The Australian property snapback is drawing near

A period of elevated inflation and interest rates has challenged Australia’s commercial property sector. But performance has varied across different parts of the space.

As Charter Hall’s CEO of Direct, Steve Bennett, explains, the last couple of years have been nothing like a GFC moment for Australian commercial property.

“The liquidity and availability of debt from the finance sector is still there,” he says, pointing out that his own division successfully refinanced some $2.6 billion of debt in the last six months.

“Ultimately, you can't insulate yourself entirely from the cycle – if capitalisation rates are increasing and property values are coming down, you can't push back the tide. But you can make sure you have tenants that can go through the cycle, and it will be the quality assets that come out the other side with the strongest growth prospects,” Bennett says.

In the following Q&A, he explains how his team has done just that, looking at how Charter Hall is positioned currently, and the most exciting parts of the property sector from here.

What’s the current backdrop for Australian listed property?

There's no question that the last 12 months have been particularly challenging. We're the best part of two years into the property down cycle, where many of the valuations – depending on the underlying property sector –peaked around March or June 2022.

Many of the challenges…have stemmed from the fastest rise in interest rates that we’ve seen in a generation. And it’s not that rates are particularly high now, it's more the speed of the increases, which led many investors to sit on the sidelines. People don't necessarily like uncertainty when investing, particularly in asset classes such as real estate, where you do – and should – take a longer-term investment horizon.

People naturally wanted to get more comfortable with where peak interest rates will be and when rates begin to come off.

In terms of the work-from-home thematic. The discussion around this is transitioning.

Looking at the Sydney market as an example, it's pretty clear that tenants want their people back at least three or four days a week. Whilst there are always exceptions, if you want your people back in the office, it's because you want them to collaborate and to help train the younger people. The best way to do that is to put them in assets that are well located, close to your clients, have good natural light, open floor plans, and ample meeting rooms and facilities. In summary, you want your offices in the highest quality real estate.

We are seeing a clear bifurcation in the working-from-home trend. An interesting statistic I saw recently is that around 80% of the vacant space is in 20% of the office buildings.

I think office is going to have its time in the sun again. But the expectation is that 2024 will be a trough year. Whether that's now or the second half of this calendar year, I think you will see a lot of the smart money come back into real estate that's been sitting on the sidelines for the last couple of years.

How is your portfolio currently positioned – are you a net seller or a net buyer of property assets?

We’re always buying and selling assets and continuing to curate the portfolio’s and increase the quality over time. We're probably selling a more than we normally would because we are proactive. There will likely be some good buying opportunities coming up in the back half of this year.

At our group earnings result the other month, our managing director and group CEO, David Harrison, said his expectation is we're going to be a net buyer of assets in the near term.

It's part of the property cycle – and our funds are well positioned, notwithstanding that you do need to recognise higher interest rates have reset expectations around required rates of return, which has affected property cap rates and discount rates.

Unfortunately, that meant a decline in asset values across most property sectors over the last 12 months. Some sectors such as social infrastructure or triple net leases linked to CPI, have declined much less, while others such as office, have been hit harder.

We're not changing anything materially in our portfolio curation across the group, based on what has happened in recent times with interest rates.

A long time ago, we identified the thematic around the industrial and logistics sector, where we saw there would be much greater demand from both tenants and institutional investors.

Across Charter Hall’s total assets under management, there is around 40% in office, industrial and logistics is around 40%, followed by other sectors such as A-REITs, social infrastructure, and diversified and long lease retail making up the balance of 20%.

We're not seeing any material tenant distress across our property book. I think that's probably surprised people a bit that there hasn't been more distress in the market. It hasn't surprised us in terms of our portfolio as we typically focus on Federal or State Governments, ASX 200 entities, or large private firms as our tenants. We spend a lot of time targeting the right tenants that can ride through economic cycles.

Are you hearing more confidence from the market now, when you are out speaking with investors?

Absolutely. The large institutions, the sophisticated wealth groups, and the experienced financial advisers know that we've had a tough period and they're looking at quality assets that you can buy at 120 basis points softer capitalisation rates than 12 - 18 months ago. They're looking to get back in at the right time and they know that the entry point after a pricing correction, whatever the asset class, is where you make your clients considerable money.

I think industrial and logistics will be the first sector to move. If you look at the MSCI data, transaction volumes across all the core sectors were materially down in calendar year 2023, office was down around 65%. However, even industrial and logistics, which only has a 1% tenant vacancy rate throughout Australia, which is incredible, was still down 35% on transaction volumes and retail down around the same level. There is money waiting and we do think that this calendar year 2024 will be the trough year and as I said, whether it's June, whether it's now, whether it's the back end of the year, you will start to see that buying pickup and people looking to get set and ready for the new part of the cycle.

As interest rates peak and ultimately come off, the discussion will quickly move from capitalisation rate expansion to contraction. If you are getting rental growth, you don't need the cap rates to move, as long as they're stable. So, the forward-looking financial returns, which we're seeing across many property sub-sectors are starting to look pretty attractive.

Have you had to steer a property portfolio through periods like this before, and if so, what do you recall from the booms, busts, and recoveries?

I've been in property for 24 years and have had to manage a property portfolio at a big investment bank in London during the GFC. So, I landed in London in August 2007 and for the next three years, managed not just the tenant side but also the financial relationships with banks and lenders during what was a very difficult time.

But I also want to stress that, despite valuations coming off, this is nothing like the GFC. It really isn't. The liquidity from the finance sector is still there.

For example, we refinanced around $2.6 billion of debt in the last six months. The margins we’re getting from the bank were only around 8 to15 basis points softer regardless of the property sector.

Managing through those difficult times…that’s what really taught me the importance going into any downturn with the right level of gearing and asset quality.

Ultimately, you can't insulate yourself entirely from the cycle – if capitalisation rates are increasing and property values are coming down, you can't push back the tide. But you can make sure you have tenants that can go through the cycle, and it will be the quality assets that come out the other side with the strongest growth prospects.

What are you most excited about now? Where are the best opportunities in Australian commercial property?

IThis calendar year will likely prove to be a great entry point if you want to pick up quality real estate at a cheaper price point than we’ve seen in the last few years.

You've got to be patient with real estate, you're not trying to buy it and have a revaluation three or six months later. You buy it aiming and expecting to grow the cash flows and ultimately, what falls out of that is higher valuations and a higher total return when the assets are sold.

We think the fundamentals around industrial and logistics still look attractive, with a 1% vacancy rate. All the challenges everyone's heard around getting residential housing out of the ground – approvals, navigating councils, increasing building costs and having in place the enabling infrastructure – are exactly the same challenges getting a 50,000 square metre industrial property out of the ground. 

You need roads, water, and electricity connections in place, which is why the vacancy rate is so low. Supply simply hasn’t been able to keep up with demand and whilst the supply response will come, it is going to take some time to work through the system.

And it may be a little controversial, and I'm not necessarily saying right now, but office will come back. It's such an important part of not just the property space but of the way companies and their staff work and operate. You will see institutional money come back into the office market, once people have more confidence around valuations bottoming and the peak interest rates being hit. 

Managed Fund

Charter Hall Direct Office Wholesale A Fund

Australian Property

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Managed Fund

Charter Hall Direct Industrial No.4 Fund

Australian Property

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Charter Hall Direct is one of Australia’s leading direct property fund managers for SMSFs, high net worth individuals and retail investors. 

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