NSW commercial property market and predictions for 2020

CAPITAL MARKETS

According to Ian Hetherington, National Head, Capital Transactions at Savills Australia, “2020 will see further yield compression off the back of low interest rates, shrinking margins as it becomes more competitive between the banks and low vacancies driving rental growth. 

“Demand from offshore investors will dominate the market due to the low AUD, geopolitical security and their ability to use leverage at levels double that of domestic investors,” he said.

According to Ben Azar, National Head of Cross Border Investments, Capital Transactions at Savills Australia, in 2020, Australia and particularly Sydney and Melbourne will see increased demand from offshore investors, predominantly from Singapore and Hong Kong.

“In light of recent reductions in debt costs, Australia is enjoying some of the largest spreads globally which is capturing the attention of institutional global investors. This is coupled with an accelerated urgency from Hong Kong capital seeking quality assets in Australia, meaning there will be no shortage of capital in 2020 trying to find a home in the Australian market,” he said.

RESEARCH & CONSULTANCY

According to Phil Montgomerie, Head of Research, Research & Consultancy at Savills Australia, retail is the interesting story and perhaps one for the countercyclical investor. All reports are that retail is problematic and facing large headwinds as the consumer changes its spending habits based on low income growth, underemployment (8.6% versus the unemployment rate of 5.3%, highlighting slack in the work force) and rising cost of living impinging on low savings ratio at 3.2% (US 8.3%). 

Retail yields have reverted somewhat despite no signs of distressed owners having to sell, and are now trading at a meaningful margin above bonds. Retail and Industrial yields are circa 6% and Office at 5% vs 10yr bonds at 1%. We feel this is an opportunity, especially for those centres exposed to non-discretionary spending such as supermarkets and day-to-day living items. As such, we prefer Neighbourhood centres and Standalone retail assets located in densifying areas with higher socio-economic demographics.

Australian property was encouraged by lower interest rates from the RBA easing 3 times to 0.75%, as it reacted to low economic growth, low inflation, higher than desired unemployment and underemployment, resulting in flat business and consumer sentiment. 

Sydney, North Sydney and Parramatta Office remain our preferred asset class supported by a chase for high quality asets, strong tenant demand and scarcity. Office demand has started to push the boundaries of supply as business' start to outgrow their current office space. 

Developers have remained disciplined and are requiring >30% tenant pre-commitments before projects are commenced. As such, vacancy is at all-time lows of 3.7%, with rents continuing to rise sustainably, which in turn is driving capital values higher and is attracting both domestic and international investors. We continue to view that office remains our preferred asset class, and will remain sought after by global investors seeking sustainable income returns with capital growth.

Industrial and Logistics in Western Sydney is our next preferred asset class. It is supported by densification and location infill as the population grows and gravitates towards infrastructure. Both domestic and international investors continue to seek this asset class as they follow the distribution and e-commerce thematic, towards servicing this infill and densification cities trend. Sydney continues to see capital prices appreciate and hence yields compress, as investors tend to “buy to bury” into core portfolio holdings. 2020 saw yield compression of circa 75bp to 4.9% in Sydney’s West, with other state’s markets seeing circa 50bp compression. We expect more modest compression in 2020 as investors continue to chase yield, supported by inbuilt 2-3%pa rental resets.

Overall, we remain positive on Australian Real Estate in 2020, supported by low for longer interest rates, under-leveraged property owners, a densifying population from positive immigration policy and positive employment growth and disciplined developers retaining a market of scarcity.

ASIA MARKETS

Andy Hu, Joint State Head, Asia Markets at Savills Australia believes there will be significantly more Hong Kong, Singapore and Taiwan capital flow into the Sydney market over the next 12 months. “The majority of the capital is looking for CBD office assets with future redevelopment upside,” he said. 

“Retail assets are also seen as a status symbol and an asset class which is well known and well respected across the Asia Pacific region, if not the world.

“There is strong investor appetite in the $50-100 million market, and CBD retail strata remains an easy and achievable entry point for many first time investors looking to secure a safe haven CBD asset.” 

CAPITAL ADVISORY

According to Andrew Cottam and Ben Jackson, Directors of Capital Advisory at Savills Australia, 2019 was a year of further regulatory impact on the banks with APRA’s lending benchmarks continuing to effect the market and the Banking Royal Commission causing additional conservatism. The RBA also slashed interest rates three times to the lowest point ever experienced, now 0.75%, making the cost of debt extremely attractive for borrowers.

“This increased pressure on the banks has opened the way for non-bank lenders to further compete and infiltrate the lending market, providing more lending options for borrowers.

“In 2020 we could see further interest rate cuts by the RBA given where futures markets are trading, and soft economic indicators. This is consistent with the global low yield environment and sea of capital chasing yields, so we may see further yield compression and flow of capital into debt markets given where we are in the cycle.

“Additionally, given trends in the bank / non-bank lending sector, further diversification of lenders in the market is expected with non-bank lenders continuing to grow their exposure to real estate.”

RETAIL INVESTMENTS

According to Steven Lerche, National Director, Retail Investments at Savills Australia, retail transaction activity came to a standstill at the beginning of 2019 with both institutional and corporate groups reluctant to sell. “This momentum didn’t really change during the year and deal flow could remain sluggish in 2020.”

“Many larger assets put up for sale failed to transact due to disruption in the retail industry, noise from overseas and fewer buyers in the market. Contrary to this, the smaller end of the market, freestanding retail investments and neighbourhood shopping centre sectors have been in high demand, fuelled by the low interest rate environment.

“Coles and Woolworths freehold disposal programme has kept the smaller end of the market strong with tight yields remaining the norm.”

Mr Lerche believes deal flow in 2020 is likely to come from funds looking to dispose of non-core assets and it will be the small fund managers and privates that remain active on the buy side.

“Innovation will continue to provide uncertainty in the retail sector and it will be counter cyclical purchasers that will benefit from those groups looking to exit.

“Shopping centre performance is linked to individual characteristics and location and it’s the metro retail assets that will continue to attract investor interest due to their long term mixed use potential.’”

RESIDENTIAL SITE SALES

2019 was an exceptional year for Savills NSW Residential Site Sales Division with over $400m worth of sites sold, predominantly within a 12km radius of the Sydney CBD. Sites situated within close proximity to rail, retail amenity and educational facilities continue to do well, especially within this 12km radius.

According to Stuart Cox, Director of Residential Site Sales at Savills Australia, the standout areas with increasing demand for sites predominantly comprises the Lower and Upper North Shore, Sydney CBD (The Rocks) and the Inner West.

“There is still a complete lack of available sites available within the Northern Beaches capable of providing scale. Hot suburbs with immense interest from offshore capital include Burwood, Strathfield, Chatswood and the Sydney CBD.

“There is increasing demand for sites that can provide premium owner occupier product as opposed to predominantly run-of-the-mill investor grade product.  With a significant shift away from developers wanting to acquire high density residential sites within Box Hill and Rouse Hill with slow presales, bank lending criteria and lack of infrastructure is to blame.” 

Mr Cox said his team is still experiencing significant interest from large, well established offshore developers for sites in excess of $50m that can provide scale and access to rail networks. 

“There is also increasing demand for B-Grade commercial buildings capable of being converted to residential apartments, with developers paying tight yields for these well located assets. We have also seen a renewed interest from developers in zoned land subdivision product as well as biodiversity offerings, particularly around the Badgery’s Creek Airport where bio-credits are in demand by private developers and government infrastructure.”  

Looking ahead to 2020, there are a significant number of sites already signed up and set to hit the market towards the beginning of 2020, with site values ranging from $10m to over $150m, all located within prime areas of Sydney. 

Mr Cox said, “A large number of well positioned Private and Government assets are set to be sold in 2020 and the expected return of the pre-sale market will bring a new confidence to developers with their eye on the 2-5 year horizon.

“We expect many private residential home owners to come together to create large collective sales to reap the rewards of the rezoning brought about by newly announced state and local government strategies and we will continue to follow these precincts closely,” Mr Cox continued.

INDUSTRIAL & LOGISTICS

According to Michael Fenton, National Head, Industrial and Logistics at Savills Australia, 2019 was characterised by the dichotomy created by the vast amount of capital scouring the Australian industrial and logistics market for a broad spectrum of investment opportunities, to the diminishing demand and reduced take up of new supply in most of the major tier markets.  

“The former trend has seen an unprecedented record achieved for core capitalisation rates, while the combined lack of opportunities has seen the spread between core and secondary rates compress to 100 basis points, or less in some instances.

“The relative lack of stabilised product has sent many institutions in search of large tracts of land to develop their own product, which has been a dominant theme in major eastern seaboard markets, particularly Sydney. The recent boom in infrastructure investment in NSW has been a catalyst for this, with transport infrastructure projects creating the need for new land releases, which have been snapped up by the major institutions.

“The prediction for 2020 is more of the same, for the first half of the year at least, with no foreseeable catalyst to change the current dynamic,” he said.

According to Darren Curry, Director, Industrial and Logistics at Savills Australia, “Looking ahead for 2020, Industrial vendors should expect face rents to remain steady across broader Western Sydney. With fewer sites being ‘shovel ready,’ i.e., zoned and serviced, there will certainly be a limited supply of the larger pre lease sites for tenants looking for a footprint in excess of 10,000sq m of GLA within the South West and Western Sydney precincts.

“Land values for serviced and benched sites reached historic highs during 2019 and unless rental levels increase significantly, then those land rates should remain consistent in 2020. With many companies looking to improve margins and their EBIT via supply chain savings, sites with an ‘infill & last mile’ advantage will be highly sought after by industrial developers and owner occupiers. Automation will continue to gain momentum in 2020 for major corporates that have significant SKU’s and can leverage the B2B & B2C piece within their business platform.

“Yields for ‘Super Prime’ investments should remain steady at 4.5% for ‘logistics grade’ buildings with A-Grade covenants on long term lease structures,” he continued.

According to Ed Washer, Director, Head of South Sydney at Savills Australia, “In 2019, the South Sydney industrial market saw a slowdown in rental growth and capital values due to a lull in activity which was heavily influenced by a shortage of business confidence. Market rents and capital values have still held strong, although the rate of growth that we have seen in recent years didn’t continue this year. 

“However, 2020 is already gearing up to be an improvement from 2019 in terms of activity level. I believe we will see an increase in rental growth, capital values and take up of space across the market which landlords will be able to benefit from.”

METROPOLITAN AND REGIONAL SALES

Strong activity throughout NSW has proven that investment stock is still considered hot property for well leased retail/commercial properties, including single tenant properties through to properties with multiple tenancies and well located properties.

According to Nick Lower, Director, Metropolitan & Regional Sales at Savills Australia, “With interest rates now at historic lows, we are continuing to see strong sales results being achieved along with solid yields across most inner city locations within Sydney. For example, 62-64 Australia Street, Camperdown sold for $2m on a 2.6 percent yield, achieving an impressive building rate of $10,204 per square metre.

“Although 2019 has had its challenges, when we briefly glance at what occurred globally, it is evident factors such as the federal election, global uncertainty (through US and China Trade Wars, Brexit, Hong Kong riots) and the RBA’s decision to drop interest rates to the lowest in Australian History (0.75%) have all in some way, shape or form had an effect on Australia’s property market. Whilst the residential market has seen a significant slowdown in sentiment, there is still increasing momentum in the commercial sector.

“Over the past couple of months, renowned suburbs such as Bondi, Double Bay and Woollahra have witnessed record breaking transactions as we continue to see a flight to quality from investors. It is suburbs like these that are being regarded (locally & globally) as the preeminent locations to invest within,” said Mr Lower.

Recent key transactions across the Sydney CBD fringe include:

• 27-29 Knox Street in Double Bay sold for $9,830,000 representing a net initial yield of 1.76%
• 261 Bondi Road, Bondi sold for $3.75m reflecting a net initial yield of 4%
• 10 Cross Street in Double Bay sold for $10.25m reflecting a record breaking yield of 1.59%

Mr Lower said the Sydney CBD in particular is a market that has not seen the peaks and troughs that the media has been portraying. 

“The tightly held nature of the Sydney CBD, along with market sentiment, are working together to create highly favourable conditions for commercial property owners. 

“There is a significant undersupply of both strata retail and office spaces available to purchase– and a deep buyer pool of both local and off shore capital desperately wanting to break into the Sydney CBD market,” he said.

“As an example, Shop 1, 37 York Street, Sydney– a 14sq m shop, sold at auction for $1,570,000, with a building rate of $112,143, close to the Sydney CBD record. The property sold to a local investor who simply was looking for an alternative vehicle for return other than holding funds in the bank.”

Metro sales predications for 2020:

Interest rates will fall further
“With weak wage growth and stalling spending, a further reduction in rates is a likely occurrence in 2020. Should this be the case, we will continue to see occupier assets trade well and investors continue to accept sharper yields,” said Mr Lower.

Investment stock will continue to be attractive
Mr Lower believes lowering interest rates will drive purchasers towards income producing assets as they find alternative vehicles for returns whilst banks and term deposits will offer no support (to returns).

The residential market will improve
“With the tides already beginning to turn in late 2019 with interest rates remaining low, we will begin to see values of median house prices across Metropolitan Sydney recover. The flow on effect for commercial property is that as confidence increases (as residential markets improve), the level of competition amongst purchasers naturally rises resulting in higher pricing being achieved,” said Mr Lower.

Distressed asset sales will increase
“Although the story of 2020 will ultimately be an improvement on 2019, with the banks continuing to ‘tighten their belts’ and second & third tier lenders having more power within the market, secondary assets, especially of residential development and retail nature, will feel the effects of purchasers’ desire to buy ‘safer’ assets (in better located areas),” he said.

OFFICE LEASING

According to Tom Mott, State Director – NSW Office Leasing at Savills Australia, the Sydney CBD office market in 2019 was driven by supply constraints. One new prime grade development reached practical completion with near 100% commitment being Investa and Gwynvill’s 60 Martin Place, Sydney, where they achieved a rent of $1,830 net for the top floor. 

The world class Quay Quarter Tower (50 Bridge Street, Sydney) development will end 2019 with circa 98% commitment despite completion not anticipated until 2022.

Leasing volumes in the Sydney CBD remained below historical averages in 2019.  A number of factors influenced this which included Co Working disruption to the 100-500sq m market, lack of attractiveness around deals enticing tenants to move, owners renewing leases well in advance of expiry and at times a sense of uncertainty around the economy.

There were however a number of significant leasing deals, those included Deloitte who secured 32,000 square metres in AMP Capital’s development Quay Quarter Tower (50 Bridge Street), Wework at 320 Pitt Street where they will occupy 11,000 square metres & Lend Lease has secured Salesforce to anchor 24 floors of its 53 floor $1.9 billion Circular Quay development. 

“There were also a number of significant deals which occurred in advance of lease expiry, QBE, Boston Consulting Group and First State Super all committed to new premises and left behind sublease space or premises to be assigned. The combined Net lettable area of these three moves was approximately 25,000sq m.

“With the release valve of supply not forecast to hit the market until 2023 onwards, the outlook for 2020 remains strong, we anticipate positive net absorption, effective rental growth and generally fertile conditions to do business,” said Mr Mott.

HOTELS

The Australian and New Zealand Hotel sector looks set to finish 2019 on a high, with all states and territories recording double digit growth in domestic expenditure.

For year ending June 2019, Australia’s international visitors have increased by 2.8% to 8.6 million, domestic visitors increased by 11.7% to 113.3 million and New Zealand’s international visitors increased by 2.5% to 3.9 million.

Domestic tourism is at an all-time high and continues to grow. The Australian dollar has hovered below 70 cents (relative to USA) for some time now, which further attracts international tourists to our shores, as Australia represents an even more affordable destination. In addition, a lower Australian dollar is also encouraging more Aussies to travel locally due to overseas destinations (particularly USA, Europe & UK) being a more costly travel option. However, while much is said about the Australian exchange rate and its impact on travel attitudes, international travellers are also drawn to Australia due to its “clean & green” status, amazing natural wonders and attractions, and world class food and wine. 

According to Michael Simpson, Managing Director, Hotels at Savills Australia, of the 10 Australian key hotel markets for year to date October 2019, six achieved occupancy in excess of 77%, reflecting the continuing growth in International and Domestic Visitors. 

“Growth in demand for rooms was achieved in eight markets with seven of those markets also experiencing increased new room supply. 

“Overall, Sydney was the top performer nationally (in terms of dollar value of RevPAR $178), outperforming the next best performing market (Melbourne) by $31. 

Mr Simpson said China remains Australia’s number 1 International Visitor representing 15% of the total share of visitors and recorded a 5.9% YOY increase in expenditure approximating $12b. 

“The key growth market was India which rose by 11.6% in terms of visitors and recorded a substantial growth of 21.9% in Visitor Nights (4m more Visitor Nights). Japan also reported a strong growth in Visitors up by 9.1% YOY

In New Zealand, International Visitors were up 2.5% to 3.9 million for the year ending August 2019. “Of the top 10 international visitor markets, Australia made up 39.0% of the total share of Visitors, with China following at 10.7%. Domestic Visitor Nights were up 4.0% to 23.4 million.”

Michael Simpson, added “The NZ exchange rate (relative to USA) is having similar effects on international and domestic travel patterns in the NZ market as being experienced in Australia”. 

In 2020, and beyond, in order to satisfy the needs of discerning international and domestic travellers, the industry will need to constantly improve its hotel product. 

According to Savills Hotels research, the recent boom in hotel development in Australia has seen the arrival of upper upscale and luxury brands as well as a healthy pipeline of brands still to enter key markets. This will ensure Australia’s key markets remain competitive on a world’s stage. 

“We are expecting the Reserve Bank to lower the official cash rate to 0.25% in 2020 which will put further downward pressure on capitalisation rates which will result in property values increasing.

“There is a wall of hotel investment capital which is unsatisfied due to a shortage of available investment grade hotels in Australia, which will continue to drive hotel transactions during 2020,” said Michael Simpson.

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