID-19 and it is probably the only economy globally which has above pre-crisis GDP levels. That's a huge positive. It is a huge positive for Australia's commodities exports, which are supporting iron ore pricing and Australia’s export sector.
The other point to make, interestingly, is if you're a global investor and you've got a core allocation to Asia Pacific - particularly if you're an American investor - you're going to be much more hesitant about allocating to China, including Shanghai and Beijing, going forward. So, if you're forced to place that into real estate in the region, you then look at Japan. We know where cap rates are in Japan. So by default, investors continue to either be forced into the Australian market or continue to look to the Australian market for placing capital.
So beyond any near-term disruptions from COVID-19, in terms of transaction volumes, I think, longer-term, medium-term, I envisage more capital coming back to the Australian market, which supports cap rates. And I think in a deflationary environment, I wouldn't be surprised if CBD (central business district) office cap rates are below where they are currently, or pre-COVID, over the next three or four years, given where cap rates are in the rest of the world.
FERGAL HARRIS
Leonie, we only were talking about international investors and international capital, including the dry powder, and the difficulties that people are finding in coming to Australia to inspect and to invest. If we're not going to be travelling until the second half of next year, international capital must surely be able to find a way or some solution to investing in this market.
LEONIE WILKINSON
Yeah, I think there are a couple of ways that investors are approaching it. The first is, the restrictions benefit capital that is already experienced in this market and has the confidence to transact without necessarily being on the ground – albeit that's highly unusual for the way that we traditionally work. But if they are positioned well and extensively with trusted advisors across the market, then we've seen that confidence play out already.
And I think the climate also benefits incumbent managers of offshore capital. So it's far easier for an investor to commit more capital with a manager that they already know and trust.
The other really interesting element is technology stepping up to play a role in this. We've been looking at assets ourselves that are overseas using some really high quality virtual, fly-throughs of the assets. It's absolutely not the same thing, but it's a way that you can supplement the work that you can do with the advisors that you have on the ground and pull it all together.
It's amazing how people will continue to evolve and figure out solutions to these things as we need to. It certainly make things tougher, but it's been quite encouraging to see the work and the evolution of the way that people can do this kind of investing in this environment.
FERGAL HARRIS
Necessity is the mother of invention. I’m looking forward to seeing how well-honed and tightly-held beliefs will get let go very quickly when you can't invest, and you need to invest.
I’d just like to thank you all very, very much indeed for taking time to join us this morning. It's been excellent. Many thanks on behalf of JLL. Thank you very much.
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