Relative value of the Canberra Office Market

Emergence of foreign capital in the property market

Twelve years ago, there were only a handful of foreign institutional investors looking seriously at the Canberra commercial property market, from the U.S., Singapore and Germany.  These were primarily sovereign wealth funds or pension funds looking for higher yields relative to their home markets.  

Institutions such as Real I.S. were amongst the early investors, acquiring the Geoscience Australia Headquarters in Symonston in 2007, and in 2012 the market saw activity from Frasers Commercial Trust (Singapore) and CIMB Trust Capital Office Fund No. 1 (Malaysia) with their respective acquisitions of the Caroline Chisholm Centre in Tuggeranong and 50 Marcus Clarke Street, Canberra City.  

Fast forward to the present, these investors have now been joined by several dozen new foreign investors who have either acquired office properties or engaged with local fund managers and agents to search for investment opportunities in the ACT.  This is part of the emerging trend of foreign investment in Australian real estate, which saw over 43% of office acquisitions totaling $9.2 billion funded by foreign capital in 2018.

In Canberra, property investors such as FG Asset Management (South Korea), Deka Immobilien (Germany), and Mirae Asset Global Investments (South Korea) have invested close to $680 million dollars of capital into the commercial market over the last 4 years.  Over the last 12 months they have been joined by a foreign investor base that includes Soilbuild Australia Trust (Singapore), GLL Real Estate Partners (Germany), RECAP V Fund (Singapore) and NTT Urban Development (Japan). To date two of the largest office deals in 2019 have been  completed by the latter two investors, with RECAP V acquiring The Finlay Crisp Centre, 1 Constitution Ave, Canberra City for $62 million and NTT UD acquiring a 50% equity interest in 121 Marcus Clarke Street, Canberra City for $103 million.    

Adding to this is the strong number of foreign groups that have yet to deploy capital but have expressed a strong interest to acquire properties in Canberra.    

So what has prompted this marked improvement in investor sentiment?     

This can be attributed to 3 things: 

  • The strong macroeconomic picture for the ACT
  • Positive fundamentals of the Canberra office market, and perhaps most importantly 
  • The relative value of the Canberra market compared to those of Sydney, Melbourne and selected international cities.  

Macroeconomic out performance 

Canberra has above average growth in gross state product and population, strong employment demand and a commercial office market that is being reset with demand outperforming supply. 

Canberra’s $40 billion economy grew by 4.0% in the 2018 financial year vs. the national figure of 2.9%.  Over the last 5 years the city has transformed itself from a government-centric town to one where 62% of its employment base is from the private sector, and 54% of its commercial leases are with corporate tenants. Government spending has continued strongly with transport infrastructure, healthcare and education as the largest recipients of funding.  

The city’s population grew by 1.9% at September 2018, exceeding Australia’s growth of 1.6%.  Population growth has exceeded the national average for 16 quarters and for all but three of the last 37 quarters. The ACT has the lowest national unemployment rate of 3.9% as at May 2019 and has not been above the national average since September 1982.

Lastly, the office market fundamentals remain strong, with a market vacancy of 1.7% and 0.11% for A Grade office in the Civic CBD and Parliamentary Precincts respectively as of January 2019.  Colliers International expects vacancies to tighten further for these sub-markets over the next 12 months with limited supply coming online and tenant demand growing, underpinned by roughly 130,000 sqm of Commonwealth and ACT Government leasing briefs in the market. This activity alongside recent Government lease renewals of 16 to 18 years in offices in regional town centres and the Canberra CBD will spur further selling activity in the market.

The case for relative value  

Prime office yields graph

Figure 1: Office Yields & Yield Spread vs. 10-Year Bond 

Figure 1 shows the current spreads between A Grade office yields in Australia and prime office yields in selected Asia Pacific markets and Germany relative to 10-year Government bond yields in these markets.  Of significant note is that even with negative bond yields in Japan and Germany, the 367 and 365 basis point spreads in those markets still fall below the spread in Canberra which is presently at 458 basis points.  The latter spread also exceeds those of the Sydney and Melbourne office markets.  

Of further interest is that of all the markets in Figure 1, only Australia, Singapore and Germany have AAA sovereign credit ratings from Standard & Poor. This presents an argument that Canberra, with the highest spread or risk premium, is attractively priced  in relation to its country credit rating.  This point is further supported in the case of office buildings that have Government anchor tenants which enjoy the same AAA rating.   

Forecast

Figure 2: Forecast 10-year Office IRRs vs. 10-year Government bond yields and BBB Grade corporate bond yields 

Another way to view the relative value of Canberra office properties is via the historical risk premium between the forecasted 10-year IRRs and the 10-year Government bond yields as shown in Figure 2.  

Over the last 12 years that risk premium has averaged 470 basis points but has increased in 2019 with the June figure at 582 basis points.  This is primarily due to external market forces that have driven up bond prices while IRRs have only tightened slightly by 20 basis points over the past 12 months.  

This current risk premium presents yet another argument that the Canberra office market is attractively priced relative to its historical performance.  

Positive investment outlook 

In summary, the current macroeconomic picture and pricing of the Canberra office market presents an attractive investment opportunity based on the following:

  • Canberra’s population and employment growth are expected to continue outperforming, and office vacancies are expected to tighten in the next 12 months given limited new supply and strong Government demand.
  • Pricing presents significant value relative to other office markets in Australia, Asia Pacific and Europe, given where yield spreads and risk premiums are currently trading.
  • As interest rates fall or stabilise, the risk premium should regress towards its historical average, which implies further cap rate compression.
  • New Government leasing briefs as well as lease renewals are creating new supply of long WALE office assets, prompting owners to sell and recycle capital.