MAY 2015

AUSTRALIA PROPERTY MARKET OUTLOOK

Cushman and Wakefield Research

PFA ANNUAL CONFERENCE 2015

EXPLORING THE NEXUS BETWEEN PROPERTY VALUE AND FUNDAMENTALS

Alex Pham PhD AAPI

National Research Manager

Cushman and Wakefield Australia

Alex.Pham@ap.cushwake.com

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OVERVIEW

1. THE NEXUS BETWEEN CAPITAL VALUE AND FUNDAMENTALS

2. WHAT IS HAPPENING IN THE CAPITAL MARKETS?

3. WHAT IS HAPPENING IN THE LEASING MARKETS?

4. WHAT’S NEXT?

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The nexus between capital value and fundamentals

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THE TAIL OF TWO PROPERTY MARKETS

Asset

Market

(Capital values, cap

rates)

Space

Market

(Rents, vacancy

rates)

Vendors Purchasers

Landlords Tenants

Rents Construction

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100

200

300

400

500

600

700

2010 2011 2012 2013 2014 2015

A$ p

sqm

pa

Average Grade A Face Rent

Average Grade A Rent

100

110

120

130

140

150

160

170

2010 2011 2012 2013 2014 2015

Index

Australia CBD Office Capital Return Index

CBD Office Capital Return Index

THE (DIS)CONNECTION BETWEEN ASSET PRICES AND LEASING

CONDITIONS…

Source: C&W, IPD

Asset prices have risen

significantly…

… despite the subdued

leasing conditions.

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…HAS BEEN DRIVEN BY A STRUCTURAL SHIFT IN THE

PROPERTY ASSET PRICING FUNCTION

Rent ($)

Construction (sqm)

Capital Market

(Asset)

Leasing Market

(Space)

Stock

(sqm)

Asset Price

($)

…and put a

downward

pressure on

rents.

Sources: C&W, Wheaton & DiPasquale (1992)

…has resulted

in an upward

shift in asset

prices…

This has created the

new price-rent

equilibrium.

“The new normal”

A structural

shift in the

asset pricing

function…

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What is happening in the capital market?

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A STRUCTURAL DECLINE IN LONG-TERM INTEREST RATES

GLOBALLY…

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Policy Interest Rates in Major Economies

US Japan EU UK Canada Australia

Pre-GFC

Average (ex JP)

= ~4%

The rate disparity between

Aus and the rest of the

world have widen post GFC.

Post-GFC

Average (ex

AU) = ~0.5%

Structural break in

interest rates

Sources: C&W, ABS

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0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

A$ M

illio

n

Foreign Capital into Australian Property

Office Industrial Retail Others

…HAS PARTIALLY RESULTED IN SURGING DEMAND FOR

AUSTRALIAN PROPERTY….

Low offshore

interest Pre-

GFC

Rising foreign

investment

Post-GFC…

Speculative

investment in

2007 despite the

high interest

rates.… As a result of

a rational

investor

response to a

lower cost base

and return

disparity.

Sources: C&W, RCA

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6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

2008 2009 2010 2011 2012 2013 2014 2015

Australian Property Capitalisation Rates

All Property Cap Rate Office Cap Rate Industrial Cap Rate Retail Cap Rate

… WHICH LED TO A CONTINUAL COMPRESSION OF CAP

RATES.

Continual

compression of cap

rates across all sub-

classes.

Sources: C&W, RCA

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Are we heading for a crash?

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THE TWO EPISODES OF CAP RATE COMPRESSION

-200

-100

0

100

200

300

400

500

600

-3.50%

0.00%

3.50%

7.00%

10.50%

2008 2009 2010 2011 2012 2013 2014 2015

bp

Australian Property Pricing Trends

Yield spread (bp) All Property Cap rate (%) Bond yield (%) YoY Change in cap rate (bp)

Cap rates are compressing

while yield spreads widen...

...in response to falling

bond yields.

1st phase of

compression is largely

a result of lower risk

expectation

2nd phase of

compression is

mainly driven by

falling risk-free rates

Sources: C&W, RCA

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-20

-15

-10

-5

0

5

10

15

20

25

30

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

All Property Capital Return Index

All Property

CAPITAL VALUES ARE GROWING AT THE “LONG-TERM”

TREND PACE

Capital values have

grown at a normal

pace since the GFC.

100

120

140

160

180

200

220

240

260

280

300

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Index

All Property Capital Return Index

All Property

1989

Crisis2007

GFC

Long-term trend

growth = 2.66%

Sources: C&W, IPD

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KEY TAKEAWAYS

• Capital values are determined by the asset market, while rentals are determined by the space

market.

• A structural shift in capital asset demand has resulted in the increase in capital values while

rentals are subdued.

• The low interest rate environment globally was the main cause of the structural shift in asset

demand.

• Australian interest rate (and return) disparity with the rest of the world has driven strong

interest from offshore investors…

• …leading to a gradual compression in the capitalisation rates,

• …however, property values are growing at a pace consistent with the long-term trend.

• Strong investor demand post-GFC is a rational response to lower interest rate environment.

• Interest rates are expected to remain low going forward as the world economies transitioning

into a low-growth (low inflation) period (“the new normal”).

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What is happening in the leasing market?

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OFFICE MARKET CONDITIONS

0%

5%

10%

15%

20%

25%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Grade A Office Vacancy Rates

Sydney Melbourne Brisbane Perth Adelaide

Forecast

Lower vacancies in

Sydney and

Melbourne

Rising vacancies in

Perth and Brisbane.

Source: C&W

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• Improving consumer spending

• Low interest rates

• Weaker domestic currency

• Strong interest from international fashion

brands

• Australian institutional investors and A-REITs

have been the net buyers

• Engagement of institutional investors in

regional towns and non-metro locations

• Super-regional shopping centres have been in

high demand as retail investors seek higher

yields

AUSTRALIAN RETAIL LANDSCAPE

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RETAIL SALES PICKING UP

Sources: C&W, ABS

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

%

Quarterly sales Non-discretionary Discretionary Year-ended sales

10-year trend

Retail sales have picked up …

...supported by strong

growth in

discretionary spending

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

%

Quarterly sales Non-discretionary Discretionary Year-ended sales

10-year trend

Retail sales have picked up …

...supported by strong

growth in

discretionary spending

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Supply

• Low vacancy

• Limited new construction – prime industrial

accommodation

• Strong precommitment

• Rezoning and residential conversions

INDUSTRIAL PROPERTY MARKETS

Demand

• Construction, retail, transport & logistics &

food industries drive demand

• Tenants looking for flexibility and efficiency

• Location, infrastructure and design remain

the key features

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RESIDENTIAL MARKETS – IT’S ALL ABOUT SYDNEY

0

100

200

300

400

500

600

700

800

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

A$ '000

Median Price of Established House Transfers

Sydney Melbourne Brisbane Perth Adelaide Hobart Darwin Canberra

Sydney house prices

have risen significantly

in the past two years.

Sources: C&W, ABS

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KEY TAKEAWAYS

• Office – The tail of two extremes

• Improving office demand in Sydney and Melbourne - Incentives for prime and grade A stock

slowly decrease

• Leasing conditions remain soft in Perth and Brisbane - Flight to quality trend continues –

vacancies are expected to rise

• Retail – Improving consumer spending and low interest rates will drive retail sales forward

• Industrial – Construction, retail, transport & logistics & food industries compensate the

declining demand from the manufacturing sector

• Residential – Overheating in Sydney – Increase in home building activity will limit the rapid rise

in house prices

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What’s next?

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OUTLOOK

• Strong investor demand, particularly from offshore investors, will continue to drive yields

lower and prices higher

• There is still room for further compression as the rate premium is still above long-term average

and capital growth is consistent with the long-term trend

• While the core assets remain attractive to both local and offshore investors, strong competition

will drive demand for secondary locations and alternative asset classes as investors seek for

higher yield

• Pockets of value remain available in regional locations and alternative assets – increasing

institutional engagement in “regional cities”

• The two-speed economy will remain the key feature of the market

• Leasing conditions are expected to improve in Sydney and Melbourne while falling mining

activity poses a drag on Perth and Brisbane