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Office values set to rise further as investment passes $20billion for first time

Deep and diverse pool of capital and debt set to invest in Australian office in 2019

Office values will continue to grow in 2019 following another record year which saw investment in Australian office assets surpass the $20billion mark for the first time.

According to Colliers International’s new Capital Markets Office Investment Review, more than $21.9billion worth of office assets changed hands nation-wide in 2018.

It marks the first time that sales volumes have breached the $20billion mark and the fifth year running that sale volumes have been higher than $15billion. It is an 15% increase on 2017 investment levels and an 84% increase on the 10-year average.

Domestic purchasers were the most active in the market, purchasing 51% of all assets by total dollar volume, despite the largest single transaction – Oxford Properties’ buyout of the Investa Office Fund for $3.4 billion in December 2018 – being to a Canadian buyer.

The report found institutional investors dominated both selling and buying activity, buying 77% and selling 69% of the total transaction value. Private investors were net sellers of $1.77billion.

“There remains a deep and diverse pool of capital and debt ready and willing to invest in Australian office property,” John Marasco, Colliers International Managing Director of Capital Markets, said. “Continued strong demand in Sydney and Melbourne, coupled with improving demand fundamentals in Perth, Adelaide and Brisbane, means that we expect ongoing yield compression and rental growth will be the driver for office capital value growth across most markets in 2019.

“We now have $260billion worth of major transport infrastructure projects under construction or planned across 315 projects in Australia, up from $211billion across 260 projects only three years ago. This spend is in response to the strong population growth, and will further boost property markets for years to come.

Anneke Thompson, Colliers International National Director of Research, said all markets recorded capital rate compression in 2018, with an average of 20 basis points of prime grade compression recorded across CBD office markets.

“As at December 2018, we have recorded a remarkable 27 consecutive quarters of cap rate compression, with this compression cycle starting in June 2012,” Ms Thompson said. “What is also notable is in 2018 we recorded the lowest level of compression since mid-2014, indicating that this cycle is nearing its end."

According to the Colliers International report, employment gains are strong – and getting stronger.

“The drop in vacancy in Australian office markets, from 9.6% in January 2018 to 8.5% in January 2019, has been a function of both reducing supply and solid demand. There is now 100,000sqm less office space in Australian markets than there was two years ago,” Ms Thompson said.

“Compare this against a solid jobs market over the same time period – the seasonally adjusted Australian unemployment rate has dropped from 5.8% in December 2016, to 5% in December 2018, which represents an additional 682,000 persons employed – and the supply demand imbalance starts to become clear."

2019 is likely to see a pivot of the major institutions, including local super funds, to emerging asset classes and markets.

“While certain markets, such as Sydney and Melbourne CBD and Metro office markets, still offer investors the opportunity for good income growth over the next two years, the yield compression cycle is seen to be nearing its trough,” Mr Marasco said.

“Vacancy continues to decline in Brisbane and Perth, and the Adelaide CBD in particular saw a record ten CBD sales over $20million in 2018, totalling $902million. Yields in Adelaide remain higher than the east coast markets which has seen significant compression over the past few years. The Adelaide market is expected to remain strong, driven by rental growth, falling vacancies, decreasing incentives and all-time high business sentiment.

“To meet total return hurdles, we are already seeing the super funds look to the healthcare and retirement living and student accommodation sectors. The emerging Build-to-Rent sector continues to be watched closely by these groups.

“Mergers and Acquisitions was a theme in 2018 and we believe will continue into 2019. With a lack of opportunity for our major global investors to source large scale individual assets, well funded groups are going after their smaller counterparts, in order to achieve scale and deploy capital."

The report found 2019 would also be characterised by the rise of alternative lenders and “borrowing outside the framework”.

“For office assets or funding requirements that don’t sit neatly within major bank criteria, alternative lenders, such as offshore banks, sovereign wealth funds, family offices, fixed income specialists, life insurance companies and debt funds, are most certainly open for business,” Mr Marasco said. “These groups are actively and successfully taking up market share by addressing some of the funding gaps that have emerged in the Australian commercial real estate lending market.

“For example, long duration funding (loan terms greater than five years), higher LVRs of 60% plus, development funding with greater flexibility around pre-commitments and structured solutions, for example to accommodate repositioning and refurbishment strategies where cash flow is deferred or uncertain.

“In general, the all-in cost of alternative debt appears higher than traditional senior debt loans. However, in our view, the increasing number of alternative lenders in the Australian commercial real estate debt market and the active participation of the major banks in funding office assets, is putting downward pressure on pricing, with alternative finance continuing to prove accretive to equity on a total return basis.”


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