How your portfolio can benefit from Australia’s strong fundamentals

Many of the fundamental reasons to invest in real estate hold true for considering investments today.

The typical stability of income from real estate investing continues to be a strong characteristic across the sector but it is important to maintain diversification within investment portfolios, as not all asset classes move in lockstep.

The property sector in Australia is underpinned by a strong population growth rate of 2.2% p.a., one of the highest of OECD countries, which continues to drive demand for high-quality property.

The outlook for Australian property in 2024

Commercial property will likely stabilise once interest rates level out and inflation has been tamed. The Australian economy is in better shape than we thought it would be 12 months ago, and from a global perspective, the Australian economy is screening attractively.

What we are seeing on the ground is consumer sentiment remaining weak and spending is moderating as the impact of the interest rates flows through. Although employment growth is easing, companies are still hiring and the unemployment rate remains low.

Population growth and infrastructure spending are also providing a boost and will continue to underpin the growth of the economy. A soft landing rather than a recession seems the most likely outcome.

Where to now for retail, industrial, healthcare and others?

Opportunity funds. Australia is now 18 months into the most rapid increase in interest rates on record. The market has started digesting the size and duration of these interest rate moves. We have seen the listed property market re-price with shares trading at a large discount to net tangible assets. We have seen credit markets re-price too, with borrowers paying wide margins because of the scarcity of capital available for real estate generally and development particularly. This has created a structural market dislocation where the cost of capital is high, and some real estate is not valued as highly as it was at other points of the rate cycle – creating opportunity. Dexus’s opportunity fund series has a unique mandate to invest in situations from distress through to growth and to pursue opportunities right through the capital stack across all of the real estate sub-sectors in Australia. The first fund in this series, DREP1 is on track to deliver the target net equity IRR of circa 15%.

Healthcare benefits from unique fundamentals of strong government support, strong inelastic demand and a positive long-term outlook supported by a larger population living longer. Every state in Australia has recognised the critical role of private capital in helping to facilitate the delivery of vital healthcare services for the community. Dexus manages $2 billion in healthcare assets, predominantly held in Dexus Healthcare Property Fund (DHPF), and has the capability to work with private and government providers across the real estate and infrastructure (PPP) spectrum. Key assets in this portfolio include Royal Adelaide Hospital serviced as a PPP and North Shore Health Hub owned by DHPF.

Industrial is very healthy in most key markets with vacancy levels between 1–3%. Rezoning around the country has been very slow and most of the attention is turning to the creation of residential opportunities due to the housing shortage. While there continues to be a shortage of appropriate industrial land, along with strong consumer demand, we expect logistics and industrial property will remain well supported for the next 12 months, enough to cover any movement in cap rates.

Retail has been resilient. At the close of 2023 we experienced a record Black Friday and Cyber Monday sales period across our $10 billion of retail assets. We expect asset pricing to be steady once cap rates stabilise.

Office will continue to have its challenges as organisations navigate workplace flexibility however we have already seen better-quality assets in locations with good amenity continuing to provide strong cash flows. Prime grade office assets offer modern, collaborative workplaces in the best location and are highly sought after by quality tenants.

What are the biggest risks for 2024?

Investors will need conviction to realise value and appreciate the long-term benefits of holding assets. Holders of assets need to look through the cycle and partner with managers that are well-resourced and have a deep track record in delivering performance over the long term. With the scarcity of capital, buyers in this market have plenty of opportunity across real estate.

At a portfolio level, we have conviction across healthcare, industrial and retail investments, which we expect to remain steady.

When should investors strongly consider investing in property?

Liquidity is expected to improve from Q3 CY2024. By then, we believe property valuations will reset and interest rates are likely to have peaked, giving buyers greater certainty about the cost of capital. So, it could be a good time to invest in property ahead of this stabilisation, particularly for longer-term investors, as returns are likely to offset the short-term risks of the asset class. It is important to consider a property fund that has a diverse range of assets as it reduces the risk of being exposed to risks associated with any single sector.