Over the course of 2019, the Colliers International Capital Markets and Investment Services team has worked on over 30 sales campaigns for office properties in Canberra with a market value of approximately $800 million. We have worked extensively with a variety of investors – institutional, private, domestic, and offshore - and have compiled the key questions and misconceptions we have addressed during our campaigns. These are discussed below in detail.
Canberra office market is too small for investors to build scale.
On the contrary, scale is available given the size and historical sales volume of the Canberra office market. Per PCA reports, the Canberra market at approximately 2.3 million m2 in size is the 3rd largest office market in Australia, trailing Sydney (4.95M m2) and Melbourne (4.6M m2). Office sales in the $10 million and above price point has averaged over $500 million annually in total volume from 2016 to 2018, with 2019 and 2020 sales estimated to be over $400 million and $700 million respectively.
At the individual property level, two office properties each transacted above $100 million in 2019, with 16-18 Mort Street selling at $108.5 million and 50% of 121 Marcus Clarke Street selling for $103 million. The sales pipeline for 2020 should include up to 3 individual assets that are expected to achieve over $250 million each in price.
From a historical perspective, national investors such as Challenger, ISPT, Cromwell, Real I.S. and Centuria have achieved scale in Canberra primarily via acquisitions. Local developers such as Molonglo Group, DOMA Group, Amalgamated Property Group and Morris Property Group have also built up large property portfolios.
Canberra office market has no rental growth.
NOTE: Although Canberra office rents are often quoted on a gross basis, the discussion below refers to net effective rents as the metric to track historical growth.
The figure above shows historical A grade annual effective rents in the Canberra CBD, from June 2009 to June 2019. During the period 2009 to 2016 rents experienced a significant decline, primarily due to macroeconomic factors negatively impacting office rents (e.g. GFC, contraction of commonwealth and private sector tenancies, the government’s Project Tetris to address vacancies in agency offices). However, over the last 3 years effective rental growth has returned, with 7.1% and 6.6% growth achieved in the last 3 years and 12 months ending June 2019 respectively. This significantly exceeded inflation with the CPI growing by 1.9% and 1.6% over the same time periods.
This rent growth has been driven by government and private sector expansion on the demand side, while new office supply has been limited up until 2018. New office supply will increase significantly in 2019 and 2020 with the delivery of 4 buildings totalling over 60,000 m2. Moreover, the ACT recorded strong economic growth with an average of 3.9% over the last 3 years (2016 to 2019), outpacing the national average of 2.4% over the same period.
While certain historical time periods have shown negative growth, recent performance shows a far different picture with rental growth far outpacing inflation.
There is only one tenant group that matters – the Commonwealth of Australia.
Although the Commonwealth still plays an important role in the local property market, the private sector has grown significantly over the last 5 years. Presently over 60% of employed persons in the ACT work in the private sector, and approximately 54% of all commercial leases in Canberra are with corporate tenants, taking up approximately 1.3 million m2 of the 2.3 million m2 of office space, per Colliers International estimates.
From an office sales perspective, 3 of the largest transactions in 2019 were multi-tenanted assets without a large government anchor. These are: (i) 10 Moore Street which had 15 tenants, including Optus, ANZ and Property Council of Australia; (ii) 16-18 Mort Street which had Telstra as its anchor tenant; and (iii) 121 Marcus Clarke Street which has EY, Club Lime, ANU and several law firms. Collectively these sale transactions had a transaction value of $245 million which represents 68% of all major office sales in 2019 YTD.
Moreover, of the other major office sale transactions in 2019 YTD, only 1 included a Commonwealth tenant remaining in the property, which was Investec’s acquisition of 24 Wormald Street in Symonston. The remaining 2 transactions included a major refurbishment of a building with vacant possession (Finlay Crisp, City) and the redevelopment of an existing office building into a 250-room Meriton hotel (40 Allara Street, City).
While the Commonwealth is certainly a key occupier for office buildings across Canberra, the market’s office tenancy profile is evolving and becoming more diversified with an increasing role for the private sector.
Canberra is only a passive investor market given the long-WALE tenancies.
Although historically most of the office sale transactions have been passive investments of long-WALE assets with government tenancies, more recently we have seen the successful implementation of value-add strategies which we expect to continue. This includes the sale of 10 Moore Street by Quintessential Equity, which was acquired by the company in mid-2014 for $18 million. The property underwent an extensive refurbishment programme, increased the WALE from 3 years to 4.5 years, and subsequently sold for $35 million. Quintessential’s sale of 44 Sydney Avenue in Forrest was another successful execution of its value-add strategy, having acquired the property in March 2015 with a circa 50% vacancy and selling it in November 2017 with 100% occupancy at roughly twice the purchase price. The recent sale of Finlay Crisp in the CBD is also indicative of a value-add strategy to be employed by the purchaser SC Capital, who are taking the property with vacant possession in August 2020 and launching a $50 million refurbishment programme.
We expect similar acquisition opportunities to arise in 2020 of buildings with some vacancy that could be targeted for a value-add strategy, particularly in the eastern core of the CBD.
Canberra is a 6%+ cap rate office market.
There has been precedent for A-Grade office properties trading below a 6% capitalisation rate in Canberra, in both CBD and Town centre locations, provided as follows:
• In June 2019, a 50% interest in 121 Marcus Clarke street transacted at $103 million which reflected a 5.80% market yield. The asset was 10 years old and had a WALE of 4.8 years.
• In May 2019, 16-18 Mort street sold for $108.5 mill which is a market yield of 5.92%. This was a refurbished 21-year old building that was substantially refurbished in 2012 with a 6.8-year WALE to Telstra.
• In 2017, the $321 million sale of 50 Marcus Clarke street reflected a market yield of 5.87% with an 8.2-year WALE on a 7-year old building.
• In 2015/2016, the Louisa Lawson building in Greenway sold for $224.5 mill showing a market yield of 5.78 % with a 16-year WALE.
Although the majority of the above transactions were in the CBD, we expect certain long-WALE properties in the town centres to sell in 2020 at sub-6% cap rates, reflective of the tenancy profile and lease term, security of income, age and quality of building. We also expect to see tighter cap rates trending towards 5% for CBD properties.
Infrastructure investment in the ACT is insignificant, particularly relative to NSW and Victoria.
Per recent ACT and Federal government budgets, total infrastructure investment for the four years to the financial year 2022-23 is estimated to be $3.3 billion. Roads and urban transport initiatives will take the bulk of the investment, followed by investments in health, education and other sectors. In contrast, the headline infrastructure investment figures for New South Wales and Victoria over the same time period are $93.0 billion and $38.4 billion respectively.
These investment figures need to be taken in the context of population, given the ACT’s 425,000 figure relative to NSW at 7.9 million and Victoria at 6.4 million. On the basis of infrastructure investment per capita, the ACT performs well with roughly $1,900 per capita per annum, as compared to NSW and Victoria at approximately $$2,900 and $2,100 respectively. Moreover, the ACT government’s investments in the Light Rail, upgraded hospital facilities and new schools should continue to support government and private sector expansion which in turn supports the fundamentals of the local property market.
Canberra is a leasehold property market and should be priced differently than freehold markets.
Under the ACT leasehold system, all commercial, residential, rural and community title land is owned and leased by the Commonwealth and managed by the ACT Government. The typical lease term is 99 years, but the term is not automatically renewed upon ‘purchase’ of the land, i.e. a buyer inherits the remaining term of the lease.
The lease is typically renewed at the end of the term for another 99 years, and in fact there is precedent for renewal prior to the end of term, as most owners renew leases from 25 to 40 years prior to expiration. The rent to be paid under the Crown lease (if demanded, and to date no demand has been made) is nominal, as is the cost to renew. For these reasons land ownership in the ACT effectively behaves like a ‘perpetual leasehold’ structure, more similar to freehold land and hence there is no argument for a different pricing treatment.