Rebecca Kent
What are the three main topics that have got real estate talking right now? I put that to JLL’s head of research for Australasia, Andrew Ballantyne, who is easily one of the industry’s most respected commentators. I tore him away from his hectic calendar of events and presentations to share his observations on the office, build-to-rent (or multifamily), and industrial sectors.
I’m Rebecca Kent, host of this JLL Perspectives podcast.
Rebecca Kent
Welcome back, Andrew to our perspectives podcast. It's great to have you back. You spend your time day in day out making presentations to clients, industry peers and colleagues. And we've also released our quarter 1 figures for 2023 as well. Maybe you can shed some light on what some of the big talking points have been?
Andrew Ballantyne
Sure. I think the three main stories that I look across the market at the moment are:
Office leasing market resilience;
Industrial and logistics rental growth, which continues to be at phenomenal levels;
And not from our statistics, but what we saw on the announcement from the national cabinet that there will be a change in the MIT structure as it relates to BTR (build-to-rent) projects. So going from 30% to 15% withholding tax.
Rebecca Kent
So just to clarify, what's MIT?
Andrew Ballantyne
It's managed investment trusts. It's a tax that you pay as an offshore investor on having your investments through that vehicle.
Rebecca Kent
All right. We'll definitely touch on all those points throughout this conversation.
How did Q1, the first three months of this year pan out? Is it what we expected?
Andrew Ballantyne
I think what we've seen in the office sector from the leasing market is it has continued to remain fairly resilient. If you look at the numbers we put out there, we recorded 43,000 square meters of net absorption. So that's positive demand across Australian CBD office markets.
And if you look over the last 12 months, it was 124,000. So it was below the trend that we saw for demand pre-COVID. But it's still a positive result. And ultimately, a positive result shows us that organisations have been growing headcount and that has translated into positive net absorption. If you look at some other mature economies, you're not seeing this level of strength in the office leasing market that we are here in Australia.
Rebecca Kent
So you talk about headcount there. That presumably correlates with a fairly strong employment rate across the country.
Andrew Ballantyne
Yes, the labor market has been very strong over the past 12 to 15 months. There are some signs that it is slowing slightly at the moment. If you look at the lead indicators around job advertisement surveys, they've come off their most recent peaks, but they're still at fairly elevated levels. And most organisations that you speak to have pulled back their recruitment plans, but they're still looking to attract and retain knowledge workers who can help grow their business over the medium to longer term.
Rebecca Kent
Is that across most industries, or are there some sectors, for example, the tech sector … I know there's been a lot of commentary around its performance ...
Andrew Ballantyne
I think you've got to be careful with the tech sector in that it is very broad and diverse. What we've essentially seen at those NASDAQ-listed companies, whose footprint is a lot smaller in Australia than what you see in New York and San Francisco, is they’re looking to rationalise their workforce at the moment. If you look at the headcount growth that they've had over the past three-to-four years, it's been phenomenal. So, it's only actually bringing them back to where they were 18 months ago, in terms of overall headcount growth. So, while there's volatility in that sector at the moment, we still see that as a growth trajectory over the medium-to-longer term.
Rebecca Kent
Is there much difference in decision making about offices with big global companies with HQs, say in the northern hemisphere, or in the Singapores and the Hong Kongs of this world, compared to the domestic organisations?
Andrew Ballantyne
I think you need to look at it as Asia Pacific versus the rest of the world.
In the Asia Pacific region, we're still seeing positive economic growth across most mature economies. If you look at Australia, most economists expect that our GDP will grow by around 1.8% this year. It's not the trend growth of 2.7% to 3% but it's still a positive figure.
When you look at Western Europe and North America, you're clearly seeing the economy slowing, you're clearly seeing risk of recession being greater there. And for those organisations that are headquartered in the U.S., they are certainly becoming a little more conscious in their decision making, and you are certainly seeing some delays in that overall decision making. Whereas domestic organisations tend to be a lot quicker in terms of when they're making real estate decisions.
Rebecca Kent
Yeah. Okay. So you sound positive and optimistic about the office market. And the positive net absorption there obviously supports that. Does perception out there align with what the figures are telling us?
Andrew Ballantyne
If you only sourced your information on the office market from social media, you could have a whole diverse range of views out there, because there’s a lot of different commentary around how office space is going to be used moving forward. And we are certainly big subscribers to flexibility. But we're also big subscribers to looking at the actual numbers. And the numbers, as I said, are below trend from a pre-COVID, but they're certainly not negative at the moment.
The other big trend that you see in the numbers is the demand for higher quality assets. If you take Sydney and Melbourne in particular, there is a significant divergence over the past two years for net absorption for prime grade assets versus secondary. So, a very strong result for prime and a very negative result for secondary grade assets. So that ultimately shows that organisations are wanting to move into better and higher quality real estate.
If you look at the U.S. statistics, and as I said they are a little softer than our own, you do see similar observations. They tend to look at net absorption by building age cohort. Since the onset of COVID, it has been negative for every single cohort with the exception of those assets constructed since 2015. It's very much a ‘new’ story. In Australia, we argue it's not just a ‘new’ story, it's a ‘quality’ story. We've seen (owners of) some buildings that were constructed in the late 80s and early 90s, continue to invest capex, continue to invest in the characteristics that organisations want, and continue to see quite strong leasing success.
Rebecca Kent
What are some of the features of these repositioned and prime grade buildings that we're seeing?
Andrew Ballantyne
There's a combination. So, there's obviously the characteristics of the asset itself: What does that offer in terms of the entry statement in the lobby? What does it offer in terms of the end-of-trip and the broader wellness offering within the building? But then you can also go into the design of the workplace by the organisations and the consultants themselves. And we've clearly moved to a model where … and having moved into a new building here at 180 George Street, the number of people that say, ‘it feels like sitting in the lobby of a hotel’, on our on our level 27, client-facing floor. (That relates to) the type of furnishings we have, the atmosphere that we have, we've also got wellness areas, we've got prayer rooms, we've got a very big social hub. And I think that's one of the aspects that people really like, that social aspect of the workplace.
So you really need to consider what you actually have within your workplace design that encourages that socialisation. It essentially encourages the ‘bump’ factor where you catch up with a colleague unexpectedly, you have a brief discussion and then you go away with one or two new ideas. And ultimately, what all organisations are trying to do at the moment is to try and be productive and innovative. And if you look at the statistics, they've not been very good recently.
Rebecca Kent
Just to be clear, that's 180 George Street in Sydney. It’s right by the Circular Quay area with wonderful views over the Harbour Bridge and Opera House - pretty magical. And do you see any emerging trends in terms of office features? Trends abroad that we might see here or emerging generally, anywhere?
Andrew Ballantyne
It's actually interesting. A lot of people look at Australia for guidance. A number of clients that I speak to tend to view Australia as being world leaders in terms of how we actually design, construct and manage commercial real estate. I think there's a few reasons for that. The one that I start with is actually the ‘E’ of ESG, the environmental component. We've had mandatory reporting in Australia for a long time and due to that mandatory reporting and the visibility that we have around it, I would argue, that from the ‘E’ perspective, that our assets are world-leading.
What we're seeing at the moment is the ‘S’ aspect of ESG. So those more ‘social’ aspects. There are two ways of looking at that: The first way is how an investor thinks about it from a socially aware investment. And the second part is, what are you actually doing or providing for the workforce? So even just stepping away from the office sector, we're starting to see big shifts in industrial and logistics around the ‘S’ aspect. A number of the new estates that we've seen being developed in Sydney and Melbourne actually have outdoor wellness and outdoor gym facilities. That's part of why organisations want to be in those estates, because it actually helps with their attraction and retention of the types of workers they're trying to bring into their business.
Rebecca Kent
Okay, fantastic. I think we should move on to our second major trend: build-to-rent. First of all, it would be great if you could explain what build-to-rent is. It's called multifamily in the United States. So maybe just explain that and then what we're seeing there.
Andrew Ballantyne
So essentially, build-to-rent is a term that’s also used in the UK. The UK and Australia use build-to-rent and as you correctly said, in the U.S. they use ‘multifamily’. Given it's a nascent asset class, it's a product that's been developed, usually by a large developer, an institutional developer. What they do upon completion is actually hold the product and they lease the individual units or apartments to the general population. What we've seen in the early wave of BTR projects in Australia is they’ve largely been orientated, in my opinion, more towards younger professionals. So that’s certainly influenced the type of units that have been developed, and also the type of amenity that's been offered through these projects.
Rebecca Kent
And what are the questions that our clients and colleagues are asking you about BTR?
Andrew Ballantyne
Well, if you look at the U.S., where the asset class is considered a core asset class, it forms a large part of a diversified portfolio for major real estate investors. So they actually view it as a sector with very low volatility. Ultimately, when you invest in real estate, for core investors, that's what you're seeking, you're seeking exposure to assets or sectors with low volatility. So they're basically saying in North America that I can invest in multifamily, and also have exposure to the other core sectors of office, retail, logistics, and then the real estate alternatives. We're still calling BTR a real estate alternative in Australia, but it's a mainstream asset class in the U.S..
So part of the role that BTR is playing in Australia is … we have very low residential vacancy rates. If you look at our population projections, they're quite strong for a mature economy. And even on the most recent migration statistics, we saw 400,000 arrivals into Australia up to June 2022. Unfortunately, those are the latest numbers. They were still influenced by COVID. But if you actually look at where we were pre-COVID, then we were only 550. So, we're almost back to where we were in terms of inbound migration. So that certainly supports the population growth story that we're seeing here in Australia. And if you look at any market, pretty much across this whole country at the moment, you see residential vacancy rates somewhere between 0% and 3%. It is extremely tight.
Rebecca Kent
So what's the - and we touched on this at the beginning - what's the regulatory framework around build-to-rent? Because I understand that that is one of the challenges with the sector moving into an institutional or core asset class.
Andrew Ballantyne
So a lot of people look at it as a challenge and see the withholding tax on the MIT structure is higher for build-to-rent than commercial, hotels and student accommodation. So ultimately, what the Property Council and other groups have advocated is, it should be comparable, given the type of product that it is. So ultimately, what it does through this change in the MIT structure is it actually makes it just a level playing field with those other sectors. So the MIT structure is currently the same now between student accommodation, hotels, other commercial property, and BTR as of the first of 1 July 2024.
Rebecca Kent
So what development activity are we seeing?
Andrew Ballantyne
We have seen quite strong activity in Melbourne in particular, in the Melbourne CBD. So if you look at the build-to-rent development pipeline, it is very concentrated towards Melbourne, followed moreso by Queensland and then New South Wales. Part of the challenge in New South Wales has been, especially for CBDs, site availability. We've seen a number of build-to-rent projects in Parramatta simply due to its position as the geo graphical centre of Sydney, and also there's been site availability. But Parramatta, over period of time, has seen its demographics change. If you look at educational attainment from the Australian Bureau of Statistics, the city of Parramatta has been one of the strongest growth areas for people that actually hold a bachelor's degree. So that is influencing my thinking at the moment that most of the product that is being developed has ultimately been orientated towards professionals in their 20s and early 30s.
What I think's going to be interesting is how the sector evolves. If you look at the U.S., you see product that is targeted more towards downsizers, that’s people that have had their families and then they’re actually looking to have a different experience. You see product that's targeted towards people over 45-50. In the U.S.. You also get it you get product which is not the conventional tower product. They call them ‘garden variety’. So it's ultimately detached dwellings or townhouses, but still part of a multifamily product. What I'm really interested to see in Australia as we move through this evolution, is actually the change in the type of product offering, or the evolution and the type of product offering, that actually targets different demographic cohorts.
Rebecca Kent
And as you say, we've got a ridiculously tight housing market at the moment. So some more BTR developments would go a huge way towards alleviating that, presumably?
Andrew Ballantyne
It’s part of the solution. It's not the only part of the solution. I think Australia more broadly has looked at in the housing shortage that we currently have, we still have ambitions to be a high population growth economy. We ultimately benefit from the import of human capital in terms of how we've grown our economy over a period of time. And I think what's interesting is to actually see the shift in demographics.
Because one of the stories that got missed pre-COVID was essentially the rise of Indian migration. It was actually at a similar level to what we saw from China just before COVID. And it's actually rebounded very quickly given some of the COVID restrictions that we saw in China that lasted longer that have now been lifted. So, I think that's quite interesting to look forward at, in terms of what type of product do we see the migrants ultimately looking for.
The whole residential sector to me is going to be fascinating, led by what we see in the shift in migration patterns, and also having different product types with build-to-rent.
Rebecca Kent
I feel like there are conversations around build-to-rent building momentum have been happening for many years. If we can look at the momentum compared to previous years, where is it at the moment?
Andrew Ballantyne
I think given we just got this announcement fairly recently, that has certainly changed sentiment from certain groups towards the sector. Because one of the challenges that a number of groups had is essentially, they were saying to us that this is a nascent asset class. When you generally invest into a nascent asset class, either through development or the stabilised product, you should get an additional risk premium. It's actually priced for maturity. So now, through this change in the MIT structure, that should actually help your return hurdles, or your returns being slightly higher.
Rebecca Kent
Yep. Okay. Let's move on to the third discussion point, industrial and logistics. Is it still the golden child of the real estate sector?
Andrew Ballantyne
I think it's fair to say it is still very much the golden child of the real estate sector. So as you know, through the COVID period, we saw a very strong occupier demand for a number of reasons. Clearly, the growth in online retail was one reason but we always said that was only one ingredient. We were seeing strong demand from food and beverage, we were seeing strong demand from discretionary retailers, we're seeing strong demand from third party logistics companies, even the manufacturing sector, not traditional manufacturing, but more import and assembly, and even a positive impact from the broader health sector as well.
So there were a number of different sectors that were ultimately driving the demand side of the equation. And that's part of the reason we've seen the vacancy rates trend down to pretty much zero in most markets. There's very, very limited availability.
When you have vacancy at this sort of level, you tend to get very strong rental growth. And when you look at some of the numbers that we published over the last 12 months, in Sydney's outer central west, we're seeing market rents were up 40%. It was a little more sedate in Melbourne, it was only 25% in the southeast and 30% in the west. And poor old Brisbane was only a very modest 16% year-on-year rental growth. So you can see the types of numbers that we're seeing.
Now, what's interesting about the sector is this rental growth that we're seeing at the moment creates a tailwind. So if you assume that you were an occupier that signed up 12 months ago to a five year lease (you would have fixed indexation in the leases) we estimate that that lease is now going to be under-rented by as much as 60% when it expires in 2024.
So we're very much talking about the marginal transaction, but it actually takes time to flow through the broader sector. Because ultimately, it's captured by owners and investors when those leases actually expire.
Rebecca Kent
I made a sharp intake of breath for every percentage you said there. So, is that sustainable for occupiers? I mean, not all, but I presumably many are being hit by inflationary pressures, cost pressures and that sort of thing.
Andrew Ballantyne
Your rent is a reasonably small proportion of your overall operating expense. And it differs by industry sectors and different occupiers. Clearly growth of 40% per annum is not going to be sustainable over the over the longer period of time. So, what our expectations is that this year, 2023, will still be a very strong year, and then we'll start to see more of a normalisation in those growth rates around 2024 to 2025.
The reason we don't see a significant market correction in rents is there's fairly limited available zoned land at the moment. So, there's a process in terms of how supply comes through. There has to be ultimately, land availability, that land has to be zoned and it has to be serviced. And there's a timeline in terms of that overall journey. When you look at the activity that we've seen over the last few years, it's consumed a lot of that serviceable land. And it hasn't been getting replenished at a rate that has met occupier demand. So yes, it will come, but there is a lag in terms of identifying, and then having land rezoned.
Rebecca Kent
So is it the rezoning of land, the infrastructure and supply that is ultimately going to create a sort of equilibrium, then in the market?
Andrew Ballantyne
Over the longer term? Yes. You did touch on the fact that some businesses would be doing it tough, and I think what you will see through this year is an increase in the business failure rate. But a slight increase in the business failure rate isn't going to create significant opportunity for other occupiers, you're really going to be dealing with a handful. So it's not going to be enough to actually shift the overall market vacancy statistic in any meaningful way. Ultimately, what is required is a more meaningful supply response. And there's a delay. In Brisbane, there's a reasonable development pipeline, but when you look at Sydney in particular, it's very modest over the next few years, up until essentially the Sydney Airport and the land availability around that.
Rebecca Kent
We talked about the tenants. But the landlords and owners have pressures as well, right? Can you maybe go into some of those?
Andrew Ballantyne
What a lot of investors are thinking about more broadly is the fact that we have been in a higher inflation environment. And that higher inflation environment has ultimately led to a shift in monetary policy in Australia. And we've seen the official cash rate move higher, we've seen bond yields move out. So we're going through a period where ultimately investors are considering how they price assets at a higher interest rate environment. We call it the price discovery journey that we're going through at the moment. And we're going through that journey at the moment to essentially see what are the return hurdles for real estate in a higher interest rate environment than where we were in the COVID period and also just before.
Also, being in a higher interest rate environment, a number of owners are clearly going to have refinancing come through on their portfolio, and their overall costs of refinancing are going to be higher than where they were. So that has an impact on their equity internal rates of return.
Rebecca Kent
Okay. Great to touch on those three topics with you, Andrew, thank you. We're going to catch up again for the next quarter to do a review. But if you could describe what we see coming over the next, say, six months or so what would you say?
Andrew Ballantyne
So we touched on right at the start of the discussion that we are very fortunate to be here in Australia, where we're actually debating what level of economic growth we're going to have rather than whether or not we're going to have economic growth.
We're certainly not naïve. As economies slow, it does have an impact on the demand for space, whether that be office, whether that be industrial and logistics, or whether that be retail.
So if you look at the office sector, we have actually revised down our net absorption or demand forecasts for Sydney and Melbourne in particular, through the course of this year. But we have also been making some adjustments to our supply forecasts as well. And we've been making those adjustments because construction costs are significantly higher, and also the capitalisation rate that developers can apply to feasibilities has moved out, so the economic rent that they require to make that project stack up has gone higher. So as a result, we have actually scaled back the probability of some of our development pipeline, which will lead to, in Sydney CBD in particular, a significant reduction on our expectations over that 2025 and 2026 period.
Rebecca Kent
Okay. Thanks very much Andrew, and we'll speak again soon.
That was Andrew Ballantyne, head of research across Australasia for JLL. I’m Rebecca Kent. Thank you for listening to JLL’s Perspectives podcast.
Do add this podcast to your favourites on your preferred listening app so you don’t miss our next episode.
