Fitzroys 2021 Outlook – Capital Markets

Posted on 16th February 2021

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Investors are recognising the upside and potential of Melbourne’s suburban office market, while some parts of the market are entering a phase of “price discovery”.

“Cashed-up investors looking for income are particularly prominent in the market, wanting to avoid holding cash in the bank, which returns more or less nothing in the ultra-low interest rate environment,” Fitzroys Director, Paul Burns said.

The Reserve Bank of Australia has just flagged the current historic low interest rate of 0.1% is unlikely to move until 2024.

“Opportunistic groups, including wholesale funds established by boutique pooled investment groups, will also be on the lookout to buy at a discount.”

Burns said Foreign Investment Review Board restrictions may provide an impediment to some sales to offshore buyers, as some vendors want a quick and certain solution.

“However, this hasn’t dampened interest from offshore investors looking at assets in Australia and Melbourne.

“Compared to most other countries, Australia has been in a better position overall throughout the pandemic and offers strong potential for a fast recovery, reaffirming its safe-haven status that had attracted so many offshore investors in the past.

“Offshore investors are already more comfortable with lower property returns, further making the location ideal for portfolio diversification.”

Burns said that some major REITs may be sellers as they look to reweight their portfolios. Some are shifting away from secondary-grade office and retail assets in favour of prime assets and industrial properties, which are very much “flavour of the month” based on the booming e-commerce economy.

Security still key

Burns said the heightened competition seeking passive property is likely to see yields firming for higher-grade assets with secure income.

“There is a significant appetite for property with secure, long-term income, from tenants who can and will pay rent,” he said.

“Banks will lend and at record-low, long-term rates – it’s a no-brainer, however the weight of money chasing passive property may see yields for higher-grade assets tighten further, and a widening of the gap between those and secondary-grade assets with shorter lease terms or vacancies.

“Significantly, property without income or impaired income will not be supported by the banks. Buyers can’t get funding, and equity is precious and expensive. We are entering a phase of ‘price discovery’ – we don’t know what the price is for some types of property.”

Burns noted that banks continue to be selective when it comes to properties with current vacancies and short-term leases.

“However, secondary and non-bank lenders have continued to pick up the slack in this space.”

Suburbs in focus

Burns said the CBD investment market is still suffering from a shortage of supply of available stock for sale.

“In spite of Melbourne’s CBD being the hardest hit during the COVID period, investor demand is still there, partly unsatisfied from a shortage of offerings over recent years.”

There is caution around the city fringe office market.

“A reasonable amount of supply without tenants still exists, and big incentives are now on offer. There is also a considerable pipeline of new and refurbished stock coming to the market throughout the CBD and the fringe in the coming years.”

New data from the Property Council of Australia has the CBD vacancy rate increasing to 8.2% over the past six months. An estimated 350,000sqm of office space was added to the CBD market during 2020, and almost 390,000sqm will enter the market over the next three years. Multiple estimates pin the pending amount of city fringe stock at above 270,000sqm over the three-year period.

“The suburban office market is now recognised as having a great deal of upside and potential,” Burns said.

“Rent is comparatively very cheap, and assets are closer to where people live, so there isn’t the same reliance on public transport connections, while still making it easier to access the workplace and collaborate with colleagues in-person during a period of more flexible working hours and arrangements.

“Investors will recognise the increased competition for these spaces from a deeper pool of higher-quality tenants, which will likely elevate occupancy rates and rental growth prospects.”

Burns said the short-term effect of the pandemic has clearly been significant on the office market.

“Working from home has been accepted as a valid part of the working week and business operations, but it remains to be seen just how much it will play a role as businesses return to fuller operations.

“The long-term effect will be modest. Businesses may be reluctant to split their workforce further and still gravitate towards central locations, particularly larger corporates.”

“People need the collaborative and social environment of an office, and employers need to see what their employees are doing. Now more than ever, productivity will need to be driven to catch up for the losses.”