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29th Jan, 2013 Commercial Real Estate

Peeking Into the Murky Crystal Ball and the 2013 Property Market – Part 2

Welcome to the final instalment to our two-part blog series focusing on the 2013 property market. If you missed the First-Part where we examined the key events that will shape the global economy and their impact on the Australian real estate market in 2013, please click here.

In this post, Trident Real Estate undertakes a property type-specific analysis and offers its views on how each of these sectors will perform in 2013.

Residential

According to RP Data, capital city home values increased by 1.8% over the second half  of 2012, driven mainly by improving household sentiment. Favourable interest rates, first home buyer incentives and soft new dwelling supply, combined with increasing net migration, will equate to modest house price growth in 2013. John McGrath recently explained that weekend clearance rates of 69% for the under $750,000 properties in the Sydney market means that Sydney still remains the “BHP of Australian real estate.”

Trident Real Estate believes that unit dwellings within 5km of the CBD will perform particularly well in 2013 and enjoy capital growth of at least 3%, particularly those first home buyer apartments in the $450,000 to $800,000 price bracket. The recent ABS Housing Finance figures, providing an increase in dwelling finance commitments in each of the months compromising the final quarter of 2012, support our position that the residential property market will strengthen. Demand is expected to be derived from Asian investors, local investors seeking to withdraw cash from term deposits, chasing higher yields, and young professionals and families taking their first step on the property ladder.

Office

Demand for office space, particularly in Melbourne, is expected to remain under pressure as a result of continuing economic uncertainty and large financial institutions scaling back and shedding costs as a direct result of permanent structural change. Knight Frank reported in their September 2012 Sydney CBD Office Market Overview that tenant enquiry levels remain inconsistent, with very few major tenants looking to increase occupied space in a meaningful way. The ANZ job advertisement series, which as of December 2012 had decreased by 16% over the year, confirms our assessment that leasing office activity will remain flat. Unsurprisingly, Perth stands out from the crowd with an office vacancy rate of only 4%. The city will continue to enjoy the best performing office market as a result of pent up demand and little new supply. Demand will be derived from the mining industry’s commitments in the form of long term offtake agreements for commodities such as iron ore and coal.

Acquisition of prime office buildings by offshore investors will continue in 2013 attracted by the large yield gap, Australia’s strong regulatory system and a transparent market. Trident Real Estate believes that the relative limited offering for prime core assets will result in firmer cap rates for this asset class in 2013.

Industrial

A lack of new supply of prime grade space in the Sydney and Melbourne industrial markets, combined with continued demand, has lead to a tightening in the available stock. Demand is expected to continue to shift from the traditional manufacturing businesses to the warehouse, logistics and transport sector. This is a result of the strong Australian dollar, changing behaviour of consumers who are now switching to online purchases, and globalised supply chains each contributing to driving import volumes. In South Sydney, where Trident Real Estate Capital is active, there has been a noticeable softening in supply as a result of the City of Sydney’s new Planning Controls that have rezoned industrial areas into residential use. Notwithstanding, there is strong owner occupier demand for strata industrial units, ranging in size from 140 to 300 square meters. New industrial complexes are built to cater for creative and light impact storage occupiers. Conditions for bulk freight users in South Sydney remain in decline. The Employment Lands Study authored by the City of Sydney released in November 2012 notes that the lack of new development, coupled with the demand from prospective tenants in addition to existing tenants seeking to expand, has led to an undersupply of large industrial space in strategically located South Sydney. Unsurprisingly, we believe that rents will increase and availability of industrial space will tighten.

According to Knight Frank, yields for prime industrial assets in Sydney and Melbourne average between 8% and 8.75%. We anticipate yield compression as owner occupiers become more active in 2013 as a result of the easing of debt and finance availability.

Retail

The Australian Retailers Association released disappointing November retail sales figures for the Christmas season, dropping by 0.1%,
with the largest contributor to the fall being household goods (-0.9%), while the only contributor to growth was food retailing. The most recent NAB online retail sales index noted that Australians spent around $12.6 billion on e-tailing, equivalent to 5.7% of traditional retail sales. As this trend continues, we expect to see shopping centre mixes redefined with more dining and entertaining venues and less clothing stores. We expect online retail will become more integrated into the Australian shopping experience.  Retailers may concentrate on one, or several, large flagship stores to communicate a brand, while blurring the boundaries between physical store and online marketing according to Urbis’ report titled, Online Retailing in Australia. Physical retail stores will reduce their floor size and their purpose will change to focus on providing the customer with an “experience” that will ultimately focus on entertainment.

On the investment front, prime and CBD strip space will see a moderate pick up in investment activity in 2013 with demand driven by favourable yields. Retail on high streets outside the CBD and other more secondary locations will, however, continue to suffer and result in rents coming under pressure. Expect shopping centres to have lower rates of growth in the short to medium term.

Wrap Up

Europe’s economic woes will continue in 2013 and although steps will be taken to resolve the debt crisis, politicians will need to accept that the peripheral countries must let the Euro go. The US’s low interest rate environment is creating motion in the economy, but Trident Real Estate believes that quantitative easing is creating an unhealthy subsidised interest rate climate. This climate may be preventing corporates from carrying out their investment activities. China is allegedly picking up steam and growth is still strong relative to other economies, yet all is not what it seems! The Australian economy will continue to enjoy cuts in interest rates in 2013, which we hope will be enough to continue its positive growth trajectory. When considering each of the property types, Trident Real Estate is bullish on unit dwellings within 5km of the CBD in the $450,000 to $800,000 price bracket. We project capital growth of at least 3% being driven by first home buyers and investors switching into property and out of low yield term deposits. Trident Real Estate is least confident with retail property in secondary locations as a result of weak consumer demand and the impact of e-tailing, malls in prime locations will need to redevelopment in order to continue to experience growth. Investment pitfalls may be avoided, regardless of property type, by ensuring that pro forma models factor in a large margin of safety and a sizeable cash yield upfront.