Values emerging Down Under?
Signs of bottoming in Australia
Investor optimism seems to be returning to the Australia real estate market if the listed market is anything to go by. So far this year, Australia REITs (AREITs) have outperformed relative to both regional peers and its national stock index. Year-to-April, AREITs’ share prices have increased 7%, trumping APAC REITs (Japan 0%, Singapore -12% and Hong Kong -25%) and S&P/ASX 200 (flat). While the index heavyweight Goodman Group (+25%) drove bulk of this outperformance, we note the underlying performance was still commendable (-1% excluding GMG) in the context of 50bps higher 10-year government bond yields. Is there finally light at the end of the tunnel?
In the unlisted market, investment activity remains relatively quiet. Australia’s transaction volume was among the worst hit in 2023 (-50%) and stayed subdued in the first quarter of 2024. Nonetheless, the bid-ask spread is narrowing fast, and sellers are becoming more realistic with pricing. Australia cap rates expanded aggressively and rose the most in APAC. Since mid-2022, prime yields have risen 120bps for office, 170bps for industrial and 60bps for retail (see Figure 2). At these levels, more deals are starting to offer reasonable returns.
While further cap rate expansions are likely in the coming quarters, we think the worst of this correction cycle is likely behind us. We believe the second half would likely offer a better entry point. By sector, we think industrial offers the best risk-reward ratio with fundamentals still solid. Residential build-to-rent could continue to see tight cap rates given a strong rental outlook and investor interest. However, core assets are not readily available and likely to limit the pool of buyers. Retail in the right segment could potentially offer strong returns given improved occupancy costs. Retail sales are tracking at 20–30% above 2019 levels, significantly above rental increases since then and offer reversion potential.
Office remains a challenging sector despite the sizeable correction thus far (-12% appraised valuations, -15% to -20% recent transactions). Stock picking is important given the market bifurcation. Among the big three cities, Brisbane is performing the best, followed by Sydney. Within Sydney, the flight-to-quality trend is keeping the best stocks desirable. In core CBD, premium grade valuation (-10% since mid-2022) was more resilient than the 30% decline for B grade assets, according to CBRE data. Singapore’s Keppel REIT, for example, took a plunge at an A grade office in this location at mid-6% cap rate or 17% discount to peak valuation in 2022. Melbourne remains a tough market to underwrite given its record high incentive levels of 47% on the back of a low utilization rate.
Japan in transition
Japan has historically been a relatively easier market to underwrite due to its stability. Growth in the last few decades was uninspiring but its low and steady finance costs kept the market interesting. That dynamic is now changing as the country transitions into a new era with modest inflation and higher interest rates. It is not straight forward, but we think overall policy setting is likely to stay supportive. If successful, this environment could rekindle animal spirit and boost investment activity.
Mitsui Fudosan’s recent announcement of reinvesting in growth under its new business strategies is a case in point. The plan includes recycling JPY 2 trillion (USD 13 billion) of real estate assets over the next three years. According to Bloomberg, more activist investors are participating in a push for Japanese companies to unlock values in their real estate holdings. All this could lead to improved liquidity for the market. After all, Japan’s transaction volume only ranks fifth after the US, UK, Germany and China despite it being the second largest real estate market in size globally.
We continue to like the market but would be selective on real estate sectors that are able to deliver income growth in mitigation of potential cap rate pressure. Policy errors could be a risk and the weak JPY may be a trigger. The central bank’s dovish stance remains at odds with the global higher-for-longer mantra. The authorities have a tough job to tread, a fine line between stabilizing the currency and seizing the golden opportunity to reinvigorate Japan.
