The Experts

Jasonhuljich_normal
Jason Huljich
Commercial Property Expert
+ About Jason Huljich

Head of Real Estate and Funds Management

Jason leads Centuria’s $4.6 billion Property Funds Management business, which is responsible for both listed and unlisted property funds; the property services business; property acquisition; and disposal and special property and debt opportunities. He is also an Executive Director of Centuria Capital Group. In this role he provides strategic leadership, ensuring the effective operation of Centuria’s property business.

He has extensive experience in the commercial property sector, with specialist skills in property investment and funds management. He is also the immediate past President of the Property Funds Association (PFA), which represents the $125 billion direct property investment body in Australia. He held the role from 2013-17, and continues to serve on their national executive.

Jason holds a Bachelor of Commerce (Commercial Law) from the University of Auckland, New Zealand.

Would you like to own an office block?

Monday, October 22, 2018

Commercial property, whether held directly or in a listed or unlisted trust, can make an attractive addition to a balanced investment portfolio. Quality office property offers investors a regular, often tax-advantaged, income stream, and because commercial leases are frequently inflation-linked, it can be a good hedge against inflation as well. In addition, there is the potential for capital upside. Property has traditionally (although not without exception) been de-correlated from equity and fixed interest markets, meaning it can provide diversification benefits and smooth out returns from a portfolio over time.  

Listed property trusts, or Australian real estate investment trusts (A-REITs), are a form of joint ownership, in which investors’ pool their money together to buy either a single property, or more typically, a portfolio of properties. Investors purchase units in the trust and the trust is listed on the Australian Stock Exchange (ASX). This means that investors can buy and sell units in the same way they might buy equities, making A-REITs an appealing option for investors looking for commercial property exposure, but with the liquidity that comes from listing on an exchange. 

In essence, A-REITs give investors access to commercial property portfolios for a fraction of the cost of buying a property directly, without tying up funds, and with the added benefit of being able to increase and/or decrease exposure easily.

A-REITs can differ significantly

A-REITs vary, both in terms of portfolio and investment strategy. Some are sector-based, in that they invest only in one sector of the property market – for example retail, office, industrial, hotel, or healthcare. Others have a more diverse portfolio, with a mix of properties from different sectors, and still others focus on other specialisations, such as location – e.g. metro versus CBD or prime versus secondary assets. According to Deloitte as at the end of 2017, retail A-REITs made up 45% of the market capitalisation of the sector in Australia, office 12%, industrial 12%, diversified 27% and alternatives 4%. However, a closer look at the composition of the diversified A-REITs reveals that they are largely weighted to the office and retail sectors, making the actual exposure of the market to these sectors higher. 

Investment strategies also vary from trust to trust. Some A-REITs are rental-income focused, meaning their primary aim is to maximise rental income from their portfolio of properties and to distribute as high a proportion as is prudent, in the form of income to their investors. Others may retain a higher percentage of rental and other income, and distribute a lower percentage of gross income, for a variety of reasons, including undertaking of funds management and property development within the trust. The manager of the trust should make the strategy of the trust clear to investors.    

Because they are listed, A-REIT unit prices can be influenced by general market movements, in addition to investors’ and the market view of the underlying property portfolio. This means that general economic data – some of which may not be directly tied to specific property performance or price, at least in the short-term – can affect the unit price of A-REITs.

In this respect, they are a less ‘direct’ investment in commercial property than an unlisted property trust. Property valuations in unlisted trusts are typically performed only once a year and therefore the unit price does not move up and down daily in the way that it can in an A-REIT. 

Key changes in the sector over time

A-REITs have been a part of the listed market for many years, however, their structures and some of their fundamental metrics have changed significantly over time – we believe for the better. 

The following table shows some of the key differences and gives some of the reasons for the change. 

Listed property trusts: then and now

Feature

2007

2018

Payout ratio

95%

82%

Offshore assets

40%

21%

Gearing levels

40% +

26%

Funding tenure

Shorter term

Longer term

Let’s describe each feature:

1. Payout ratio

The payout ratio describes the percentage of returns distributed to investors. This will vary depending on the REIT’s investment strategy. 

A-REITs that are straight rent collecting vehicles – such as the Centuria Metropolitan REIT (CMA) and the Centuria Industrial REIT (CIP) – will generally distribute a high percentage of their income, while keeping aside some funds for maintenance, improvements and unexpected costs. These A-REITs have simple structures and a simple purpose – to distribute rental returns from tenants to investors. 

Some A-REIT’s retain the funds management and property development functions within the entity. There are a number of reasons for this – in general linked to the size of the portfolio or any specialised aims it might have.  

In general, a development-focused A-REIT has a lower payout ratio, because property development requires significant capital and returns can be lumpy. This means keeping back a larger percentage of earnings to fund the development or smooth out returns. 

2. Offshore assets 

Offshore assets refer to the percentage of offshore property assets held in the trust. 

In general terms, a more diversified portfolio is likely to be less risky than a highly concentrated one, and in this respect, offshore exposure could be seen as offering diversification benefits. However, given the risks associated with investing in physical assets offshore, a high level of offshore assets in a portfolio (40% plus in 2007) will typically be a riskier strategy than keeping offshore assets at a more conservative level. 

This was demonstrated clearly in the lead up to the GFC, when managers were tempted overseas because property values compared favourably with a hot market at home – yields were higher, which meant balance sheets looked better, and earnings per unit were higher. 

When the GFC hit however, and property markets turned, some A-REITs struggled to sell their assets, not only because the market itself was more difficult, but because they had the added burden of negotiating a different regulatory environment, without the market knowledge and relationships they had at home. 

These days, overseas assets make up on average 21% of A-REIT portfolios, and the bulk of the exposure comes from two major players – Westfield, which owns shopping centres in the United States and the United Kingdom, and the Goodman Group, which owns industrial property in Asia. Both of these groups are world-class investors in each of those asset classes.

3. Gearing levels 

Gearing levels refers to the amount of debt in the trust. In 2007, interest rates were higher and there was a significant gap between the cost of long-term financing (very expensive) and short-term financing (much cheaper). This created problems for some trusts, which used short-term funding to pay for acquisitions, and then sought to arbitrage the difference between the funding cost of a property and its yield. When credit markets changed, some found it difficult to close the gap, resulting in poor performance for investors.

4. Funding costs 

Funding costs are lower today than in 2007, and gearing levels much more conservative – 26% on average. 

Funding tenure is also now longer. Funding sources are more diverse than in the past, and on average, most trusts have longer funding terms, which usually means better quality, more conservative debt.

Quality commercial property can be an attractive addition to an investment portfolio, but if, like most investors, you don’t have the funds to purchase an entire commercial building at your fingertips, pooling your money with others can be a good option. Listed and unlisted structures both have pros and cons. Unlisted property trusts arguably offer a more direct exposure to commercial property, in that the underlying property portfolio is usually valued once a year and unit prices do not move up and down with market movements in the same way listed investments do. But at the same time, most unlisted property trusts will require you to lock up your money for between 5-7 years. 

A-REITs, on the other hand, are listed and therefore liquid, and allow for you to move your commercial property exposure up and down. Structurally, they are more conservative now than they have been in the past, in terms of gearing, percentage of profits distributed, and number and value of offshore assets in the portfolio, all of which is positive for risk-averse investors. The flipside of being listed, however, is that unit prices can move in line with general market sentiment and are not as closely tied to property fundamentals.

However, it’s most important to understand that whether you are considering an A-REIT or an unlisted trust, all investments carry risk. The best way to understand and mitigate this risk is to look carefully not just at the underlying portfolio of a trust, but at the experience and quality of the manager, including investment strategy. Make sure you obtain the relevant offer documentation, consider it carefully, and think about seeking advice from a professional investment adviser if you have any questions. 

 

Unlisted property’s renaissance

Thursday, August 02, 2018

Unlisted property syndicates first came about in the 1980’s, where numerous investors pooled their capital to invest in commercial, retail or industrial properties that may have otherwise been too expensive for the investors to invest in directly.

Over the years, the asset class has grown and matured through many property cycles and – in my opinion – improved with age.

I believe there’s a number of reasons for this improvement – for example, transparency, performance and accessibility. But most importantly it’s been improvements to the structure and constitutions of unlisted property funds that put increased power into investor’s hands.

Improvements to structure, management and transparency

Lessons learned in the global financial crisis (GFC) prompted a wave of change, with positive consequences for unlisted property. The push for better management, more transparency and less risk has mitigated the risks of the past, making the appeal of the unlisted property sector greater than ever.

That said, it’s important to remember that not all unlisted property trusts carry the same level of risk, and not all managers are equally skilled and experienced. So, as with any investment, doing your due diligence is crucial.

Unlisted property’s evolution

In the lead up to the GFC, property prices rose sharply and a number of financial planners and investors turned to unlisted property trusts for their property exposure. Just as demand was increasing, however, risks were rising as well. Gearing levels went up – on the back of easy credit following a period of de-regulation in financial markets – and this increased overall risk. This meant that when the GFC hit, some managers found themselves, and their investors, caught: stuck with high levels of debt and properties they couldn’t sell.

The good news is that I believe the property trust sector is very different nowadays. To show how, I have outlined in general terms some of the key metrics in unlisted property trusts and how I have seen them change over time.

Unlisted property trusts: then and now

So, what changed between 2007 and 2018 and what does it means for investors? The fact that distributions are more likely to be paid solely from rents / cash reserves rather than rents and debt, and that for most managers gearing levels are at a maximum of 50% compared with 65%, means that interest rate risk is less significant in unlisted property now than before. Lower gearing means a more conservative capital structure, and therefore a reduction in overall risk.

Despite today’s climate of low interest rates and cheap debt, investors are right to ask themselves what would happen in the case of a significant rise in interest rates. In my view, the ‘longer for lower’ scenario currently still holds true, and a major spike in rates remains less likely. Nonetheless, if and when rates eventually normalise, interest rate risk is likely to become more of a concern – so I believe it is key that rate-associated risks are lower for unlisted trusts, due to lower debt levels.

Funding tenure refers to the average length of the loan taken out by managers. Longer loan periods generally mean more stability and less uncertainty when it comes time to refinancing the loan.

I have witnessed the constitution becoming more investor-friendly rather than manager-friendly. I believe this is due to the typical terms and conditions of current trust structures favouring the investor, rather than the manager. In the past, so-called ‘poison pill’ clauses meant that managers were paid a small fortune if they were removed by investors – a process that typically required 50% of the entire register to vote and agree. The reality was that it was almost impossible to remove poorly-performing or unscrupulous managers, and if you did they would receive a large pay day.

The reality now is that there are fewer, larger managers – the majority of whom have both scale and experience. They have weathered the recession and GFC storms, and have learnt the hard lessons. And structures reflect this. Most unlisted trusts now have clear fixed terms, identifiable voting hurdles, and minimum internal rates of return before performance fees can be charged.

In the case of Centuria’s unlisted property trusts, the initial fixed term is five years. After that, 50% of the register must agree for the term to be extended by two years, and then 100% of the register must agree for the term to be extended further. 

Unlisted property trusts, like all investments, carry a level of risk, and returns are never guaranteed. However, I believe that more conservative capital structures, less risky behaviour and better communication and transparency means that financial planners and investors do have a range of better quality unlisted trusts to choose from. It remains crucial, however, to look carefully at the track record and experience of the manager you choose, obtain the relevant offer documentation and consider seeking advice from a professional investment adviser.

 

 

How to tap into the benefits of direct property – without tying up your money

Tuesday, April 24, 2018

 

Unlisted real estate has long been a favourite of institutional investors due to its reliable, tax-advantaged income and the potential for capital upside. The challenge for smaller investors is its lack of liquidity, which can see funds locked up for between 5 to 7 years. 

If diversification really is the only free lunch in finance, then commercial property has an important role to play in any investment portfolio. Over time, real estate has shown itself to have a low correlation to equities and bonds, as well as having a competitive, risk-adjusted relative rate of return. What it does have is a positive correlation with anticipated and unanticipated inflation, meaning it offers a positive inflation hedge. This combination of factors makes it an attractive asset class, both in terms of the returns it offers and its diversification benefits. 

Of course, using the past as a predictor for future performance is no guarantee of results, and it’s important to bear that in mind when deciding where to invest. But at the same time, investors could do a lot worse than to consider commercial real estate as part of their investment portfolio now. 

Commercial real estate particularly attractive in this moment

Interest rates are at historically low levels, which means that yields from commercial real estate compare very favourably with bonds, and while there is a difference in risk profile, the potential for capital growth provides an additional upside kick. Yields from commercial property are usually inflation-linked (because they are tied to commercial leases), which is more good news for investors. And thanks to depreciation and other deductible expenses associated with property, income can be tax-advantaged as well. 

And if you are looking for true portfolio diversification – as a means of mitigating risk and providing downside protection – recent history has some valuable lessons that show real estate in a particularly flattering light. The long-accepted wisdom that equities and bonds are always de-correlated broke down during the GFC, when the two began to move in lockstep, and this in turn prompted investors to look at portfolio diversification differently. 

The result is an increase in demand for alternative assets, including commercial real estate, to provide true diversification. 

Unlisted versus listed exposure

The next question investors ask themselves is how best to achieve real estate exposure. For most investors, actually buying a commercial property outright is out of possible bounds, so pooling money with other investors to access commercial property is generally the best option. This can be done in one of two ways: via the listed A-REIT market, or via an unlisted trust.

Both have their pros and cons, and both have a role in a diversified real estate portfolio, but one of the most significant differences between the two lies in their structure. A-REITs are listed, meaning investors can buy and sell units easily, whereas unlisted trusts typically lock up funds for between 5 to 7 years, during which time it can be difficult or impossible to exit prior to the fund winding up.

On the other hand, because they are listed, A-REITs tend to be highly correlated with equity markets, and therefore offer less direct property exposure than unlisted property trusts. 

Unlisted trusts, which in many cases comprise a single commercial office property, offer predictable and regular income that is based on leases to quality tenants. In addition, their performance is less volatile than that of listed investments, because valuations are typically made annually (rather than daily, as with listed vehicles). Volatility is lower still because annual valuations are based more on reliability of rental income than on the transaction data and extraneous market-driven factors that influence A-REIT valuations.

At the same time, due to the high minimum investment barrier and illiquid nature of an unlisted trust, they are not suitable for all investors, despite strong demand. For the same reasons, closed-end fully unlisted trusts are unsuitable for platforms, which means that financial advisers cannot always recommend them to all clients. 

The good news is that it is possible to access the benefits of direct property exposure, with the ability to exit.

Direct property exposure – with liquidity 

The Centuria Diversified Property Fund is a multi-asset unlisted property fund that is open-ended, and offers daily unit pricing and a limited monthly liquidity. In other words, investors can access the direct property investment benefits of an unlisted fund, but with some ability to withdraw funds in any month. As with most listed and unlisted funds, distributions are made monthly and can be re-invested via a reinvestment program if required. 

The Fund’s aim is to provide tax-effective income, with the potential for long-term capital growth. The portfolio is made up of a diversified group of commercial office assets across Australia, approximately 80% of which are held via Centuria’s unlisted property trusts. Looking forward, however, the intention is for the Fund to acquire direct commercial property assets as it grows, probably in the $10 to $20 million range. You can see the most recent Fund fact sheet, which contains details of the Fund’s performance and portfolio, here.

The strategy for the Fund is the same as Centuria’s overarching strategy for all of its funds. We are asset-specific buyers, and rely heavily on our expertise in active asset management to extract value from our properties. This means we don’t reject markets out of hand (even those with relatively weaker fundamentals), rather we purchase properties with the aim of unlocking value – through our hands-on approach to refurbishment, facility upgrades, and development of spec fit-outs, undertaken by an in-house team of asset managers. And, when it comes to accessibility for advisers and smaller investors, because the Fund is open-ended and offers some liquidity, it sits on a number of platforms and wrap platforms so is easy to access. 

While there are no guarantees in property, as in any investment – given that yield compression is no longer doing investors’ work for them – active property management is more important than ever. We are confident our active approach to both acquisitions and property management will continue to bear dividends for investors. 

Disclaimer: Information relating to the Centuria Diversified Property Fund (Fund) (ARSN 611 510 699) is issued by the responsible entity of the Fund, Centuria Property Funds Limited ABN 11 086 553 639 AFSL 231149 (Centuria). This information is general information only and does not take into account the objectives, financial situation or particular needs of any person. You should consider whether this information is appropriate for you and consult your financial or other professional advisor before investing. You should obtain and read a copy of the relevant Product Disclosure Statement (PDS) for the Fund before making a decision to invest. Centuria and its associates will receive fees in relation to an investment in the Fund. An Investment in the Fund is subject to risk including possible delays in payment or loss of income and principal invested. Centuria does not guarantee the performance of the Fund.

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Property markets evolve, fundamentals stay the same

Thursday, March 29, 2018

Due diligence is essential before making any investment decision – and property is no exception. Direct property markets may not be as volatile as equities and other listed investments, but they are affected by a large number of factors (both macroeconomic and property-specific), so understanding and interpreting these factors is essential to making the best possible decisions.   

When it comes to commercial property there are a number of tools to help decide which properties will outperform in different markets. They include knowing what to focus on, having the experience to make judgements about how markets will evolve and transform, and combining this with the influence of macroeconomic factors. This combination is particularly important when considering property markets, because their cyclical nature means that at the top and the bottom of the cycle it can be difficult to separate rumour from fact and reality. It is this complexity that makes staying focused on the underlying fundamentals and data so important. 

Understanding the fundamentals driving property markets

The major factors that influence all property markets from a macro perspective are the overall health of the economy and interest rates.

A healthy, growing economy (as measured by economic indicators such as employment data, manufacturing activity, consumer spending, etc.), is – unsurprisingly – a positive for property markets. It promotes population growth and encourages the creation of new businesses and expansion of existing ones – which, in turn, drives demand for housing and office space. 

Interest rates also significantly influence property markets. Lower interest rates mean a lower cost of borrowing, which enables more investment in commercial property, and low rates also serve to prop up weak markets. This is because a lower cost of debt means that, even if tenant demand is weak and vacancies are rising, landlords are under less pressure to sell assets. 

Assessing how markets may change over time

Suburbs and precincts change over time – something that we all understand from looking at residential property markets. The same evolutions occur in commercial property markets, which is why experience, research, and keeping a long-term view, are so important. By looking at changes in: suburbs; improvements in infrastructure; new construction; changing demographics; and of course, location, it is possible to have an informed view on how demand, vacancies, and rents in a particular location, are likely to develop over time.    

The changing face of Redfern

A good example of this strategy in action is Centuria’s decision to buy in Redfern, in Sydney’s fringe. Redfern had historically been considered dangerous and unsavoury, and therefore unattractive as a business precinct despite its location only 2.5km from the Sydney CBD. It is one train strop from Central station and is right in the centre of the government’s “Central to Eveleigh Urban Transformation and Transport Program”, which includes a proposed redevelopment of Redfern station. 

We began to see evidence of change and gentrification a while ago – but at first rental increases didn’t keep pace with improvements to the area. When we assessed office property in the area, we found that rents were lower than those on offer in Parramatta and Chatswood, despite Redfern’s changing demographic and central location. We made the decision to move into the area before any other major institutional owners, and were able to purchase the $200 million 8 Central Avenue asset and then embark on a joint venture with Mirvac to purchase the remainder of Australian Technology Park (ATP) from the State Government. 

The Commonwealth Bank has now signed a pre-lease for over 90,000 sqm of new buildings in the Park, changing perceptions of the area. With Centuria, Mirvac, AMP and Sunsuper now owning assets in ATP, the Park is now seen as the pre-eminent office precinct in the Sydney CBD fringe. Tenant demand is strong – rents have risen significantly, and returns to investors in our three ATP Funds have been exceptional.

St Leonards as a competitor to Chatswood

St Leonards is located on Sydney’s lower north shore and is on the train line. Over the past decade, a large number of office buildings in the area have been withdrawn for residential conversion, resulting in reduced office space. We have seen rents in the area lag other office precincts such as Chatswood. 

Chatswood, on the other hand, was growing rapidly at the same time, and thriving as both an office- and residential- precinct – with the latter further encouraging office tenants towards Chatswood. 

St Leonards is closer to the city than Chatswood however rental levels for office property had not increased as much as in Chatswood for A grade properties. We had also seen with Royal North Shore Hospital expanding within St Leonards, and the area re-positioning itself as a healthcare hub, with the NSW Department of Health set to move into the area in 2019. We have the view that St Leonards is an important metro office market with significant rental growth potential as vacancy rates across Sydney’s north shore tighten and supply becomes limited. We therefore recently purchased 201 Pacific Highway St Leonards for $171.6 million, adjacent to 203 Pacific Highway, which we already own. 

10 Spring Street, Sydney – a win for investors

When Centuria purchased 10 Spring Street, we had formed the view that the prices of B-grade stock were out of kilter with the market – particularly given the large amounts of stock being withdrawn for residential conversion. The property was 20% vacant and needed extensive refurbishment – but the location, in Sydney’s CBD core, was excellent. Our property management team undertook the refurbishment and began actively leasing the property. As supply fell and prices rose, our experienced property management team were able to re-lease the property at increased rents. When we sold the property, investors had tripled their money as well as received income returns of 8% per year over the four-year investment period.

There’s no question that the returns from Spring Street will be difficult to replicate, but it is a good example of how reading market fundamentals correctly can result in excellent returns.   

Looking forward – active asset management key to capital growth now

Over the past few years, we have seen significant yield compression in the Sydney and Melbourne markets, which has resulted in strong capital gains across the board. In our view, while there may be slightly more to come, going forward there will be nothing that compares to what we have seen over the past five years. Capital returns are now more likely to be made through active asset management rather than from merely holding and waiting for capitalisation rates to fall. This means actively re-mixing tenants within a property to extend its weighted average lease expiry (WALE) is key to maximising returns.

 

Active strategies key to property success

Tuesday, February 27, 2018

As some things change, the important things stay the same. For Centuria’s Property Funds Management division, active management has always been a central tenet of its corporate strategy, and it remains the key to our ongoing success. Our ability to identify profitable buying (and selling) opportunities, as well as our hands-on management of individual property assets, is the foundation upon which our strong investment returns are built.

2017: A TRANSFORMATIONAL YEAR

Organic growth and strategic acquisitions within the Property Funds Management division saw assets under management grow to $3.7 billion in HY18. This includes $655 million in property acquisitions and $115 million in asset revaluations across the two ASX listed REITs and 17 unlisted property funds.

We also saw significant inflows into Centuria’s Diversified Property Fund – up 110%. This open-ended fund offers investors direct property exposure, in the same way as an unlisted property trust, but with the addition of liquidity. It has daily unit pricing and applications, as well as liquidity through monthly redemptions – and is therefore appealing to financial advisers and their clients who are looking for exposure to quality commercial property, but require liquidity. The Fund is now accessible on the Macquarie, Colonial First State, OneVue, Hub24, Powerwrap and Netwealth platforms.

2018: A YEAR OF CONSOLIDATION

This year, we expect economic conditions to remain largely unchanged from last year. Property markets are tightly correlated to economic conditions, yet despite some weakness in global economies, including Australia, low interest rates mean low cost of capital for investors, encouraging investment in property.

Looking forward, there is a general expectation that rates will start to normalise over the year, albeit at a slow and steady pace. Interest rates will stay low for a while yet, but nonetheless, as they rise, prudent capital management will be key to success in property transactions. For example, locking in rates can offset the possible negative effects of rising rates on returns.

Our focus remains long-term, quality income flow from our property portfolios and, to this end, locked-in leases – which are less affected by interest rate fluctuations – are attractive.

Organic growth, and growth through acquisition, remains our focus. We intend to leverage our stronger balance sheet and increased access to capital markets to maintain the momentum we built up during 2017. At the same time, we will continue to use the strong relationships that we have developed in property markets across Australia to allow the option of off-market purchases where we see value.

In terms of specific markets, over the past years Sydney and Melbourne have been the best performing office markets, but in our view they are now fully priced, so our focus is on other markets where we see more potential.

METRO MARKETS

In line with our view that certain metro markets offer good opportunities, we purchased an office property at 60 Brougham Street, Geelong in Victoria in January 2018. The property is leased to the Victorian government on a long, 10.3 year lease and will form the Centuria Geelong Office Fund, a single-asset, closed-end unlisted fund.

We foresee Geelong continuing to expand and develop, and – as a result – quality office property there producing not only strong income yields, but also the potential for capital growth. Population growth predictions for Geelong are strong at 36.5% between now and 2036, and the local economy is already diverse and robust. Over 17,000 businesses are located there with a workforce of over 100,000. The port is the second largest in Victoria and construction is at a record high. In addition, the Deakin University campus at Geelong is home to over 11,000 students.

At the same time, the twin drivers of affordable housing and a desire for a change are also fueling growth. Median house prices in Geelong are just over half those in Melbourne – making it an attractive alternative.

FOCUS ON QUALITY

We continue to seek acquisition opportunities for our listed vehicles, while we simultaneously work to improve returns from our existing portfolios by focusing on individual property assets.

This year, the Centuria Metropolitan Trust’s (CMA) market capitalisation hit the $500 million mark as a result of an increase in portfolio value. CMA merged with the Centuria Urban REIT (CUA) adding $210 million to the portfolio. CMA is now included in the S&P/ASX 300 Index.

We made a number of strategic acquisitions during the year, including a 50% share in 201 Pacific Highway, St Leonards and 2 Kendall Street in Williams Landing, Victoria. This property is currently under construction and will be leased to Target Australia for 10 years from completion. In line with our view that the Perth market has likely bottomed, we made our first foray into the Western Australian market, with the purchase of two office properties in Stirling and West Perth, via a successful $90 million capital raising.

Centuria Industrial REIT maintained is position as Australia’s largest ASX-listed, income-focused industrial REIT – with the portfolio growing to over $1 billion.

The concept of fit-for-purpose properties guides our strategy when it comes to metro markets. This means identifying properties that perform well in their particular location and niche, and that also complement our existing portfolio – while maintaining a disciplined approach to capital management.

CONCLUSION

We are looking forward to another year of consolidation, growth and identification of value for our shareholders. Our strategy for the year ahead is simple – to seek every opportunity to extract maximum value from our existing portfolio through asset management and repositioning initiatives, while at the same time identifying new opportunities to grow.

 

2018 commercial property outlook

Monday, January 29, 2018

Sydney and Melbourne have been the pick for office property returns over the past few years. Despite some significant yield compression in both markets, they continue to present strong fundamentals and good opportunities for investors this year. At the same time, the second half of last year evidenced some promising green shoots to our north in Brisbane, and even to our west in mining-dependant Perth, setting the tone for what’s to come. Jason Huljich, CEO of Unlisted Property Funds for Centuria, looks at where the returns came in for his investors in 2017 and where he’ll be seeking them this year.

Overall, 2017 presented no real surprises for commercial property investors, and we are likely see more of the same in early 2018. With the national office vacancy rate falling in 2017 by 1.5% to 10.4% and rents increasing, the value of commercial property has lifted across the board with strong demand from both local and global investors. This is strongest in Sydney and Melbourne, where this demand – particularly from overseas buyers – has seen significant yield compression. 

Yield compression in Sydney sign of rising prices 

The sale of Sydney’s Australian Securities Exchange building to a Hong Kong investor for $330 million last year, for example, was struck at cap rate of 4.6% – setting a new return benchmark for investors and serving as a reminder of the recent uplift in values. In a number of other sub 5% yield deals, boutique B-grade office 28 O’Connell Street was bought by Coombes Property for $91 million, and 210 and 220 George Street were sold to Chinese state-owned Poly Group for $165 million; almost 60% more than what they were purchased for at around the same time the year prior. 

In what has been described as the “Deal of the year”, Centuria also settled contracts with Lendlease to sell 10 Spring Street, Sydney for $270.05 million in October last year, reflecting a 3.9% passing yield and a capital value rate of $19,447 psm. The listing resulted in significant interest from both local and global investors who were looking for 100% ownership of a property with development potential in the heart of the CBD, and ultimately led to the record sale price. This exceptional result tripled the original purchase price of $91.6 million in 2013 and is just one example of the significant investor appetite for Sydney CBD assets that we expect to continue steadily into the new year.

Concerns of a bubble overstated

Despite the concerns expressed by the Reserve Bank about the sustainability of recent pricing levels, we believe the likelihood that commercial property is in a bubble on the verge of bursting is potentially overstated. The spread between government bond rates and property yields remains substantial enough to keep investors happy, and we anticipate that further strong rental growth in both Sydney and Melbourne will keep the lure of quality commercial property alive.

This is backed up by a global survey of investors undertaken by CBRE last year, which identified this yield spread (between property and the risk-free bond rate) as the dominant factor influencing foreign investors – ahead of capital appreciation, income levels and geographic diversification. This spread puts markets like Melbourne, Sydney, and to a lesser extent Brisbane, in a strong position going forward, as compared with a number of Asia-Pacific markets. 

Sydney CBD vacancy rates driving demand in metro markets

Sydney is set to benefit from the $12.1 billion investment in public transport infrastructure currently underway. This is driving demand for office space, not just in the CBD, but also in metro markets, where new transport links are likely to improve commuting times and connectivity. 

Furthermore, improving economic conditions have buoyed corporate Australia’s confidence in the medium-term revenue outlook, translating into strong employment growth throughout 2017. As a result, we have seen a corresponding decline in office vacancies across the nation – but especially in Sydney. As recently reported by commercial agents JLL, Sydney’s CBD office vacancy rate fell to 5.4% in the December quarter, down from 7.7% 12 months prior and prime rents have increased more than 20%.

As a result, quality stock remains scarce in the Sydney CBD market, prompting strong demand and upward pressure on prices. The withdrawal of office space for conversion to residential – and for the construction of the Metro Rail project – continues to play a role in reducing supply, although we believe that the majority of these withdrawals have now been completed. 

To our north, Brisbane is picking up

There is good news in Brisbane, where the office market is showing signs of reinvigoration. Vacancy rates have stabilised, and with no significant supply coming online anytime soon, we expect to see some recovery in rents. 

In fact, as shown in the graph below, our expectation is that vacancy rates have peaked and will begin to fall over the next few years. According to JLL, the Brisbane CBD office leasing market ended 2017 in a stronger position than it started, with the overall vacancy rate falling to 15% from 16.8% a year ago and a positive net absorbtion of 33,200 sqm recorded over the year. This has been confirmed with several transactions in Brisabane CBD, the fringe and suburban markets in the first half of 2017, suggesting increased investor appetite and compressing yields.  

 

Brisbane office market supply expected to continue contracting. Source: Centuria

To the south, a bright spot in Geelong

We see the regional city of Geelong, the second largest in Victoria, undergoing a significant reinvigoration – thanks in large part to the relocation of several Government agencies, including WorkSafe and the National Disability Insurance Agency. The city is currently an hour from Melbourne by train, but this should drop by 20 minutes with the completion of Transurban’s West Gate Tunnel Project. On track for 36.5% population growth over the next 18 years, the city offers an attractive prospect for investment.

To this end, Centuria has acquired an A-Grade building at 60 Brougham Street for $115.25 million. The office building has ten years remaining on a lease to the AAA-rated State Government owned entity, the Traffic Accident Commission. The Centuria Geelong Office fund, a single asset unlisted fund, will launch February 2018. 

To our west, the first green shoots are appearing in Perth

In what has been the weakest of the CBD markets in recent years, yields are now holding up in Perth, with some indications of improving fundamentals. According to JLL, Perth’s vacancy rate remained high at 21.8%, but fell from 24.1% a year ago with a net absorbtion of 41,800 sqm in 2017. 

The general feeling about mining is more optimistic than it has been, and some of the larger corporations, like Chevron for example, which has been shedding large numbers of staff over the past few years, are now starting to employ again – all good news for office space. 

As evidenced in the graph below, we believe that vacancy rates, while still very high, have peaked, and moving forward we expect to see them start to fall as the economy in Western Australian continues to pick up.

 

Perth office markets showing showing signs of recovery. Source: Centuria

Canberra stable

Canberra remains stable and its fundamentals sound. Vacancies are low in A grade stock, and we believe that downward pressure will continue. Effective rents are beginning to rise and there is some buyer-side demand that is helping keep prices solid. We continue to focus on B and C grade space where there is potential for refurbishment and upgrades. 

Conclusion

We continue to actively seek quality property in markets across the country. As asset-specific buyers, we consider all properties that we believe we can actively manage for the potential to produce an attractive return for investors – even in markets with weaker fundamentals. As we anticipated, with the sale of 10 Spring Street in Sydney’s CBD, we received outstanding results our investors that will allow us to re-direct that capital to other markets where we see value. 

 

Commercial property with liquidity: the best of both worlds

Monday, November 27, 2017

By Jason Huljich

Unlisted property funds have long been recognised for their ability to pool investors’ funds and thereby provide direct access to quality commercial property that would otherwise be out of reach. While the returns of such funds are undoubtedly appealing, the sticking point for some investors has traditionally been the fact that investments are locked up for five or even seven years. Jason Huljich, CEO of Unlisted Property for Centuria, reveals how investors can now achieve the best of both worlds.
 
Quality commercial property – when purchased well and actively managed – has long been recognised for its investment potential. The potential for attractive, tax-advantaged income along with the potential for capital gain when the property is sold is an appealing combination. The challenge for investors, however, is the cost of entry to quality property – something which puts it out of reach of many.
 
This is where unlisted property funds, which pool investors’ funds to purchase commercial property, have the potential for attractive returns for investors, typically in the form of tax-advantaged income and capital gains at the end of the trust.  
 
Unlisted trusts have a closed structure in which property assets are valued annually, so unit price movements are not as volatile. In contrast, A-REITs are traded on an exchange, making them strongly correlated with equity markets (and therefore more volatile), and less likely to move in line with the value of the underlying properties, meaning they don’t necessarily achieve the same level of portfolio diversification.
 
While both listed and unlisted trusts have their advantages – and a sound investment portfolio should incorporate both – the challenge comes in accessing unlisted funds. With cash locked up for a minimum of five years, sometimes seven, and minimum investments as high $50,000 or more, unlisted trusts are naturally more appealing (and accessible) to self-directed high net worth investors, SMSF trustees and the clients of boutique financial planning firms. Furthermore, by not offering daily unit pricing and redemptions, most unlisted funds are not suitable for larger investment platforms, which typically are the starting point for investors that come via most major financial advice firms and aligned planners. This means that a large proportion of investors have lacked easy access to unlisted property trusts and the benefits they bring – a clear market shortcoming.
 
Meeting market needs

In order to level the playing field, Centuria made the decision last year to create a fund which would offer investors unlisted property exposure, with liquidity. The resultant Centuria Diversified Property Fund (CDPF) invests in a range of unlisted funds as well as some A-REITs and cash in order to provide the daily unit pricing and a limited monthly redemption facility that is required by some investors. In essence, what we have created is an open-ended, diversified commercial property portfolio with target liquidity levels and which aims to provide tax-effective monthly income, coupled with the potential for capital growth.
 
Initially funded with internal group money in order to thoroughly test the concept, the CDPF became open to direct investors earlier this year. Today, 92% of the portfolio is comprised of units in a number of Centuria’s unlisted property funds, with the remaining 8% in the form of cash and A-REITs, to provide a strong level of liquidity. Already this year we have secured five million units in the unlisted Centuria Sandgate Road Fund as well as an additional 2.6 million units in the Centuria Havelock House Fund, which will be purchased as investment continue to flow into the fund.
 
Such additional investment will serve to further diversify the fund, reduce its gearing, increase the overall weighted average lease expiry (WALE) and improve distributions, at which point the weighting to cash and A-REITs will also be increased in order to provide enhanced liquidity. 
 
Understanding the changing environment 

As investment increases in CDPF, our intention is to purchase property directly – leveraging the investment process and research that has proved successful in the past for purchasing and managing properties for both our unlisted and listed vehicles.
 
As an asset-specific buyer, we don’t reject markets out of hand, even those with comparatively weak fundamentals (although naturally we take such fundamentals into account). For example, one of the striking features of the market cycle at the moment is the divergent nature of Australia’s different CBD markets. In particular, markets which are heavily reliant on the resources sector (Brisbane and Perth in particular) are much weaker than the east-coast markets of Sydney and Melbourne. This comes as no surprise, as the fading resources boom has impacted demand for office space in these related markets, leading to an excess level of supply. This in turn has been compounded by a strong construction cycle, meaning that supply has continued to grow even as demand dwindles.
 
If you look at the bigger picture, however, the RBA estimates that non-rural commodity prices have significantly recovered – good news for Perth and Brisbane – while net absorption in non-resource led CBD centres has started to ease, diminishing the gap between CBD markets. There are also green shoots appearing in both Perth and Brisbane as demand starts to pick up. Given that supply is likely to remain limited, we anticipate favourable investment conditions to come, and potentially some strategic buying opportunities in these markets.
               
Of course, even as market conditions continue to ebb and flow, one thing remains constant and that’s our commitment to actively manage the commercial properties we own in order to unlock greater value. Our ability to maximise returns from our properties, rather than taking a ‘buy and hold’ approach or holding properties as passive assets, remains central to our strategy and competitive advantage. Through a hands-on approach that includes refurbishments, facility upgrades and the development of spec fitouts to appeal to tenants – all conducted by our own in-house leasing and property management team – we are able to proactively add value to properties wherever possible.
 
Consider and understand the risks to investing

As with all investments, each property trust will have varying degrees of risk that should be considered by prospective investors. Investors should read the Product Disclosure Statement for a Fund carefully to better understand the risks of investing in commercial property and/or unlisted property funds.  
 
The best of both worlds

While we’re still in the relatively early days of what we hope will be a prosperous future for the CDPF, we’re certainly very pleased with its performance so far. Indeed, it’s proved to be a ‘win-win-win’ situation: providing investors with an opportunity for attractive returns; building a much-needed bridge in the market to provide all investors with access to unlisted funds (and direct exposure to commercial property and its potential capital gain); and creating tangible improvements to properties, to the benefit of tenants and users alike. Commercial property with some liquidity is achievable, making this investment class accessible to more.
 
This is a sponsored article from Centuria.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 

Deferring tax can make a big difference to total returns

Monday, November 13, 2017

By Jason Huljich

No one likes giving the tax man more of their money than they need to. And when personal tax rates range from a third to a half of your income, finding ways of reducing the burden is definitely time well spent. Negatively gearing residential property, or investing in companies which pay a franked dividend, for example, are two well-used solutions to the problem of reducing and/or deferring tax liabilities over time.
 
What some investors may not realise is that the income, and potentially the capital gains, on commercial property can also be significantly tax-advantaged. The reason is that the ATO allows for certain deductions and allowances on commercial property, which can serve to reduce assessable income and defer tax liabilities for the period the property is owned.
 
Furthermore, these tax benefits are available to investors regardless of the structure in which their property asset is held, e.g. as a direct investment, or through a pooled investment, such as an unlisted property trust or even a listed property trust.
 
Why does depreciation make income tax-advantaged?

Property funds make distributions to investors which come primarily from the rental income received from tenants. Tax-deferred distributions arise because the tax deductions that property owners can claim mean there is a difference between the trust’s cash or distributable income and its taxable income.
 
These benefits flow through to investors, because investors can effectively claim the deductions (in proportion to the size of their ownership in the property) against their personal income. This means that their taxable income (not their actual income) is reduced, thereby reducing their tax liability. This difference between distributed income and taxable income, referred to as a tax deferred distribution from a property trust, is only recouped when the investment is sold. This is because the cost base of the investment is reduced by these deferred tax amounts and CGT will be paid on the difference between the cost base and the sale price.
 
The good news is that if the property is held in a trust structure, such as an unlisted trust, then you will be eligible for 50% CGT discount if the investment has been held for over 12 months. This is almost always the case in an unlisted property trust, which typically has a fixed term of five or seven years during which time investors cannot exit and the property will not be sold. This means you are paying only about 50% of your marginal tax rate for this portion of the income.
 
What is a Depreciation Schedule and how does it work?

Commercial properties are subject to a ‘depreciation schedule’ – which sets out capital allowances and tax depreciation. There are two main elements: deductions for capital works, and deductions for plant and equipment.
 
High quality commercial properties tend to have higher depreciation allowances, and larger, higher buildings, which have more services (lifts, fire services, air-conditioning etc.) typically have higher depreciation allowances as well.
 
Capital works deductions

Sometimes referred to a ‘building write-off’, capital works deductions are allowed for various structural elements of a building, including fixed parts of the property such as the foundations, walls, roof, doors and windows. How much you can ‘depreciate’ depends on when the property was built, and ranges from 2.5% to a maximum of 4% per annum.  
 
These kinds of structural elements of a property are typically depreciated over a long time period, potentially up to 40 years.
 
Plant and equipment deductions

Plant and equipment refers to assets which can be easily removed or are mechanical in nature – in essence, assets which are deemed to have a limited effective life so could reasonably be expected to depreciate over time. The effective life of an asset is set by the tax commissioner and changes over time.
 
Plant and equipment such as air conditioners and even lifts usually don’t last more than 10 years or so, so are depreciated more quickly and at a higher rate.
 
Deciding how to claim depreciation entitlement is also important.

Once depreciation has been calculated, the property owner (in an unlisted trust this will be the manager of the trust), can choose one of two methods to claim: the ‘prime cost’ method and the ‘diminishing value’ method. Prime cost means the deduction for each year is calculated as a percentage of the cost. The diminishing value method calculates the deduction as a percentage of the balance you have left to deduct.
 
Neither method is intrinsically better than the other – the one which will work best depends on the time horizon of the property investment. Under the diminishing value method, more of the depreciation allowances will be claimed in the earlier years, whereas with the prime cost method, deductions are spread evenly over time, which will tend to suit long-term investors better.
 
Transparency. At the beginning and over the life of the trust.

One of the nice things about tax benefits from property investment in an unlisted trust structure is that they are transparent – from the beginning of the trust to the end. The Product Disclosure Statement (PDS) will outline the first two years of returns and forecast tax benefits clearly.
 
Unlisted trusts do not pay tax within the trust structure; rather, all benefits and deductions flow through to the investor. At the end of the financial year, Centuria will issue you with a tax certificate which shows all tax deferrals and depreciation which can be included in your personal tax returns. And chances are, you may end up paying less tax than you think.

This is a sponsored article from Centuria.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 

Can property investments provide a yield to live on anymore?

Friday, August 04, 2017

By Jason Huljich

Real estate investment has performed very well across the board for investors over the past few years. But depending on what investors are looking for, not all property investment is the same. If you’re looking for a yield to live on, commercial property may just be the answer. 

For many investors, and particularly those in or heading towards retirement, yield can be everything. Capital growth is important, but it’s the yield that makes the difference between living on the returns from your investments and drawing down on capital too soon. But with interest rates at record lows, returns from low-risk assets like cash and fixed interest are pretty grim, and investors are facing up to the reality that they need to look at other asset classes to achieve the returns they need.

Residential property can provide stellar total returns – but for how long?

According to a 2016 Long-term Investing Report produced by the ASX and Russell Investments, Australian residential property has been the top performing asset class over the past 20 years. Yet at the same time, in our low-growth, low-return world, Australia’s commercial property sector – including office towers, industrial facilities and shopping malls – has also delivered standout returns.

In fact, data produced by the Property Council of Australia shows that as at March last year, the average annual return on commercial property was 14%, excluding leverage. Add in leverage, and the returns look even better. These are figures which compare very favourably to the 9.2% from listed property and the depressing 1.6% from fixed interest.

Unlike residential property, in commercial property, rental returns drive the results. Average income yields on the $160 billion of commercial property in the Property Council’s index was 6.6%, whereas in residential property, the picture is very different. Residential rental yields in Sydney and Melbourne are at all-time lows: just 2.8% in Sydney and 2.7% in Melbourne as at January this year.

The seemingly endless upward trajectory of residential property prices (in other words, capital growth), has been the major factor driving its great performance. But continuing to bank on massive capital gains to make up for very low yields is starting to look like a risky strategy. Tax-driven investment strategies, like negative gearing, have played a role in propping up the market, but plenty of analysts are now predicting that the tide is about to turn, or at the very least stall.

So where investors should be looking for their property exposure?

Commercial property can offer a better yield/capital growth ratio.

Investors looking for a yield they can live on, without foregoing the prospect of capital growth, could do a lot worse than commercial property. Most investors are not in a position to purchase a commercial building outright – but there are other, pooled investment options which might appeal. Unlisted property trusts are one.

Unlisted property trusts pool investors’ funds to purchase one or more properties. Investors buy units in the trust, which is managed by a professional property manager, with investors’ money remaining in the trust for a specified time period. At Centuria, the period is usually five years, with an option for a further two years if unit holders agree. Investors receive monthly income distributions (yield) from rent throughout the life of the trust, and any capital gain achieved on the sale of the property is distributed when the trust is wound up.

The good news is that the yield/capital growth profile of commercial property can be very attractive – but it does depend on a number of factors.  Chief among them is quality of the property itself, but the quality and track record of the manager is equally crucial.

Factors which impact returns from a property asset

The quality of the property and whether it is fit for purpose, i.e. will the property perform well in its market/compared with comparable products?

- Location, Location, Location.

Weighted average lease expiry (WALE). This is a measure of the amount of time that leases are locked in across the property. Depending on the property and the manager’s intention, a long or short WALE can be equally attractive. Where a property does not need a great deal of refurbishment and is tenanted by quality businesses or government departments, then a long WALE is preferable. However, some properties offer scope to be upgraded and refurbished and rents raised as a result. In this case, a shorter WALE may be better, because it means that when existing tenants leave new tenants can be brought in at higher rents.

Tenant profile. In most cases, quality corporations and businesses with a track record are more attractive than start-up companies, for example, because investors have more comfort that rents will be paid.

Factors to consider when assessing an unlisted property trust manager

The manager’s track record. A track record of success is a positive sign, and while not a guarantee, it's a good indication that future success is likely. Experience in property markets and in managing unlisted trusts is important.

Whether or not the manager is an active property manager. At Centuria, we are active managers. This means we actively seek to add value to the property assets and back ourselves to generate attractive total returns as a result. We do not use external property managers, but rather an in-house team which is close to our tenants, and knows our properties inside out. We see this as our competitive advantage – our ability to buy well and then really work our assets to get the best out of them.

-The trust structure itself. Look carefully at how the trust is structured. Is it clear when the trust can, or will be, wound up? Is it clear when distributions will be made? What is the gearing level of the trust? How well, and how often, does the manager communicate with investors?

Unlisted property trusts – some examples

We have a long track record in unlisted property trusts. To date, we have completed 33 unlisted funds – with an average return to investors of 13.2% per annum.

At the same time, not all our unlisted property trusts are the same, and our strategy with respect to different properties is reflected in different structures and outlooks for the trusts themselves. 

Sandgate Road – a bond-like structure, with better yields than bonds

Sandgate Road Fund is a ‘passive’ unlisted trust and, in this regard, is somewhat bond-like in its structure. The property does not require refurbishment as it is only four years old, offers a long WALE (9.4 years), is 100% occupied, with 81% of the space leased to State Government-owned entities.

This means that income distributions are locked and fixed, in the same way that bond yields are.

The term of the trust is six years and forecast distributions are 6.5% initially, increasing to 7% in the 2019 financial year – with additional rental growth forecast to increase distributions to 8% by the 2023 financial year.

Zenith Fund – active management in a strengthening market

The Zenith Fund – which co-owns the Zenith, an institutional grade office tower in Chatswood on Sydney’s lower north shore is arguably higher risk, but we believe has more potential upside than Sandgate.

The property required refurbishment when it was purchased, and we are about to undertake $27.8 million of capital expenditure to improve amenities. Zenith was 94.8% occupied at purchase, but with a WALE of only 2.7 years.

Given our view that metro market of Chatswood is set to benefit from falling vacancies and strong rental growth, partly due to State Government investment in infrastructure in the area, the lower WALE was very attractive.

We have already been able to raise rents for incoming tenants, and anticipate further rental growth going forward. The current yield is 7.6% and we anticipate that this will rise over the next year.

The bottom line

The nature of property investment means that it has always been appealing to investors looking for on-going yield, but with some potential upside in terms of capital growth at the end. The issue in the current economic environment is that yields from some property investments are simply not high enough, particularly for investors relying on it to live. In this case, commercial property in general, and unlisted property trusts in particular, are certainly worth considering.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 

Mixed outlook for Australian office property

Thursday, April 06, 2017

By Jason Huljich

Australian office property will continue to be a mixed bag in 2017. Despite the weight of offshore money flowing into Sydney and Melbourne in search of a safe-haven from global volatility, a measure of overall weakness in the Australian economy and the on-going effect of the demise of the mining boom are contributing to some very different fundamentals.

Nonetheless, according to Jason Huljich, CEO of Unlisted Property for Centuria, it’s not all doom and gloom – there remains opportunities for attractive yields and solid returns from office property for the well-researched investor.

According to the Property Council of Australia’s (PCA) most recent office property report, the Australian CBD office vacancy rate remained steady over the six months to January 2017, declining only slightly, from 11% to 10.9%. However, this steadiness belies significant differences in the markets which make up the index.

While Sydney and Melbourne remain robust, the residual effects of the end of the mining boom continue to negatively affect exposed markets. Perth has been particularly exposed to the fallout of the mining boom, and Brisbane is also feeling its impact. In South Australia, the overall economy remains weak with flow-on effects to the Adelaide CBD office market.

So, what does 2017 hold for the major office markets? The bottom line is that we are seeing little change from 2016.

Sydney and Melbourne the pick

Sydney and Melbourne are the pick of the major markets. According to the PCA, at the end of January vacancy rates were 6.2% and 6.4% respectively. Both markets benefit from strong underlying fundamentals.

In Sydney, over the past two years, we saw B-grade office rents double, which is clearly unsustainable. With some tenants now paying excess of $1,000 per sqm, flattening is to be expected this year.

The trigger for rapid rental growth was the ongoing withdrawal of B-grade office stock for the Sydney Metro and residential conversions. We don’t foresee major additional withdrawals in the near future, which should keep rental growth capped. At the same time, demand remains strong for A and B-grade stock, and we continue to see suites of sub 1,000 sqm leased before the previous tenant vacates. Vacancy rates will fall particularly in the B grade market however, in our view, both demand and the resulting rental levels are now stabilising.

On the sales side, we are starting to see an injection of new stock into the market. Over the past few years, most owners believed that the office market still had some way to run, and as a result, were unwilling to sell. However, now there is growing divergence in views with some believing that the market may be close to its peak. We therefore expect more stock to come up for sale. This is good news for buyers, who at the very least will be presented with more opportunity and more activity than they have seen in past few years.

Sydney metro markets benefit from stock withdrawals and infrastructure

Sydney metro markets continue to go from strength-to-strength. Withdrawal of office stock for residential conversion in metro and CBD markets has been dominant driver of demand for office space in these markets, and as A and B grade office space has become more scarce and more expensive in the Sydney CBD, businesses have looked to move further afield. North Sydney was the first recipient of overflow demand from the CBD, followed by St Leonards, and now Chatswood on Sydney’s north shore.

Centuria recently purchased a property in Chatswood. This created The Centuria Zenith Fund, which is already proving to be strong performer for investors. Leasing deals are coming in at rents up to 10% higher than we forecast, and the recent re-valuation of our stake in the property saw it rise from our purchase price of $279 million to $301 million – all of which is good news for investors.

The fact that the NSW Government is investing heavily in infrastructure has been a contributing factor to rising demand in metro markets. Parramatta is worth mentioning. Situated in the heart of Sydney’s rapidly growing western suburbs, and with new transport links, Sydney's "second CBD" is now one of the strongest office markets in the country. Quality assets are in hot demand, and this has resulted in upward pressure on prices.

Melbourne is solid, but remains tightly held

Demand for office space in Melbourne is strong. Over the past six months, it grew at 3.5 times the historical average – yet Melbourne continues to be tightly held, and supply is constrained. As a result, we expect vacancy rates will continue to fall throughout 2017.

However, despite the lack of new supply, we expect demand for office property to continue to be strong throughout 2017, as investors seek safe property havens in markets with strong underlying leasing market fundamentals. Offshore money continues to pour in – and we expect offshore groups to dominate the investment landscape looking forward. In 2016, 10 out of the 14 office purchases were made by offshore groups, and this kind of ratio is unlikely to change.

Rental levels have held up well on the back of strong tenant demand, particularly at the Premium end of the market, where landlords have gained some face rental growth. In the A and B sector, however, rental growth has been more subdued, and landlords are finding they need to offer a competitive product to appeal. This means taking an active property management approach – speculative fitouts and upgrading and refurbishing of common areas such as lifts and lobbies have been key to success.

Other markets are struggling, but there are opportunities

Outside of Sydney and Melbourne, capital city markets are weaker. Brisbane, Perth and Adelaide remain weak early in the year. Both Perth and Adelaide saw a sharp contraction in rental levels during 2016 as demand for space fell and vacancy rates rose.

The Perth market is struggling and landlords are offering very significant incentives, in some cases up to 50% incentives to secure quality tenants. Incentives like this are a feature of weak markets, because when there is plenty of available space to lease, landlords compete to attract tenants in one of two ways – by contributing to the tenant’s fitout, or by offering rent-free periods.

On the upside, the Perth Landlords has been saved from complete disaster by on-going low interest rates, which are allowing owners to continue servicing debt despite the poor returns.

The most recent figures from the PCA saw Brisbane picking up. Over the six months to end January 2017, demand for office space grew at over five times the historical average. Nonetheless, conditions remain tough. Money is continuing to flow into the market looking for yield, helping to keep conditions more positive. The fundamentals are weak but should improve during 2017, all of which means we may have seen the bottom and come out the other side!

Little significant change overall

Office CBD markets have not changed significantly since the end of 2016, and our view is that in most cases the fundamental drivers of return have not changed. While Brisbane may have seen the worst and should improve from low levels, Sydney and Melbourne remain our top picks. Given that there is no major new supply in either city (albeit expectation of some new stock in Sydney), we expect to see both markets perform well through 2017. 

 Source: Property Council of Australia

 Colliers International, Research and Forecast Report, CBD Office, First Half 2017

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 

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