Sector outlooks shed light on real estate’s next opportunities for 2021
The investment hypothesis for Australia’s real estate sector unmasks how significantly COVID-19 and the associated lockdowns reshaped how we live, work and shop in the space of just one year. As vaccines are rolled out across the country, Australia has adjusted to a new normal and the early stage of the recovery has taken an unexpected form.
The gradual withdrawal of some government stimulus in March still poses a risk to the economic outlook, but many indicators point to a faster-than-expected recovery with unemployment holding at low levels.
Globally, macro conditions have dramatically improved, bolstered by successful inoculation roll outs in the US and the UK, which have supported gains in both business and consumer confidence.
We see Australia within a clique of geographies in our region, including Japan, Singapore and the higher quality Chinese cities, as markets expected to attract significant allocations of international capital in the near future. The global hunt for yield, combined with the ongoing low interest rate environment, partly explains Australia’s attraction as an investment location, but its strong response to COVID-19 is also playing a role.
From unknown to the alternative
The uncertainty that turned out to be the theme of 2020, has largely rewritten the investment theses for the core sectors and elevated the profile of assets that were once considered niche or alternative. Structural demand drivers are the common denominator among the assets that make up this segment and they are being leveraged to offset the potential impact on the performance of core assets in property portfolios.
If the US experience is reflected in Australia, we believe domestic investment inflows should find their way into these defensive real estate assets, including built-to-rent property, refrigerated logistics sites, neighbourhood shopping centres, land lease communities and data centres.
In our view, investing outside traditional real estate segments will be the key to achieving target income returns through this post-pandemic period, but this is not the only segment where we see opportunities. Disciplined analysis of the core sector assets should reveal opportunities where reactionary negative sentiment disconnects from investment fundamentals.
We believe pricing support for low interest rates is expected to continue but the recessionary impacts on spending may result in more moderate returns, even as business performance recovers.
The rise of the home office
Retail and office bore the brunt of pandemic shutdowns and the ongoing investment case for these markets is nuanced. The single biggest local impact of COVID-19, apart from economic repercussions, is the profound and structural shift in how millions of Australians work. The impact of this historic and structural change is evident and while the full impact is yet to play out, what we do know, is that it is driving convergence and strengthening the case for flexible design.
The COVID-normal workplace will include a higher WFH component, resulting in a reimagining of many office tenancies as collaborative, community spaces that leverage technology and innovation to deliver healthier, more efficient workspaces.
We also expected to see an increased drive to decentralisation, with companies exploring options outside of city centres.
Demand in Australia’s major office markets, Sydney and Melbourne, contracted sharply at the start of COVID-19 as sub-lease activity spiked. Vacancy levels in these two markets are expected to remain above historical averages before recovering from 2022 onwards, but early signs of leasing enquiry levels are positive, particularly for quality assets, as reflected by the recent signing of 15-year and 10-year lease deals for Sydney CBD assets and more in the pipeline.1
Retail reaches into logistics…
The investment case for retail continues to be challenged, particularly given the way in which COVID-19 led to mobility restrictions and accelerated the growth in online transacting. Despite this, retail remains an adaptable and resilient sector, which is why we are now seeing greater emphasis on entertainment, food and convenience to bring back foot traffic.
Online consumption is predicted to account for 20 per cent of retail sales in Australia by 20232, revealing how profoundly the lockdowns influenced consumer behaviour. This technological transformation triggered significant investment in online platforms as well as back-end logistics and supply chain, to drive efficiencies and cost savings. In turn, it also supported activity in the industrial sector and with it, the investment profile of high-quality, tech-enabled stock.
Rising investor allocations for industrial, particularly properties with automation and embedded digital capabilities are putting pressure on the availability of investable product. The development pipeline remains narrow even as demand from retailers for smart-system property grows to support customer expectations related to availability and delivery. Amazon and the major supermarkets have been the big space takers in logistics as they automate their supply chain and push to make savings through digital inventory management.
Our sector analysis suggests infill developments on the east coast should provide more resilient demand through the cycle, but access to major infrastructure, such as key arterial roads is critical. Investment assessment must be disciplined and focus on asset fundamentals to avoid paying too much to secure exposure to the sector, particularly given the lessons of the past, when major developments led to an over-supply and depressed rents.
Looking beyond traditional sectors
Investing in real estate in this post-COVID-19 period will require thinking outside of the traditional sectors, but not exclusively in alternatives. Discipline and patience will be essential to identify opportunities and act to secure them when negative sentiment masks investment fundamentals.
The road out of COVID-19 will be bumpy. Whilst the effectiveness of a vaccine is not yet known, there is still cause for optimism given, the economic indicators all point to a gradual recovery for Australia, but it is worth remembering that we are still in unchartered territory. Investment fundamentals are strong but if the pandemic has taught us anything, it is the value of defensive positioning which quality commercial real estate can offer.
In sum, despite the structural changes experienced in 2020 as a result of COVID-19, high-quality office assets continued to fare well and we’re optimistic about a broad recovery in 2021 as the impact of COVID-19 recedes. As the economic recovery continues and Australia emerges in a relative position of strength versus global peers, we believe investors in quality Australian commercial real estate, will be well positioned to take advantage of any potential upside which we expect to emerge in late 2021 and into 2022.
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