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.