The real estate industry has navigated significant economic and social shifts since the outbreak of COVID two years ago – and throughout 2022 (and beyond) we will continue to see the flow on effects.
With 2022 well underway, the Corrs Real Estate team unpack their expectations for the coming 12 months.
Investment: strong interest from offshore capital
In uncertain times, Australia’s real estate industry will continue to attract foreign investors as a flight to safety. However the source of interest is shifting.
The financial regulatory guidelines introduced by China in August 2020 (the three red lines) relating to the ratio of debt to cash, equity, and assets and concerns about Australia’s foreign investment regime are likely to see a continued reduction in Chinese investment in Australian estate.
With unprecedented dry powder of private equity, we expect to see ongoing investment by Singapore and the United States. AUD conversation rates mean Australia will continue to be viewed as an attractive market, for the most part.
Commercial: premium assets to perform
In our article in the early stages of the COVID pandemic, we called for the end of eulogies for the office and that prediction has stood the test of time.
Despite the increase in working from home, office demand has been more positive than predicted and there is a weight of capital looking to invest in office buildings, not only within the traditional large markets but also in fringe markets and secondary CBDs.
Acquisitions of trophy assets like Grosvenor Place in Sydney, on which Corrs acted, highlight the continuing confidence in the Australian market and the willingness of sophisticated investors to take a long term view with respect to not only the market, but the assets within it. With that said, uncertainty in the labour market and the inflation forecast pose a risk for the offices that are hoping to enjoy the same vibrancy they did in the pre-COVID landscape.
Ultimately, core assets are set to remain favourable, however there may be a bifurcation between core premium assets (with value driven by long WALE and ESG factors as mentioned below) and B Grade assets which may not be as resilient.
Office occupier’s reframe their corporate real estate strategy in different ways
How this translates into office space requirements for occupiers will be a hot topic for many organisations and will differ across and within sectors depending on workplace culture and approach to staff preferences and employer expectations.
While professional service firms have coped remarkably well with remote working, many recognise the need to amplify collaboration and teamwork – and in-person experiences can be a crucial component of this. Creating compelling reasons to attract staff back to the office will be key, while maintaining flexibility to work remotely.
What appears to be clear is a flight to quality, with growing demand for good amenities such as third spaces and innovative retail, combined with office fitouts that emphasise communal spaces to share and collaborate. Reducing space requirements and rent bills are set to be less of a focus – in contrast to attracting and retaining the best talent.
Many ASX companies with large national office footprints are continuing to ‘right size’ their office portfolios as they promote and adjust to a ‘new normal’ hybrid of remote and in office working. The corporate real estate function is constantly adjusting to the needs of the company. We will continue to see sublease and negotiated surrender deals to utilise surplus space, as well as new office requirements hitting the market which hone in on the office needs of the future.
Industrial: sector strength set to continue
For the Australian industrial sector, 2021 was a year of records – record deal volume, record yield, record occupancy demand, and it looks like the trend will continue in 2022.
The global thematic investment with respect to logistics is continuing to evolve. We have seen widespread increases in rent and the demand for logistics premises strengthening, in particular last mile and infill sites.
In recent years the landscape has been dominated by a number of institutional investors often acquiring assets from disaggregated private investors. Last year, we saw this trend endure with a number of institutional players selling large portfolios, showing the aggregation and ‘develop-to-core’ approach pay off. This points to a continuation of these strategies.
New buyer entrants from the United States, Hong Kong and Singapore teaming up with local investment, development, and property managers are also likely to intensify market competition with buyers seeking value by securing elusive off-market opportunities.
Given the sharp yield available, corporates will be looking at their land holdings and considering whether now is the right time to cash in by way of a sale and lease back, which are attractive to institutional investors, particularly with triple net leases backed by a strong tenant covenant.
For tenants looking for bespoke premises, cold storage or high automated facilities, fund throughs may be a good options given they provide tailored premises and are financially efficient, albeit with more legal intricacies.
Issues pertaining to construction costs and supply, which were already stretched even in the pre-pandemic world, mean it is too early to assess the extent of the contagion from ProBuild’s collapse and the impact across the sector on the issues of development costs and timing.
Retail: essential assets in favour
After a difficult period for the retail sector, there is continued strong demand for essential retail assets (neighbourhood centres and large format retail), especially in strong growth corridors. With investor demand being driven by unprecedented growth in groceries and household goods sales, last year was a record year for retail investment activity.
With the changing focus of consumer demand has continued to spur some key themes we have seen emerge in recent years:
- Further market activity in large format retail assets with a secure long term retail tenant covenant, increasing the crossover between retail and industrial property investment mandates driven by growth of online shopping and retail innovations such as click and collect;
- The emergence of other hybrid models where retail land owners are looking to diversify or reposition the assets in the market, coupling retail with medical, office and residential;
- The repurposing of retail assets for alternative and mixed uses to unlock value. Location, demand and infrastructure dictating what is viable; and
- The acceleration of non-core disposals to enable reinvestment in core assets and development opportunities.
Retailers will continue to adapt to the changing retail market including down-sizing stores in exchange for ramping up on-lines sales, changing formats and pressing for reduced rents.
Residential and mixed use developments: shifting supply and demand considerations
The significant constraints on the supply of labour and materials caused by COVID are unlikely to ease any time soon. This means that construction timeframes will continue to be stretched, potentially increasing the attractiveness of established housing, particularly in WA where the constraints have been compounded by closed borders.
Across the eastern seaboard, we have been seeing an uptick in demand for new residential sales, particularly in the outer suburban rings where demand for house and land, and land only, is strong. However we are now starting to see sentiments and demand turn, particularly in Sydney after a buoyant run on residential property. Developers have been reporting record sales prices despite the authority delays, rising costs and interest rate rises on the horizon. We may start to see state differences emerge due to the impact of interstate migration in the next 12 – 24 months and an increased focus on sustainable developments across the nation.
The desire to realise the great Australian dream of owning property is not changing, but the property the subject of that dream is shifting as owners and occupiers seek a ‘live, work and play’ lifestyle at affordable prices.
As developers pursue opportunities in a supply constrained market and landowners look to unlock unrealised development potential in their sites, mixed use developments are on the rise – and not just building apartments on top of a desirable retail offering (although there is still plenty of that). New developments are considering how best to provide amenity to residents, particularly in the wake of COVID-19, exploring working from home hubs, outdoor space, complementary retail and office space in the area.
However, it is the airspace above structures that is currently receiving significant attention. As traditional development sites become scarce, particularly in urban areas, developers are looking for opportunities to develop above existing structures (such as transport hubs, churches, supermarkets and commercial buildings). Landowners are the beneficiary (and often instigator) of this trend as they either dispose of these air rights or enter into co-venture arrangements with developers for the redevelopment of their existing asset and the future asset above.
From early planning and project delivery to design, social and environmental considerations, and title structures, there are a range of challenges unique to every development which must be identified and managed to ensure the project’s successful implementation. Having a number of stakeholders with differing interests co-locating within the one development can lead to a number of future issues and disputes. Careful consideration must be given at an early stage around how the development is intended to work in practice, with governance and management structures with appropriate rights documented.
Build to Rent (BTR): favourable market conditions
BTR (or Multi-Family) has been the hot topic spoken about for a number of years. The land tax, GST and MIT issues, FIRB barriers and planning hurdles have been discussed at length and, with a couple of notable exceptions, largely ignored by State and Federal Governments.
Very few true purpose designed BTR developments have been completed and released to market for rent – but this will change in 2022.
Market conditions seem right for BTR to thrive. A weight of capital is looking to enter Australia’s BTR market, set to follow the UK’s recent growth trajectory and driven by interest rate rises and ongoing housing affordability considerations.
The recent property boom is pushing housing prices beyond the reach of many but there is also upward pressure on rents and squeezing vacancy rates. Renters continue to be treated poorly by many landlords, with recent reports in Victoria indicating that many tenants are waiting more than eight months to resolve bond disputes.
Developers, investors, operators and of course financiers will be watching to see how quickly the new BTR buildings can be fully leased, whether tenants are willing to pay a ‘premium’ rent, the uptake of ancillary services and the use (or otherwise) of communal amenities. As the year progresses, attention might turn to arrears and re-letting costs which could influence the owner’s appetite for bonds. Operators will get to test their newly developed online leasing platforms.
Supply chain issues, inflation and managing third party construction risk will result in an increased focus on back-to-back arrangement and gross maximum price contracts. Scale and opportunities for investment, along with locating experienced management with Australian local market knowledge, will continue as a headwind.
If demand for traditional residential apartments continues to rise, competition for BTR sites will escalate and combined with increased construction costs, this will cause new BTR projects to face increasing pressure to financially stack up. We expect to see increased competition exacerbated for sites that are suitable for BTR developments – inner city or inner ring with access to public transport and nearby parks.
Continued rise in alternatives
NDIS and childcare
It is expected that 2022 will see the continued growth of investment in NDIS (Specialist Disability Accommodation) and childcare real estate. In periods of change, the attraction to these assets are the long leases with income subsidised by government. Added to that, they provide a social premium that can contribute meaningfully to meeting ESG considerations of investors.
While childcare centres were on the front line during COVID-lockdowns (and there was a resultant delay in the development of new centres during 2021), there is now a three-fold increase in childcare enquiries.
Aggregation of marketable portfolios remains a key constraint for these asset classes, however, a recent childcare portfolio acquisitions and investment commitments from institutional investors show the asset class is maturing.
The self-storage sector remained buoyant in part thanks to domestic interstate migration and sea / tree change relocations. 2022 should see a return of the sector to steady growth, supported by the more typical demand drivers of population migration and growth, and demographic change.
With border restrictions now eased, 2022 looks bright for investment in student accommodation. Even during the uncertainty of the pandemic, large investments were still made by global institutional capital. .
While it may be some time before the pre-pandemic level of international students returns, expectations are for a return of deferred students and an increase in domestic demand with fewer Australian students studying overseas. Industry predictions are for the sector to almost double in size to $50 billion by 2025, so significant investments are expected in 2022.
Healthcare & life sciences
Healthcare related real estate, including hospitals, medical centres, surgeries and radiology and pathology centres, continue to attract significant interest with high levels of investment by listed REITs and other institutional investors. The asset class is considered defensive and continues to be attractive due to strong yields and long WALE lease structures.
As a result, competition for assets continues to be at unprecedented levels, resulting in tightening yields. We expect these conditions to continue in the coming quarters and for capital values to be maintained off the back of stable rent increases as a result of the expected continuing increase in inflation predicted by the RBA.
We are seeing a growing focus on large-scale life science hubs as property developers and investors collaborate with universities, healthcare providers, research laboratories and pharmaceutical companies to create new precincts and development opportunities.
Similar to previous years, we are seeing a large number of healthcare assets being acquired in suburban metropolitan areas rather than CBD locations. These locations often represent more attractive yields value and are close to population centres.
In a similar way to the industrial sector, we expect to continue to see institutional investors looking to acquire multi-asset portfolios to build scale quickly.
ESG: well beyond a tick-box exercise
Gone are the days where environmental, social and governance (ESG) monitoring was a mere tick-box exercise in a glossy report. ESG is now a fundamental element of investment in real estate, sitting at the forefront of the minds of investors. It not only drives value but in many instances, a real measurable ESG performance is required to get a seat at the table.
ESG considerations are now front page news, with ground breaking proposals like Mike Cannon-Brookes at Brookfield’s bid for AGL Energy garnering wide spread attention. The drive towards ESG is also playing out at the real estate asset level, evidenced by investors increasing willingness to pay a premium for sustainable buildings – as seen in the number of sub 4% yield office transactions that successfully took place in 2021.
From an environment perspective, the ‘stick’ is the reporting requirements imposed by regulators and the ‘carrot’ is investor and tenant expectations and requirements for Green Leases, sustainability in construction methodology and the sustainable operation of buildings. There is movement towards only wanting to deal with counterparties who have robust climate change and net zero carbon commitments.
From a social perspective, where we all live and work (which for many is commonly one and the same) is also being viewed through an ESG lens. Employees are demanding workplaces cater for all aspects of wellness, from the air they breathe, the level of amenity and food offerings, to the design allowing spaces to connect but also to distance.
The increased flexibility to work from home has also put into focus the design and use of where we live, and the explosive increase in house prices in capital cities and regional areas across the nation have ensured that housing affordability is a key focus for all Australians (in particular younger Australians who are increasingly being locked out of the housing market). This affordability crisis impacts everything from economic, tax and social policy to the rise of BTR, affordable housing, co-living and intergenerational living.
Finally, bribery and corruption, board and management diversity, donations and lobbying, remuneration, and ethical standards and general governance are now integral in how participants in the real estate sector operate and transact.
Gone are the days where ESG clauses were a necessary evil in the back of a document or board diversity was seen as a nice to have – robust and reportable governance regimes are now a requirement for many tenants, investors, employees and all other participants.
Those who don’t have an appropriate regime will be quickly left behind.
REITs: M&A remains attractive
Globally, a merger wave swept across the REIT sector last year. According to JLL, REIT M&A activity had reached US$108 billion by the end of September 2021, which had already broken the sector record set in 2006.
In 2022, we expect high levels of M&A activity to continue. A mix of rising interest rates (raising questions about leverage), assets trading below NTA, and a frustration in finding direct-investment opportunities at scale are factors likely to spur activity. In addition, takeovers enable the deployment of a big lick of capital in one hit, while providing access to quality underlying assets and management.
We expect 2022 will likely see investors looking beyond owning real estate assets, and more towards seeing the value in operating platforms and management teams that can help them expand their presence in Australia and provide a competitive edge.
This publication is introductory in nature. Its content is current at the date of publication. It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this publication. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.