The Australian retail sector is challenging with a range of cyclical and structural factors impacting centre and asset performance. The latest Australian Bureau of Statistics (ABS) figures on retail turnover (seasonally adjusted) showed turnover growth below trend at 2.5% over the 12 months to September 2019. Our monitoring of retail vacancy rates highlight a reduction in new store openings and the rationalisation of retailer footprints. Sub-regional shopping centres are most exposed to retail sector headwinds and the national vacancy rate (arithmetic average) increased to 4.8% in 2Q19 – well above the 10-year average of 3.1%.
The headline vacancy rate only tells part of the story. Our centre managers’ insight publication revealed that 35% of centre managers’ reported an incentive of over 20% was required to attract a new tenant – up from 14% in the December 2015 edition of the survey.
The phrase “experience economy” was first coined in an article by B. Joseph Pine II and James H. Gilmore in 1998. Shopping centres are a microcosm of the experience economy and consumers require a diverse range of experiences from shopping centre visits. Proactive owners have responded to changing consumer requirements by evolving the tenancy mix to include more F&B, leisure activities, beauty and even urban farms.
Against this challenging backdrop, it may seem strange to classify Australian shopping centres as opportunity rich assets. We believe the opportunity relates to development activity to diversify the income stream. Chadstone in Melbourne – the largest shopping centre in the Southern Hemisphere – is at the forefront of this evolution and includes a hotel and multiple office towers.
Development potential extends beyond traditional property sectors. The nascent Build-to-Rent sector in Australia is one clear development opportunity. However, we believe the target demographic for the first generation of Build-to-Rent projects will be younger professionals. As a result, only shopping centres with a catchment comprising a high proportion of 20-35 year olds will be relevant.
An interesting asset enhancement strategy relates to healthcare – a sector of increasing importance to the Australian economy. The ABS estimates that 15.7% of Australia’s population is above 65 years old, a figure projected to rise to 19.1% by 2050. In the US, the ageing trend is more advanced and shopping centre owners have started to respond. Simon Property Group recently opened the Leonard Cancer Institute on a former parking lot at The Shops at Mission Viejo in Southern California.
The introduction of a healthcare component to the sector comes back to understanding the catchment. A quick desktop research exercise shows the median age of a resident in Mission Viejo is 7 years higher than the US average, while the median income is double the US average.
The Australian retail sector is going through a period of evolution. Owners and investors have an opportunity to re-assess the characteristics of the sector. We believe that assets with development potential to diversify the income stream will be well positioned to navigate the structural changes within the retail sector.
The Australian economy has experienced a turbulent 2019. The most recent national accounts showed that the Australian economy only posted GDP growth of 1.8% over the 12 months to March 2019. The external environment has not been supportive with global economic uncertainty and the US-China trade war leading to fragile business and household confidence. However, the softer GDP figures are more a function of domestic factors with a reduction in consumption growth and private sector residential investment moving from a tailwind to a headwind for the Australian economy.
Economic growth projections for developed economies have been revised down over the next two years. The International Monetary Fund (IMF) World Economic Outlook (April 2019) has the Australian economy growing by 2.1% in 2019 and 2.8% in 2020. While the IMF’s projection is below Australia’s long-term (25 year) average GDP growth of 3.3%, Australia is projected to outperform major advanced economies in 2020 (Figure 1).
Figure 1: Advanced Economies GDP Growth, 2019 & 2020
Source: IMF (April 2019), JLL Research
The ingredients for a modest recovery in 2020 are already in place. The Reserve Bank of Australia (RBA) has moved to stimulate the domestic economy. The RBA has eased monetary policy with two 25 basis point cuts in the official cash rate over June and July. The official cash rate now sits at an all-time record low of 1.00%. The RBA continues to believe that the economic growth outlook is reasonable and this easing cycle is aimed at supporting economic growth and a lower unemployment rate.
The Federal Election in June re-elected the Coalition government with an improved majority in the House of Representatives. The government has moved quickly to provide fiscal stimulus with the implementation of income tax cuts. These cuts are largely aimed at low and middle income earners and should be supportive of consumer spending. Australian households are expected to respond positively to lower income tax rates and a reduction in the standard variable mortgage rate. Furthermore, the wealth effect should start to improve with Sydney and Melbourne house prices bottoming and the benchmark S&P/ASX 200 up almost 20% in 2019.
Longer-term, Australia is in the midst of major investment in economic and community infrastructure spend. Infrastructure spending will increase the productive capacity of the domestic economy. The most recent Federal Budget (2019/20) highlighted record transport infrastructure investment of $100 billion over the next decade. Real estate markets are highly sensitive to infrastructure spending and we are seeing the re-rating of sub-markets in Sydney, Melbourne and Brisbane.
The Australian economy is clearly facing short-term headwinds. However, even the most pessimistic private sector economist is not predicting an end to Australia’s record-breaking 27 years (and counting) of positive economic growth in 2019 or 2020. We may be down at the moment, but accommodative monetary and fiscal policy should support an economic recovery in 2020.
Every year we host an event for approximately 100 clients and colleagues in Australia’s capital city – Canberra. We believe that Canberra plays an important role in a diversified property portfolio as it is lowly correlated with other major Australian office markets.
However, our most recent event was more orientated towards the physical market and titled: Strategies to navigate the divergence between prime and secondary vacancy rates. We used to observe a strong correlation between prime and secondary grade vacancy rates – over the period from 2000 to 2014 – the correlation co-efficient was 0.85.
Chart 1: Canberra vacancy rate by grade
Source: JLL Research
The vacancy rate divergence from 2014 was noticeable. Prime vacancy tightened from 13.0% in 2014 to 5.4% in 1Q18 – the lowest level since early 2008. Low vacancy exerted upward pressure on effective rents which increased by 3.5% over the 12 months to March 2018. In contrast, the secondary grade vacancy rate pushed up towards 25% and secondary net effective rents are 33% lower than where they sat 10 years ago.
To put some context around these numbers a 1,000 sqm sized organisation seeking prime grade contiguous space in Canberra has 14 options. In a normal short-listing process, an organisation will typically discount half the options based on price and location, lowering the number of genuine options to seven. The same sized organisation looking for secondary grade space has 53 options. Even allowing for the normal discounting factor, that still equates to over 25 distinct secondary grade space options for a 1,000 sqm organisation across Canberra.
With so many space options in the secondary grade sector, owners have to find ways to differentiate their product. Not all of these strategies require a full asset repositioning and we believe that owners can implement capital light strategies. The ground floor lobby creates the first impression and is a potential differentiator. Owners should make use of artwork, green walls and informal seating areas to create a usable third space for building occupiers.
Organisations are committed to providing health and wellness initiatives for their employees. End of trip facilities are typically found in modern prime grade assets. However, the number of people cycling to work across the Australian Capital Territory has increased from 2.1% at the 2006 Census to 8.4% in the most recent Census (2016). The limited prevalence of end of trip facilities in secondary grade assets presents an opportunity for owners. We are advocating a circa 400 to 500 sqm facility which includes bike racks, shower facilities, lockers and changing areas.
While this blog has concentrated on the Canberra office market, the asset management strategies proposed are relevant for Perth (28.6%), Brisbane (19.7%) and Adelaide (17.4%) where secondary grade vacancy is elevated and owners are looking for ways (other than price) to differentiate their product in a competitive landscape.
In the 1980s, New South Wales (NSW) vehicle registration plates claimed to be: “The Premier State”, while “Towards 2000” was evident in the 1990s after Sydney secured the 2000 Olympics. Post 2000 our vehicle registration plates have been light on motivational messages as NSW’s share of Australia’s economic output declined from 36.5 per cent (2000) to 31.9 per cent (2012).
Since 2013, NSW has re-established itself as the premier state and created 37.3 per cent of the nation’s new jobs. Our Decoding City Performance report has seen Sydney graduate from a ‘New World City’ to a Contender behind the seven established world cities.
One of the challenges highlighted in the report was infrastructure provision. The NSW State Government is committed to addressing the infrastructure deficit. The 2017/18 Budget reported record levels of infrastructure investment across NSW, with AUD 72.7 billion (USD 55.8 billion) committed over the next four years.
The Greater Sydney Commission was established in 2015 to address the long-term challenges associated with population growth. The Commission is leading metropolitan planning to make Greater Sydney more productive, sustainable and livable.
The Greater Sydney Commission released the draft Greater Sydney region plan in October: A Metropolis of Three Cities. In the report, the Commission outlines why a cohesive plan is necessary:
The plan proposes transforming Greater Sydney into a metropolis of three cities – Eastern Harbour City, Central River City and Western Parkland City:
Source: Greater Sydney Commission
The Eastern Harbour City already has strong economic credentials and will continue to leverage its strong financial, professional, health and education sectors. The Eastern Harbour City will concentrate on urban renewal and infill development with a strong acknowledgment of local identity and amenities.
Real estate developers and investors will also be interested in exploring long-term opportunities in the Central River City and Western Parkland City.
The Central River City has Parramatta at its economic heart. New office, residential and retail developments are changing the topography of Parramatta. Our forecasts show that the Parramatta CBD is experiencing a demand-led development cycle and office stock will increase from 717,700 sqm to over 1.0 million sqm by 2023.
The Western Parkland City will be anchored by a new international airport for Greater Sydney and Badgerys Creek Aerotropolis. The initiative is expected to bring high-quality engineering, robotics and agribusiness jobs to the region, improving the diversity of employment opportunities in the Western Parkland City.
We believe the Aerotropolis will provide the catalyst for a new commercial precinct and real estate developers will explore the opportunity to develop business parks inclusive of campus-style office accommodation, high-tech logistics facilities and fulfillment centres.
The draft plan highlights the importance of connectivity and integration between the three metropolises and represents another proactive step in ensuring Sydney remains and becomes an even more relevant global city.
WeWork launched in Sydney in late 2016 and now has three locations across the city – 333 George Street, 5 Martin Place and 100 Harris Street. Sydney has embraced the co-working model and WeWork differentiates its product through providing a sense of community and a level of service more associated with the high end hospitality sector.
We have started to refer to Martin Place as ‘Silicon Place’ after the clustering of tech-related firms in the precinct. Technology sectors, in major cities around the world, have shown a desire to cluster in order to achieve the benefits of economies of agglomeration. Specifically, they are seeking knowledge spill-overs and the sharing of ideas amongst a diverse range of individuals. The presence of WeWork consolidates Martin Place as a globally recognised tech precinct.
Tech precincts are not only concentrated in CBDs – they have evolved in former industrial precincts, in close proximity to the CBD, where significant gentrification has occurred. San Francisco has South of Market Street (SOMA), New York has the Meatpacking district, and London has the rather than blandly name East London Tech City. Fortunately, Londoners are known for having innovative precinct and building names and the precinct has gained a more colloquial term – ‘Silicon Roundabout’.
The characteristics of these precincts include: a growing and highly educated population; close proximity to educational facilities; and the prevalence of converted warehouse facilities for residential and commercial use. Our analysis of these precincts also shows the presence of multiple WeWork facilities and Google as a major occupier.
That brings us back to Sydney and the largest WeWork tenancy in Sydney is 100 Harris Street, Pyrmont: the suburb where Google has been located since 2008. The gentrification of Pyrmont mirrors the former industrial precincts outlined earlier. Pyrmont went through a period of urban decline in the 1960s and 1970s, with the population dropping to only 1,500 people in 1980. The resident population in Pyrmont is now back to an estimated 14,500 people. New residential development activity and strong demand from owner-occupiers will see Pyrmont’s population grow at a rate well above the metropolitan Sydney average.
What Sydney is really lacking is an innovative branding of the Pyrmont tech precinct, similar to what we have generated for Martin Place (Silicon Place). Initially, I thought we could aim for something like West of Darling Harbour or WDH for the precinct. On reflection, we have done well with Martin Place, but the Pyrmont branding requires further work – any suggestions?
Total assets controlled by the Australian superannuation (pension) sector surpassed AUD 1.6 trillion for the first time in December 2014. To put the Australian pension system into context, Towers Watson reported that the Australian pension system has the fourth largest asset base in the world behind the US, UK and Japan. Superannuation funds have maintained a relatively consistent allocation to real estate of between 8% and 10%. The current allocation to real estate is 8%, implying that superannuation funds have a AUD 131 billion exposure to the real estate sector.
The recent acquisition of a 25% stake in the Ala Moana shopping mall in Honolulu for USD 1.1 billion by Australian Super captured media attention in Australia. However, the Australian superannuation sector has a domestic bias in its real estate portfolio. Real Capital Analytics reported that Australian investors have acquired only USD 9.09 billion worth of offshore assets over the three years to March 2015. This headline figure includes acquisitions made by listed Australian REITs and developers. Superannuation sector investment activity has been limited with the aforementioned Australian Super the most active, followed by QIC and Q Super.
The question is: when will the tipping point occur for the Australian superannuation sector moving into offshore real estate markets?
The superannuation sector is projected to increase over the next decade. The Superannuation Guarantee levy increased to 9.5% in July 2014. Based on current laws, the Superannuation Guarantee will remain at 9.5% for seven years, increasing to 10% from July 2021 and eventually to 12% from July 2025.
While the long-term projections for the size of the superannuation sector vary, we have assumed an increase of 7% per annum between 2014 and 2025. Based on this simplistic modelling the superannuation sector will increase to AUD 3.5 trillion by 2025. Assuming superannuation funds maintain an 8% allocation to real estate, the incremental demand for real estate between 2014 and 2025 will be AUD 144 billion.
Part of the incremental demand will be absorbed by the capital appreciation of existing real estate stock, but it implies there will be underlying demand of AUD 95 billion for real estate investment between 2014 and 2025.
The Australian superannuation sector is highly fragmented and a number of funds lack the scale or infrastructure to adequately assess offshore investment opportunities. Further consolidation is expected in the sector over the next two to three years with a number of large funds emerging. A shortage of real estate assets in Australia will see an increasing number of superannuation funds diversify their real estate portfolios by moving offshore. By 2020, the Australian superannuation sector could be one of the most active cross-border real estate investors.