Stuart Fox, National Head of Valuation & Advisory & Managing Director - VIC at Savills Australia, advises “People are seeking yield, and I think in 2020 there’s going to be a rise in demand for alternative investment classes in addition to what have been our traditional property investment classes of office, industrial, and retail. For example, the healthcare sector and the built-for-rent sector. People’s search for yield is going to mean they’re going to be exploring those opportunities more and more as a compliment to their existing traditional portfolio.”  

CAPITAL TRANSACTIONS 

According to James Girvan, Director of Capital Transactions at Savills Australia, the Melbourne CBD saw unprecedented low levels of major transactions in 2019. 

“The low yielding environment, domestically and globally, combined with anticipated CBD office rental growth, positions Melbourne as the most tightly held office market in Australia,” he said. “2019 office transactions in Melbourne, whilst few, have set new bench marks such as the sale of 80 Collins St. At $1.76bn, this was the largest direct property transaction at the time (May 2019).”  

“In 2020, the ‘low for longer’ interest rate environment is expected to keep yields tight, with the potential for record low yields. Rental growth will continue in the low vacancy environment and local and offshore investors’ appetite will remain extremely strong. However, investors will be cautiously optimistic on effective rental growth due to premium grade stock delivery which will push vacancy up to more ‘normalised’ levels in 2021/22.” 

CBD & METROPOLITAN SALES

According to Clinton Baxter, State Director of CBD & Metropolitan Sales at Savills Australia, the Melbourne commercial market in 2019 can be characterised by two distinct periods-- ‘before the May federal election’ and ‘after the federal election.’ 

Before the election, sentiment and confidence was weak across the board, with both buyers and sellers reluctant to make a decision or commit. After the election result was known, confidence soared and the market kicked back into gear, and was further propelled by the subsequent RBA interest rate cuts to record low levels.  

“All sectors of the commercial investment market have experienced a very strong year with yield compression a direct result of the low interest rate climate,” said Mr Baxter. “Investors have increasingly been willing to consider specialised sectors such as petrol stations, childcare centres and medical investments in their pursuit of yield.” 

“With higher yielding investment alternatives increasingly difficult to find, property owners have held back from selling assets, creating a feedback loop of investment demand outstripping supply, leading to higher prices and lower yields, with the growth in asset values encouraging more buyers into the market.  This is particularly pronounced in the Melbourne CBD retail and office markets where values have risen by 20% or more over the course of 2019.”  

Mr Baxter explained that the residential development and land sector has experienced considerable headwinds throughout the year.  

“Despite tightening residential vacancy and rising buyer demand, developers are having a difficult time funding land and construction purchases. Mortgagee action has become a feature of the market later in the year following the high profile crash of Steller and the subsequent market fallout. Development land values across the metropolitan market are typically well off their 2017 highs.” 

“All investment sectors to continue to experience strong buyer demand and ongoing capital growth, fueled by sustained low interest rates and money migrating from Asia.  The exception being sectors negatively impacted by technological change, primarily smaller suburban shopping centres and some suburban strip retail centres.”

“The residential development market will eventually spring back to life in 2020 with the overwhelming tide of population growth making housing development absolutely critical.  A further significant escalation in residential values is unescapable given the shortage of housing stock under construction, and that will create an environment where developers can again fund and construct projects.”

“The big winners will be in the CBD market – land, retail, and office assets.  All will experience considerable growth in 2020 and beyond.  A shortage of development land ensures that those CBD markets are completely insulated from over-supply whilst the local residential, worker and tourist populations continue to grow at unprecedented rates.” 

RETAIL INVESTMENTS 

According to Rick Silberman, Director of Retail Investments at Savills Australia, the retail investment market in Victoria has been dominated this year by private investors chasing non-discretionary investment grade stock.  

“We have seen yields compress significantly for fuel, fast food and standalone supermarket investments as astute investors lock in cheap 5-year debt,” he said. 

“The sub-regional shopping centre market has undergone a period of repricing throughout 2019 with several assets failing to sell after public marketing campaigns.  We have seen longer and more intense due diligence periods as investors undertake their investigations. The significant land holdings have seen many buyers look into the development options that may be available to complement the existing retail centre.”

Mr Silberman explained there had been a continued focus from sophisticated investors chasing retail grade property in the inner ring with mixed-use development upside.  

“We have seen increased activity in the mixed use residential, office and the emerging build to rent sector.”

“Our prediction for 2020 is that yields will remain tight for non-discretionary supermarket investments and standalone single tenant investments leased to national retailers. We feel that these yields will compress further in line with reducing cost of finance for these assets.”  

“2020 will see significantly more sub-regional shopping centre transactions as book values come into line with market expectations– we anticipate increased off-shore buyer activity, particularly out of Singapore and the US, utilising the expertise of local managers.” 

“Developers will continue to focus on key inner city retail assets with large land holdings– we expect to see less hotel and office mixed-use developers and more residential including BTR.” 

INDUSTRIAL & LOGISTICS 

The North Western area of Melbourne’s industrial sector has maintained its position of Australia’s premium location for warehousing and distribution. Market confidence is solid from both the ownership and occupier standpoints. Underpinning this confidence is a strong level of speculative construction and those doing so are predominantly being rewarded with those properties either sold or leased prior to the end of construction.  

“Prime rental rates have been increasing and now stand in the $80- $90 per square metre range,” said Greg Jensz, Director of Industrial & Logistics at Savills Australia. Incentives to lease have slowly been falling with many transactions now in the 10-15% range whereas just a few years ago they were as high as 30-35%. Demand for investment grade income producing properties is at historical highs with relatively small numbers of properties being made available for sale.”

“This has driven prime yields into the low 5% range. The lower levels of prime stock available for purchase has resulted in some buyers being very prepared to purchase vacant property and take on leasing risk, which is a trend we see as set to continue. Smaller industrial unit sales have nudged through $3,000 per square metre in some cases which is completely new territory for the market.” 

“Land supply in the sector is at an all-time low. In my 27 years in the industrial market, I have never seen it so hard to find a block of land to purchase, regardless of size. There is minimal supply set to come into the market in the short to medium term. Pricing has continued its strong growth as a result, with rates as high as $450 per square metre being achieved, and we see increases occurring from there.” 

SUPPLY CHAIN 

According to Bob Quirk, Director of Supply Chain at Savills Australia, increased supply chain design and operations sophistication continued in 2019. The key drivers were global competition, consolidation, ecommerce, increased customer expectations, and land and space constraints. 

“Australian supply chains now compete with global chains in terms of customer service and cost-to-serve: multinationals benchmark performance across continents; and online customers choose on a daily basis to buy from Australia or overseas,” he said. 

“With consolidation, multiple sites within a geography are being consolidated into larger purpose built sites.  These are delivering cost reductions with overheads and shared spaces, flexibility of multi-skilled labour and other procurement opportunities associated with economies of scale.” 

“Online sales are a normalised and accepted form of retailing.  The NAB Online Retail Sales Index says online sales represent under 10% of all retail sales.  However, for some, like Myer, their largest store is now online.  This means that the warehouse is becoming the store.  Both it and transport need to operate and interact differently with many customers in term of speed, performance and visibility.”

“In terms of increased customer expectations, convenience of purchase and convenience stores grow in offer with time being the new currency.  The supply chains serving these 7 days a week with fresh food still face cost and service challenges. Additionally, customers seek a true ‘omnichannel’ experience where they can buy goods and return goods from many options. Order and inventory management systems are struggling to meet these challenges.”

Mr Quirk also explained that supply chains with relatively cheap warehouses on city fringes struggle to meet the aforementioned challenges. 

“Combined with aging city infrastructure (and several years of construction upgrades underway in all capital cities) slower transits and higher transport costs mean finding the right site with the right layout and location is more important. On top of that, finding and keeping the right people with the right skill set in these locations is of course also crucial.”

2019’s supply chain challenges will continue, and to meet them, 2020 will see redesigning supply chains through Segmentation, Big Data, and Integrated Design. 

“A truly demand driven supply chain needs to understand who the customer is and develop strategies to profitably serve them. ‘Segmentation’ is required to match time, place and what customers are prepared to pay. A mix and match network model is required, so that a ‘one size fits all’ strategy is not blindly adopted,” said Mr Quirk.  

“Data is all around us. In the age of ‘Internet of Things’, sensors and data capture, there are massive amounts of data to be captured and purposed. The challenge is how to use it in a model that provides true insights to support supply chain decisions including segmentation.”  

“Processes that we once fit for purpose need to be refined, economies of scale, where attainable, are exploited, and the right locations chosen to enable service at the right time. Finding the best location in a network model needs to contemplate how the inventory will flow, inbound and outbound transport costs, demographics of current and future customers, IT costs, operating costs plus what properties are available now and in the future. Integrated design that contemplates all the enablers including people is important along with a roadmap to manage change.”

“Savills understands these challenges and has invested in capabilities to assist clients.”

OFFICE LEASING 

The 2019 Melbourne office market has produced a stellar performance for landlords with increasing rents, falling vacancies and steady demand. Rents have risen in the order of 10% + across all grades, and whilst there has been downward pressure, lease incentives have remained stubbornly high given the strong market conditions.

The lack of choice in the market and increasing costs have resulted in many tenants choosing stay put in their current premises and look to increase efficiencies. This will be reflected in the net absorption figures for the second half of 2019. 

“The steady demand has come from a wide range of sectors with business services, IT, education and coworking being the leading lights,” said Mark Rasmussen, State Director of Office Leasing at Savills Australia. “Unlike Sydney, the small suite market remains strong. The wide-ranging demand provides Melbourne with a future solid base.” 

“Melbourne’s new Silicon Valley, the Richmond/Cremorne markets, have consolidated further with Bunnings, Uber and Afterpay likely to join Reece, Seek, REA, Domain and MYOB to establish the area as a preferred alternative to the CBD, offering creative spaces helping the IT sector to attract and maintain staff. Effective rents achieved for these tenants has been comparable to CBD transactions.” 

“St Kilda Rd, Southbank, and Docklands markets have also delivered solid performances during 2019. It should be noted the low cost Docklands supply pipeline has ended, effectively removing the glass ceiling off CBD and other fringe market rentals. Melbourne rents are now gradually moving upwards toward levels in line with comparable CBDs.”

Mr Rasmussen stated that vacancy rates are expected to fall below 3% in the early part of 2020, coinciding with steady demand. Melbourne office markets will peak during Q2 2020 as the wave of new supply starts to be delivered (approximately 200,000 sq. m in 2020).  

“The majority of the new supply is leased. Well-informed landlords are using late 2019 and early 2020 to upgrade stock and be in the box seat to compete to lease the back fill space created as a result of the new supply. The majority of the 2020 backfill stock is A and Premium Grade. 

During the second half of 2020 the backfill supply will slow rental growth and put upward pressure on incentives. We forecast prime rents to remain steady assisted by the pent up demand, quality options for tenants and steady economy. Downward rental pressure is likely to increase on lower grade, poorly presented buildings with the usual flight to quality expected. Marketing of the next cycle of new office stock planned for 2022 onwards is well underway.” 

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For more articles exploring the trends, highlights and outlook of the 2019/2020 property markets, click here.