Despite falling business and consumer confidence since the start of the year, the Australian economy remains in positive territory and moderating economic conditions notwithstanding, commercial real estate assets should continue to perform this year and into the future, buoyed by strong underlying fundamentals.
On a state-by-state basis, economic growth is no longer confined to the service-led economies of Melbourne and Sydney. Recovery is now beginning in the mining states, with Brisbane entering a sustained period of recovery, although economic growth in Perth remains low. This dynamic should now start to flow through to real estate assets.
Different strokes for different states
The new economy states of Victoria and New South Wales are being powered by high-value services and migration-driven population growth. This will continue to underscore demand for office and logistics real estate.
It’s early days for Queensland and Western Australia’s economic recovery. But the office and retail sectors should benefit as the economic backdrop improves, with industrial real estate assets already enjoying the uptick in mining export volumes, which is creating renewed demand for storage and transport space.
However, lack of supply is driving investors to alternative real estate assets. For instance, more investors are interested in real estate debt. The move by investors up the risk curve into alternative assets suggests we are in a new cycle, one in which markets are more focused on how assets perform versus capital inflows.
Technology a game-changer
New business models, for instance the rise of flexible working, have challenged the way real estate is valued and managed. In this environment, owners of older assets must consider how they may need to be repositioned in light of trends such as co-working and omni-channel marketing shaping the way businesses use offices and other commercial buildings.
The average Australian office asset is 30 years’ old, and buildings constructed in the 1990s were not designed to support flexible working spaces and wellbeing initiatives, which place new demands on buildings. Next-generation assets, which are designed for more agile use, will provide new opportunities for investors in the medium-to-long term.
Economic conditions suggest sufficient demand to support the increasing pipeline of developments – particularly in the office and industrial sectors. However, there are risks to retail assets, especially those with limited scope for redevelopment and centres in secondary locations. Based on our analysis of markets such as the US, successful retail performance in a period of increased competition rests on providing customer value through experience and convenience.
The short-to-medium term outlook for total returns will favour assets that can generate strong income returns, which are less reliant on capital expenditure and are attuned to changing trends in technology, demographics and urbanisation.
Markets showing income growth potential
Growth cycles typically favour core markets, but these rules don’t necessarily apply during times of technological disruption and global economic transition. As such, the definition of what constitutes a core asset will need to change to take a more inclusive view on flexibility, amenity and technology infrastructure, as tenants’ needs evolve.
Online retailing is generating significant upside for the industrial sector, which is seeing heightened investor interest from long-term, institutional investors.
In tandem, retail tenants that have been associated with Australia’s highly stabilised retail sector in non-discretionary categories such as fresh food are now shifting more of their sales online via distribution centres, creating the potential for long term, stable, recession-proof cash flows for investors. This follows a similar trend in the US and Europe, where online spending is more than double the Australian spending rate.
Office assets are benefitting from strong demand from the technology sector, as these businesses increase their workforce and as international entrants look for locations in Australia and landlords can expect attractive conditions in the local commercial real estate sector for some time to come.
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