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Home Latest property industry research and insights
November 11, 2024

September 2024 quarter ASX A-REIT market update

Stuart Cartledge, Managing Director, Phoenix Portfolios

 

Market Commentary

The S&P/ASX 300 A-REIT Accumulation Index rocketed higher during the September quarter, gaining 14.3%. Property stocks outperformed broader equities in the period, with the S&P/ASX 300 Accumulation Index adding 7.8%. During the quarter most companies in the property sector released their full year financial results to 30 June 2024. The solid results and upbeat outlook statements aided performance. The other (related) factor was the reduction in interest rates over the period. At the end of June, the 10 Year Australian Government Bond yield was 4.4%, however it ended September below 4.0%.

Traditional property fund managers were some of the strongest performers in the September quarter. The earnings of these companies are particularly sensitive to movements in interest rates. At current levels, property funds management product is once again in demand, with yield and expected internal rates of return (IRRs) which are appealing relative to fixed income products. Charter Hall Group (CHC) led the way, gaining 42.8%, as its earnings guidance for the next financial year surpassed the expectations of market participants. Centuria Capital Group (CNI) was also a meaningful outperformer, adding 26.7%, as it was carried by the same positive sentiment that drove CHC higher. Alternatively, Goodman Group (GMG) returned a respectable 6.4%, but underperformed the index as lofty expectations of future earnings growth were not met by the guidance provided at its annual financial result.

Shopping centre owners were also outperformers, as they produced solid results and presented earnings guidance that demonstrated resilience. Operating metrics, such as specialty sales and leasing spreads did diminish across the year, but some believe that a lower interest rate environment over the medium term and tax cuts in the short term are likely to lead to strong consumer spending and income growth for retail property owners. Vicinity Centres (VCX) was the major outperformer, moving 22.6% higher in the quarter. Scentre Group (SCG) also rose sharply, up 19.7%. The owners of smaller neighbourhood shopping centres saw more muted, but still strong performance, with Charter Hall Retail REIT (CQR) returning 14.9% and Region Group (RGN) lifting 9.0%.

Large capitalisation diversified property owners were also beneficiaries of the renewed enthusiasm from property securities. Stockland (SGP) rose 25.7%, aided by solid operational progress and the prospect of an improving market for the sale of new residential homes and land. GPT Group (GPT) also performed well, up 24.5%, with new CEO Russell Prout outlining his vision for a more capital efficient and higher return on equity (ROE) future for the business. Despite dropping on an underwhelming financial result, Mirvac Group (MGR) more than recouped its losses, finishing the quarter 15.0% higher.

Larger land lease retirement property owners were the major underperformers during the quarter. Lifestyle Communities (LIC) lost 31.8% as it was the subject of an ABC investigation, which suggested it was taking financial advantage of its customers. It has also been the subject of a short report, questioning its business model. Beyond this, it solely operates in Victoria, which is currently the weakest state in terms of house price growth and new home sales. This combination of factors forced the company to withdraw its sales guidance for the coming years. Ingenia Communities Group (INA) produced a solid financial result, albeit the quality of its earnings has been questioned. It underperformed the index but still lifted 6.5% in the period.

Market outlook

The listed property sector is in good shape and provides investors with the opportunity to gain exposure to high quality commercial real estate at a discount to independently assessed values. While share market volatility may be uncomfortable at times, the offset is liquidity, enabling investors to rebalance portfolios without the risk of being trapped in illiquid vehicles.

Rising interest rates have been a headwind for many asset classes, with property, both listed and unlisted, a particularly interest rate sensitive sector. More recently, interest rates have reduced and strong returns have been seen in property securities. The August reporting season saw stocks providing solid updates, with meaningfully more optimistic outlooks, based on the assumption that interest rates may have peaked and begun to come down. Long term valuations are driven by “normalised” interest costs, meaning the impact of short term hedges maturing is mostly immaterial. Should the forecast decline in interest rates eventuate, recent momentum may continue.

The industrial sub-sector continues to be the most sought after, given the tailwinds of e-commerce growth, the potential onshoring of key manufacturing categories and the decision by many corporates to build some redundancy into supply chains to cope with current disruptions. All of these factors are contributing to ongoing demand for industrial space, which is evident by rapidly accelerating market rents and vacancy rates at historic lows of around 2% in many markets. Strong rental growth has offset capitalisation rate expansion in recent periods resulting in flat valuations and capitalisation rate spreads to government bonds more in line with long-term norms.

We remain cognisant of the structural changes occurring in the retail sector with the growing penetration of online sales and the greater importance of experiential offering inside malls. Recent performance of shopping centre owners has however been strong, with consumers showing resilience and share prices moving sharply higher. It is interesting to note the juxtaposition of very high retail sales figures despite very low levels of consumer confidence, no doubt impacted by rising costs of living. Importantly, we are also now seeing positive re-leasing spreads in shopping centres, indicating strengthening demand from retail tenants.

The jury is still out on exactly how tenants will use office space moving forward, but demand for good quality well located space remains. Leasing activity is beginning to pick up, and there has also been some transactional activity, albeit at prices typically at discounts to book values. Incentives on new leases remain elevated.

We expect to see further downside to asset values in office markets, but elsewhere expect market rent growth to largely offset cap rate expansion, particularly in industrial assets. Listed pricing provides a buffer to such movements.

The content above is taken from the Cromwell Phoenix Property Securities Fund quarterly report. Sign up here to be the first to access the latest report and to gain a deeper insight into the Fund’s performance.

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Home Latest property industry research and insights
October 28, 2024

September 2024 direct property market update

Economy1

The trajectory of inflation – and consequently interest rates – remains top of mind for financial markets, businesses, and households alike. Year-on-year headline inflation of 2.7% was recorded in the month of August, a substantial fall from the 3.5% rise recorded in July and the first time the measure has sat within the RBA’s target band of 2-3% since 2021. However, the sharp fall was in part due to Federal and State Government cost-of-living subsidies, namely electricity rebates. The RBA is “looking through” these temporary factors and instead focusing on underlying inflation, which continued to slow in August but was a more elevated 3.4% year-on-year (per the trimmed mean).

The RBA has maintained its cautious stance, making it clear that its focus is on getting inflation sustainably within the target range. Any decisions to cut the official cash rate will be made with that objective top-of-mind. While some banks are still noting the possibility of a rate cut at one of the two remaining meetings this year, consensus points to the first cut occurring in February next year, with several cuts expected by December 2025 . Lower interest rates should boost market confidence, stimulate transaction activity, and support property prices.

chart_electricitypriceindex

One of the key data points influencing the RBA’s monetary policy decisions – besides inflation – is the strength of the labour market. Employment has proven resilient, with jobs growth of 47,500 recorded in August. Similarly, the unemployment rate remained at 4.2%, having only increased by +0.3% since the start of the year. While these and other metrics indicate a robust labour market, it is important to highlight that not all industries are experiencing the same conditions. One of the more obvious divergences exists between industries exposed to the business cycle and consumers (market industries), and non-market industries such as healthcare and education. Data released in September indicates non-market industries accounted for 89% of jobs created over the 12 months to June. This poses a challenge for the RBA, which would like to see some heat come out of the labour market overall, but whose blunt tool has more of an impact on the industries and sectors which have already slowed.

Another important driver of the economy being closely watched is household consumption and how it responds to the stage 3 tax cuts which kicked in this quarter. While it’s too early to get a firm read on consumers’ response, initial indications suggest a greater propensity to save than spend. CommBank’s analysis of their proprietary data shows while incomes have increased following the tax cuts, card spending has not seen a similar lift. Instead, consumers are saving the additional cash flow by boosting offset and redraw account balances. The CommBank data was broadly corroborated by the ABS Household Spending Indicator for August, which showed spending -0.5% lower than June levels. While the retail component of household consumption exceeded expectations in August (+3.1% YoY) and should be supported by the tax cuts, a sustained recovery may take some time (and rate cuts) to materialise.

chart_incomevsspending

 

chart_additionalrepayments

Office

It was an improved quarter for office space fundamentals, but the headline figures continued to obscure varied performance across markets. Analysis of JLL Research data indicates over 90,000 square metres (sqm) of positive net absorption (demand) was recorded across the major CBD markets in aggregate, the strongest quarter since 3Q18. Most of the demand expansion was driven by Sydney CBD which recorded its strongest result since 2015, with support from Canberra and Adelaide CBD. Melbourne CBD was again the weakest performing market from a demand perspective, dragged into contraction by the western end of the city.

chart_netabsorption_YoY

With limited new supply completed over the quarter and the demand side of the equation proving solid, the national CBD vacancy rate improved from 15.4% to 15.1%. Every market except Melbourne CBD and Brisbane CBD saw vacancy decline, with Sydney CBD (-0.9%) the standout due to its strong quarter of demand. Canberra and Brisbane CBD remained the tightest markets – their vacancy rates are in line with or tighter than the long-term average.

chart_totalvacancyrate

The pace of prime net face rent growth (+1.3%) improved over the quarter, taking national CBD annual growth to +4.7% (from +3.9% last quarter). Reflecting its favourable supply-demand conditions, Brisbane CBD was again the standout market recording growth of +2.8% (QoQ). Pleasingly, there were also material improvements in face rental growth for Canberra and Sydney CBD, with Canberra delivering its strongest quarterly result since 2012. Incentives were relatively unchanged with the exception of Melbourne CBD, which worsened. This resulted in positive net effective rental growth outcomes, particularly in Sydney CBD which recorded its strongest quarter of effective growth since 2017.

 

chart_primeneteffectiverentalgrowth

While transaction activity slowed in dollar terms compared to last quarter ($2.1b vs $2.7b), the number of deals done increased. It was the absence of any ‘mega’ deals which dragged the volume figure, with the largest transaction this quarter – Billbergia’s estimated $500m acquisition of Han’s Group’s Sydney Pitt St development site – dwarfed by last quarter’s 55 Pitt St stake selldown. The Melbourne and Sydney CBDs were the most active markets comprising 71% of dollar volume, well above their average share over the last ten years of less than 50%. Across the major CBD markets, average prime yields were largely unchanged with only Sydney CBD seeing a negligible softening. This was only the second quarter since market pricing peaked approximately two years ago where national CBD yields expanded by less than 15bps.

Retail

It was a very strong quarter for retail with the core sectors (Regionals/Sub-Regionals/Neighbourhoods) recording weighted net rent growth of +0.7% compared to June. This was the best quarterly result since 2010, in aggregate and for each sub-sector. Regional centres stood tallest delivering growth of +0.9% (QoQ), but the outcomes across Sub-Regionals and Neighbourhoods were also healthy. From a market perspective it was the East Coast which outperformed. South-East Queensland recorded the strongest core retail growth for the second consecutive quarter, with growth in every sub-sector exceeding +1.0% and the convenience end of the centre type spectrum (Sub-Regionals and Neighbourhoods) performing particularly well. Sydney and Melbourne also recorded solid growth while Adelaide and Perth were unchanged across the board. Rental growth has been supported by a lack of supply, with stock growth running well below population growth over the last two years.

chart_netrent_QoQ

Transaction activity continued to improve, with September dollar volumes totalling $1.9b and exceeding the $1.8b recorded last quarter. The total was buoyed by Vicinity’s $420m acquisition of the Future Fund’s 50% stake in Lakeside Joondalup – a major shopping centre in Perth – in what was the largest deal in a year. Two other Regionals also changed hands in Perth during the quarter, resulting in the highest transaction volume on record for Western Australia. Yields were largely unchanged except for Sydney Neighbourhoods, which recorded 12.5bps of compression. This represents the second quarter of no movement for most centre types and markets, potentially signalling retail asset pricing is starting to stabilise.

Industrial

Occupier take-up (gross demand) increased on last quarter to total nearly 820k sqm, which is in line with the quarterly average of the past five years. Multiple industries recorded weaker take-up with Manufacturing and Construction (a notably volatile industry) being the main drags. These industries were more than offset by solid growth across Transport & Warehousing, Wholesale Trade, and various smaller tenant industries. The major driver of improved take-up was Brisbane, which recorded its strongest quarter since last year. Adelaide and Perth also recorded solid growth while Sydney and Melbourne were relative drags.

chart_occupiertakeup

Rental growth remains above the long-term average despite a weakening of demand relative to supply. The quarterly pace of rental growth slowed across the East Coast but improved in Perth and Adelaide. Perth recorded a sharp acceleration across all three of its precincts, while Adelaide was the top performing market over the quarter, led by rents in the Outer South growing by more than 6%. Melbourne prime rents were unchanged across the board, while Brisbane and Sydney outcomes were mixed – precincts that outperformed in the previous quarter slowed, while those which underperformed saw an acceleration this quarter. Incentives increased in Brisbane, Perth and most Sydney precincts, impacting effective rental growth.

Delivery of supply moderated compared to last quarter but remained elevated versus historical averages, with nearly 750k sqm of new stock completed over the three months to September. Melbourne recorded very little supply after a record level of completions last quarter, outpacing only the much smaller markets of Perth and Adelaide. Supply continues to be concentrated in a small number of precincts, with a single Sydney precinct (Outer Central West) accounting for more than half of new supply over the quarter. There are currently over 2 million sqm of floorspace under construction and largely due for completion in 2024 and 2025. While extended delivery schedules and solid pre-commitment levels are helping prevent a surge of unleased supply from entering the market, the elevated pipeline of projects will likely continue to push the vacancy rate upwards and dampen the pace of rental growth.

It was a solid quarter of transaction activity with dollar volumes totalling $2.1b. While Sydney activity fell after three consecutive $1b+ quarters, Melbourne recorded its strongest quarter in history. The result was underpinned by the $600m acquisition of the Austrak Business Park in Melbourne’s north, which Aware Super and Barings jointly secured. Yields across every Perth precinct expanded by 25bps, the only movement recorded over the quarter.

Interest rate expectations will remain a key influence on the performance of commercial property. We believe rate cuts will contribute to improved market confidence, support a stabilisation of pricing, and stimulate transaction activity.

 

Outlook

Global issues are expected to dominate the headlines over the coming quarter. From an economic perspective, escalating conflict in the Middle East may put upwards pressure on oil prices and hence headline inflation. However, the potential impact on underlying inflation is less clear. While consumers would notice some pain at the bowser, higher fuel prices could dampen demand across the economy more broadly. As Australia’s largest export market, the impact of economic stimulus in China will also be closely watched. Announcements to date appear unlikely to move the needle significantly, but there is scope for additional policies to be delivered. Finally, the outcome of the election and key data prints (jobs and CPI) in the US could materially shift interest rate expectations and financial conditions in Australia.

Interest rate expectations will remain a key influence on the performance of commercial property. We believe rate cuts will contribute to improved market confidence, support a stabilisation of pricing, and stimulate transaction activity. Other countries such as the US, Canada, New Zealand, and several across Europe, have already started lowering rates. Australia’s inflation cycle took hold around six months later than peer markets, and rate cuts are also expected to commence a bit later. A consensus is starting to form across economists, with February being pencilled in for the first rate cut by three of the four major banks. However, it is important to note that the precise timing is uncertain and will be data dependent.

How did the Cromwell Funds Management fare this quarter?

In late August, Cromwell Direct Property Fund completed the sale of 433 Boundary Street, Spring Hill, at a 3.8% premium to its most recent external valuation of $40.0 million. The net proceeds from the sale were used to repay debt, reducing the fund’s gearing.

In September, Cromwell Funds Management revalued approximately 28% of the fund’s portfolio, resulting in an overall decrease in value of 2.2%. As at 30 September 2024, the portfolio is valued at $554.6 million, with a weighted average capitalisation rate of 7.24%. Despite continued strong growth in rents and increased tenant demand, recent sales evidence has contributed to further cap rate expansion. Major sales in the Brisbane CBD this quarter include the William Buck Centre at 120 Edward Street, and 116 Adelaide Street.

Despite this, the outlook for both Brisbane’s CBD and fringe office markets remains positive. Market commentary suggests that while there will likely be some further downward pressure on valuations through the remainder of 2024, yields are finally nearing the bottom of the cycle.

Additionally, new interest rate hedging has been executed this quarter to provide certainty around the fund’s largest cost – its interest expense. The fund is now 58% hedged, with a weighted average hedge term of 2.4 years. Variations in interest expense can have a material impact on operating earnings, so minimising the downside risk associated with those movements through the use of interest rate derivatives helps maintain the fund’s ability to consistently deliver monthly distributions to investors.

Cromwell’s Projects Team remains hard at work on major capex updates, including the finalisation of lift modernisation at 100 Creek Street in Brisbane. This work involves upgrading the equipment and controls for the building’s eight lifts. The team is also in the procurement stage for installing a new heating plant at Creek Street.

At the O’Riordan Street asset in Mascot, a new bracketing system is being installed to secure the car park façade panels, with the project currently in the engineering design and development phase. Additionally, the team is progressing with the design for the lobby and end-of-trip facilities, which will enhance the tenant experience and support lease renewals.

At the 420 Flinders Street asset in Townsville, Cromwell continues investigations with engineers into some remediation works on the wet wall. This proactive effort aims to address issues with the shoring wall construction and prevent potential water infiltration. Due to limited access for repairs, this is a complex project, with testing underway to guide the next steps.

CromwellConnect, the new tenant platform, has been successfully rolled out and has been incredibly well received by tenants at Creek Street. The online platform and mobile app allow tenants to stay updated on the latest building news, book meeting rooms, join health and wellbeing sessions, and access local retail offers.

Annual tenant engagement surveys have been completed, with results expected later this month. The information will be included in our annual ESG report, which was released at the end of October.
Encouragingly, data from the fund’s Altitude Corporate Centre in Mascot shows an 18% reduction in base building electricity consumption over July and August this year, while our Flinders Street property in Townsville saw a 14% reduction. These results are thanks to the newly installed solar infrastructure.

The fund’s portfolio currently stands at 95% occupancy, with a weighted average lease expiry of 3.7 years. However, there are leasing deals currently under Heads of Agreement – the stage where terms have been agreed but lease documentation is not yet executed. Accounting for the largest of these agreements – a new seven-year deal across more than 2,100sqm at 545 Queen Street, Brisbane – occupancy improves to 97%.

Across the eight-asset portfolio, there is now only three floors available for lease – one each at Creek and Queen Streets in Brisbane, and one at 95 Grenfell Street in Adelaide.

Read more about the Cromwell Direct Property Fund: www.cromwell.com.au/dpf.

Past performance is not a reliable indicator of future performance.

Cromwell Funds Management Limited ACN 114 782 777 is the responsible entity of and issuer of units in the Cromwell Direct Property Fund ARSN 165 011 905.

Before making an investment decision in relation to the Fund it is important that you read and consider the Product Disclosure Statement and Target Market Determination available from www.cromwell.com.au/dpf, by calling 1300 268 078 or emailing invest@cromwell.com.au.

 

  1. Data sourced from various ABS publications, except where otherwise specified.
About Cromwell Direct Property Fund

Read more about Cromwell Direct Property Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS and TMD in deciding whether to acquire, or to continue to hold units in the Fund.

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Home Latest property industry research and insights
July 25, 2024

June 2024 quarter ASX A-REIT market update

Stuart Cartledge, Managing Director, Phoenix Portfolios

 

Market Commentary

The S&P/ASX 300 A-REIT Accumulation Index gave up some of its first quarter gains, falling 5.7% in the June quarter. Property stocks underperformed broader equities in the quarter, with the S&P/ASX 300 Accumulation Index losing a lesser 1.2%. Stronger than expected inflation figures led market participants to believe that any expected interest rate cuts by the Reserve Bank of Australia would be delayed, or that the next change in interest rates may even be a move higher.

Property fund managers saw quite divergent performance across the quarter. Goodman Group (GMG) led the way, rising 3.2%, significantly outperforming the broader property sector. GMG’s ongoing outperformance is leading to the unusual situation in which it now accounts for almost 40% of the entire property index. The impact on benchmark returns is clear, with the median property stock in the index down 8.6%, significantly more than the reported 5.7%. Centuria Capital Group (CNI) was also an outperformer in the period, giving up only 2.9%. Alternatively, each of Charter Hall Group (CHC), Elanor Investors Group (ENN) and Qualitas Limited (QAL), meaningfully underperformed, falling 17.0%, 14.4% and 10.6% respectively.

Office property owners were underperformers in the June quarter, as transactional evidence began to filter through after a dearth of transactions in recent periods. Dexus (DXS) reported the $296.2 million sale of 50% of 5 Martin Place, a somewhat new, A grade building in the heart of Martin Place in the Sydney CBD, at an implied capitalisation rate of above 6.1%. DXS also sold B grade asset, 130 George Street in Parramatta for $69.1 million at an implied capitalisation rate greater than 10% and more than 30% below its prior book value. Whilst this sale faced some asset specific concerns and Parramatta is a weaker submarket, the transaction reflects a challenging market for secondary office assets. DXS finished the quarter down 15.4%. Mirvac Group (MGR) pleasingly announced the unconditional exchange of a 66% interest in its 55 Pitt Street office development project, with an end value of approximately $2 billion, highlighting some demand for prime office investments. MGR also announced it had delivered on previously announced sales, including 367 Collins Street in the Melbourne CBD, which faced some prior delays. MGR was down 18.2% on the quarter. Centuria Office REIT (COF) was also weak, losing 15.0%, as was Growthpoint Properties Australia (GOZ), off 10.8%.

Residential property developers delivered mixed performance during the period, with the prospect of delayed interest rate cuts fighting against an ongoing supply/demand imbalance. There has been significant divergence in home price performance and new home sales across the country. After underperforming for many years, Perth has seen median dwelling price growth of more than 23% year over year, with some growth corridors significantly outpacing that number. Perth-based residential developers outperformed, with Finbar Group Limited (FRI) moving 21.7% higher and Peet Limited (PPC) up 0.4%. Melbourne has been significantly weaker, with new home and land sales falling meaningfully. The median dwelling value in Brisbane is now almost 10% above Melbourne and both Adelaide and Perth median dwelling values are within 3.5% of Melbourne. AV Jennings Limited (AVJ) has meaningful exposure to the Australian East Coast and dropped 19.7%. Stockland (SGP) was also a weak performer, giving up 10.6%.

Shopping Centre owners were also weak performers during the period, as consumer confidence and retail sales are beginning to show signs of fading. Some retailers including Mosaic Brands and KMD Brands (owner of Kathmandu), provided updates suggesting that conditions had been challenging in recent periods. Vicinity Centres (VCX) was a meaningful underperformer, off 13.1%, whilst Scentre Group (SCG) dropped 8.0%. Owners of smaller centres were not spared, with Charter Hall Retail REIT losing 12.4% and Region Group (RGN) finishing the quarter 9.2% lower.

Market outlook

The listed property sector is in good shape and provides investors with the opportunity to gain exposure to high quality commercial real estate at a meaningful discount to independently assessed values. While share market volatility may be uncomfortable at times, the offset is liquidity, enabling investors to rebalance portfolios without the risk of being trapped in illiquid vehicles.

Rising interest rates have been a headwind for many asset classes, with property, both listed and unlisted, a particularly interest rate sensitive sector. The February reporting season saw stocks providing solid updates, with cautiously optimistic outlooks, based on the assumption that interest rates may have peaked. Long term valuations are driven by “normalised” interest costs, meaning the impact of short term hedges maturing is mostly immaterial. Should the forecast decline in interest rates eventuate, recent headwinds may dissipate and possibly reverse.

The industrial sub-sector continues to be the most sought after, given the tailwinds of e-commerce growth, the potential onshoring of key manufacturing categories and the decision by many corporates to build some redundancy into supply chains to cope with current disruptions. All of these factors are contributing to ongoing demand for industrial space, which is evident by rapidly accelerating market rents and vacancy rates at historic lows of around 1% in many markets.
We remain cognisant of the structural changes occurring in the retail sector with the growing penetration of online sales and the greater importance of experiential offering inside malls. Recent performance of shopping centre owners has however been strong, with consumers showing resilience. It is interesting to note the juxtaposition of very high retail sales figures despite very low levels of consumer confidence, no doubt impacted by rising costs of living. Importantly, we are also now seeing positive re-leasing spreads in shopping centres, indicating strengthening demand from retail tenants.

The jury is still out on exactly how tenants will use office space moving forward, but demand for good quality well located space remains. Leasing activity is beginning to pick up, and there has also been some transactional activity, albeit at prices typically at discounts to book values. Incentives on new leases remain elevated.

We expect to see further downside to asset values in office markets, but elsewhere expect market rent growth to largely offset cap rate expansion, particularly in industrial assets. Listed pricing provides a buffer to such movements.

The content above is taken from the Cromwell Phoenix Property Securities Fund quarterly report. Sign up here to be the first to access the latest report and to gain a deeper insight into the Fund’s performance.

Performance commentary

Fill out the form below to view the full commentary.

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Home Latest property industry research and insights
July 22, 2024

June 2024 direct property market update

Economy

Financial markets remained volatile over the quarter, reflecting participants’ keen focus on the outlook for interest rates. A major event during the quarter was the release of the 2024-25 Federal Budget on 14 May, with the state and territory budgets also released over the course of May and June1. The Budget was slightly more accommodative and stimulatory than expected, spearheaded by a $300 per household electricity rebate and additional Commonwealth rent assistance. Many of the states followed suit, offering cost-of-living supports such as further electricity rebates, public transport fare reductions, fee indexation freezes (e.g. vehicle registration), and vouchers for families.

Federal and state governments felt pressured to act, given the ongoing squeeze on households from higher interest rates, tax bracket creep, and inflation. Retail spending continues to record very weak levels of growth, while the latest consumer sentiment print remained in deeply pessimistic territory2. More broadly, economic growth has fallen to its lowest annual pace since 1992 (excluding the pandemic), as per the March National Accounts (released June).

 

 

The key question – which will only be answered in time – is what impact the Budget measures will have on inflation, which is not slowing as quickly as the RBA had forecast? Headline inflation will be lowered by the subsidies, which should help slow inflation by reducing administered prices (i.e. CPI-linked costs). The lower headline rate may also help keep inflation expectations anchored to the RBA’s target band. On the flipside, headline inflation will get a bump in 2025 when the subsidies unwind, potentially having the opposite effect. Spending power will also be increased, with the net outcome dependent on households’ propensity to either spend or save the extra cash. Categories such as clothing could absorb additional spending without adding to inflation pressures given the spare capacity which is emerging in discretionary parts of the economy. Additional spending on supply-constrained essentials, such as housing, would be more likely to elicit an inflationary response.

Annual_Inflation_May24

Office

Divergence in performance between markets continues to be a dominant theme in office. Analysis of JLL Research data indicates national CBD net absorption of almost +8,000 square metres (sqm) was recorded over the quarter. Perth CBD (+12,000sqm) recorded the strongest net demand while Melbourne CBD struggled (-27,000sqm). The weakness in Melbourne was driven by A Grade stock, the Western and Eastern Core precincts, and small tenants occupying less than 1,000sqm. Small tenants accounted for 90% of the space contraction, an anomaly compared to other markets and the post-COVID trend.

 

Weaker space demand and elevated levels of new stock completions led to material vacancy rate increases in the Sydney and Melbourne CBDs. These markets outweighed the vacancy decline observed across the smaller markets, causing the national CBD vacancy rate to increase from 14.7% to 15.4%. Further illustrating the divergent performance by market, Brisbane CBD is currently sitting at its lowest vacancy rate since 2012, while the Sydney and Melbourne CBDs are at their highest vacancy rates since the mid-90s.

Total_vacancies_June24

Prime net face rent growth (+1.0%) matched the average quarterly pace of the past three years. Reflecting its favourable supply-demand conditions, Brisbane CBD was the standout market recording growth of +1.8%. Brisbane also saw prime incentives decline by -1.1%, while the other CBD markets were largely unchanged. These movements resulted in strong net effective rental growth of +3.4% for Brisbane CBD, with Melbourne CBD the weakest performer for the fourth consecutive quarter.

 

Capital markets continue to thaw, leading to improved
price discovery and narrower bid-ask spreads. National CBD average prime yields expanded 33bps over the quarter, taking total expansion to 182bps since the 2022 peak in values. Transaction volume for this quarter totalled $2.7 billion, representing the most active quarter since Q3 2022. Sydney CBD accounted for nearly 60% of activity, double its average share over the last decade. Mirvac’s sale of a ~66% stake in the 55 Pitt Street development to Japanese investor Mitsui Fudosan was the main transaction, supported by the 50% sale of 5 Martin Place to an existing co-owner. There was also meaningful transaction activity in the Brisbane CBD, being the only other market where volumes exceeded the quarterly average of the past five years. This was headlined by Quintessential’s acquisition of 240 Queen Street, which took more than a year to close.

Retail

There was little movement in rents over the quarter. According to JLL Research, net rents were unchanged across large discretionary shopping centres (Regionals). Growth in convenience-oriented centres (Sub-Regionals and Neighbourhoods) was slightly more positive, averaging +0.3%. This was due to very strong growth in South East Queensland, where Sub-Regionals and Neighbourhoods both recorded quarterly growth of +1.7%.

Positively for Regional centres, the vacancy rate was largely unchanged over the quarter and is in line with the 10-year average. Conditions are particularly strong across South East Queensland and Adelaide Regionals, where the vacancy rate is 1.6% and 1.7% respectively. A weaker vacancy result was recorded across Sub-Regionals and Neighbourhoods, with most markets sitting above historical average levels.

After a very quiet first quarter, transaction volume returned to a healthy level over the three months to June. Activity was headlined by the sale of Stockland Glendale (to IP Generation) and a 50% stake in Westfield Tea Tree Plaza changing hands from Dexus to a Scentre Group/Barrenjoey partnership. While Sub-Regionals represented the greatest share of transaction volume, activity was also solid across Neighbourhoods and Large Format centres. Average yields were unchanged across the quarter.

Industrial

According to JLL Research, gross occupier take-up rebounded from the soft first quarter to total just over 700,000 sqm. While leasing activity has slowed from pandemic highs, on a rolling 12-month basis it is still running at a faster pace than any period pre-2021 (data back to 2007). The main driver of weaker take-up is Retail & Wholesale Trade, potentially reflecting cautiousness from occupiers in the face of weak retail sales, together with a ‘pause’ to expansion after substantial take-up during the pandemic. Manufacturing continued to outperform, recording gross take-up 10% higher than its 5-year average, with activity particularly strong in Melbourne and Perth. Construction also saw an elevated quarter of activity but remains a small proportion of the industrial market.

 

Rental growth remains above the long-term average rate despite a weakening of demand relative to supply. Land constrained precincts such as the Brisbane Trade Coast and South Sydney recorded quarterly rental growth of around 5%, with Melbourne’s South East the only precinct to record higher face rental growth. Prime incentives increased in most markets along the East Coast, leading to softer rental growth outcomes on a net effective basis.

Just over 1 million sqm of industrial supply was delivered during the quarter, representing the second biggest quarter of completions behind Q2 2022. Activity was heavily concentrated in Melbourne, which accounted for 55% of supply nationally with four of the five largest projects. A further 1.8 million sqm of supply is currently under construction and slated for delivery in 2024. However, more than half of this floorspace is scheduled for completion in the last quarter of the year and hence is at risk of slipping into 2025 given ongoing project delays. While extended delivery schedules and solid pre-commitment levels are helping prevent a flood of unleased supply from entering the market, elevated completions relative to demand are likely to see the vacancy rate – and rental growth – trend towards the long-run average.

There was further improvement in transaction activity this quarter with dollar volume increasing to $3.2 billion, the highest quarterly level seen since Q4 2021 and the strongest result outside of that record year. The portfolio sale of 12 Goodman assets across Sydney and Melbourne, jointly acquired by Barings and Rest, was the main transaction. Capital continues to be attracted to Sydney, which accounted for 53% of transaction volume (excluding multi-market portfolio deals). Yields were largely unchanged over the quarter, with 25bps of expansion in Sydney North and Brisbane Trade Coast the only notable movements.

If rates are held steady, the labour market continues to soften, and disinflation resumes its downwards trend, we should see further improvement in capital market liquidity and property transaction activity.

 

Outlook

The RBA meeting on 6 August is the key event of the September quarter. The decision to hike or hold rates will be dependent on June quarter inflation (released 31 July) and June labour data (released 18 July). While there is a case for monetary policy to be more restrictive, the RBA has adopted the position that preserving employment gains is a key priority and so the threshold for a hike is high.
If rates are held steady, the labour market continues to soften, and disinflation resumes its downwards trend, we should see further improvement in capital market liquidity and property transaction activity. While there are risks to the outlook such as shipping disruptions, volatile election outcomes, and conflict escalation, the Australian economy appears to still be on the narrow path towards a soft landing.

How did the Cromwell Funds Management fare this quarter?

In April, approximately 25% of the Cromwell Direct Property Fund (DPF) portfolio was revalued, with another 17% in May and 52% in June. Eight of the fund’s nine assets have now been independently revalued. Overall, from December last year, capitalisation rates have softened by 30bps to a weighted average of 7.18%, equating to a 3% fall across the portfolio, which is now valued at $607 million.

The Brisbane office market, where just under 55% of DPF’s portfolio is held, is experiencing strong fundamentals. This is evidenced by positive net absorption, a decrease in headline vacancy and positive net effective rental growth of 3.4% for the quarter, and 14% over the past 12 months. As noted in the market update above, Brisbane is leading the country for rental growth and is currently one of the strongest-performing leasing markets in the APAC region.

High construction costs and upward pressure on labour, helped along by Queensland’s significant infrastructure pipeline over the next 3-4 years, will see supply constrained for some time, which bodes well for leasing demand and future rental growth on existing assets. Additionally, the anticipated rapid increase in immigration is likely to further drive demand for commercial office space, as well as in the medical, retail, and industrial sectors.

While Cromwell is optimistic that valuations have experienced the worst of the cycle and will now stabilise, it is pertinent to note that recent CPI prints and the Reserve Bank of Australia’s neutral stance on rates may delay this stabilisation. In the interim, Cromwell’s key focus remains on maximizing portfolio performance to help ensure the delivery of regular distributions.

Portfolio updates for the quarter
Cromwell is continuously exploring ways to enhance the tenant experience and improve the amenities offered within its buildings. The implementation of a tenant portal, Cromwell Connect, is currently underway across several of our assets. This portal will enable tenants to access various forms of data, make bookings for communal training or meeting rooms and interact with retailers for services such as ordering coffees, booking dry cleaning, and reserving Pilates classes.

Cromwell Property Trust 12’s (C12) Dandenong asset recently underwent balcony refurbishment works, including the replacement of artificial turf with tiling. Additionally, 100 Creek Street in the Brisbane CBD is undergoing a comprehensive lift modernisation, which includes the upgrade of lift motors, with a heating upgrade project scheduled for later this financial year.

The solar works at Dandenong, Mascot, and Townsville assets have now been completed and energized, resulting in seven of the nine DPF assets benefiting from solar power.

The portfolio experienced strong leasing performance for the quarter, with six deals signed at 100 Creek Street, four of which were completed using existing spec fitouts. The other two were renewals on just under 1,300 sqm. Furthermore, one of the largest tenants at Queen Street exercised a 2-year option over almost 1,500 sqm, and at Mascot, a 5-year renewal with a tenant secured in 2023 was recently completed, occupying just under 1,300 sqm. Cromwell is also receiving good levels of enquiry over a couple of full-floor vacancies in Brisbane and Adelaide.

The portfolio currently maintains a 95.5% occupancy rate, with a weighted average lease expiry of 4 years.

Cromwell’s asset management and projects teams remain hard at work to maximise occupancy across the portfolio, whether by renewing current tenants or relocating them within the buildings using existing fitouts. This approach allows the cost of incentives to be spread across the lease term rather than funded upfront. Moreover, Cromwell is dedicated to maximising energy efficiency and maintaining and improving NABERS ratings through carefully planned lifecycle programmes aligned with decarbonisation plans and ESG initiatives. In April, 545 Queen Street was awarded a 6.0-star NABERS Energy rating for the first time, an improvement from its 5.5 stars. This achievement was the result of years of sustainability planning, energy-saving initiatives, and ongoing consultation with Australian energy solutions provider, Conservia.

Cromwell is pleased to be progressing on its net zero pathway, having already achieved a 73% reduction in emissions across the DPF portfolio3.

Read more about the Cromwell Direct Property Fund: www.cromwell.com.au/dpf.

Past performance is not a reliable indicator of future performance.

Cromwell Funds Management Limited ACN 114 782 777 is the responsible entity of and issuer of units in the Cromwell Direct Property Fund ARSN 165 011 905.

Before making an investment decision in relation to the Fund it is important that you read and consider the Product Disclosure Statement and Target Market Determination available from www.cromwell.com.au/dpf, by calling 1300 268 078 or emailing invest@cromwell.com.au.

 

  1. Except for the Tasmanian Budget which has been delayed from May to September.
  2. Consumer Sentiment (Westpac-Melbourne Institute, May-24)
  3. This excludes Queen Street in Brisbane which is undertaking a decarbonisation audit in FY25
About Cromwell Direct Property Fund

Read more about Cromwell Direct Property Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS and TMD in deciding whether to acquire, or to continue to hold units in the Fund.

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April 30, 2024

Getting the right healthcare property exposure: why medical centres

Colin Mackay, Research and Investment Strategy Manager, Cromwell Property Group

 

Healthcare property encompasses a range of asset types such as hospitals, medical centres, and aged care facilities. As outlined in the previous article of this series, the healthcare industry is benefitting from several demand tailwinds. However, it’s not all smooth sailing, as evidenced by recent news of private hospital closures1. In this article, we’ll explain why we believe medical centres is the specific property segment investors should prioritise.

 

A necessary care model

As the population ages, the supply of health services is struggling to keep up with demand, resulting in higher costs and longer wait times. Inadequate financial and labour resources are available to improve care standards or wait times under the status quo – a more efficient and cost-effective system is required.

public hospital elective surgery wait times

Part of the required shift includes moving treatment out of hospitals and towards GPs and other primary or secondary care facilities. Focusing on primary healthcare and out-of-hospital care can result in better health outcomes2, reduced risk of infection and improved patient comfort, convenience, and satisfaction3,4. From a funding perspective, out-of-hospital care can be cheaper due to lower overheads compared to when a hospital bed is occupied4.

Avoidable emergency department presentations are clogging the hospital system, with an estimated 1.9 million preventable patient days per annum from those aged 65+ alone5. It would be more appropriate to provide this care in an efficient, fit-for-purpose medical centre environment, saving costs and freeing up hospital resources for actual emergency care and complex cases.

The shift from hospital to non-hospital care is already underway and evidenced by growth in primary healthcare spending outpacing spending on hospitals, as well as government policies putting greater emphasis on primary care and preventive health. For example, the Federal Government has announced a $99m initiative to connect frequent hospital users with a GP to reduce the likelihood of hospital re-admission, and $79m in funding to support the use of allied health services for multidisciplinary care in underserviced communities6.

GROWTH IN PRIMARY HEALTHCARE SPENDING IS OUTPACING SPENDING ON HOSPITALS

Attractive investment characteristics

In addition to demand and funding tailwinds, medical centres offer several attractive investment characteristics:

High quality cashflow
derived from a reliable tenant base
A hedge against inflation
via CPI-linked or fixed rental escalations
Long leases (typically 5-15 years)
sometimes on a triple net basis
Higher rates of lease renewal
compared to traditional office7

Compared to private hospitals, medical centres may be preferred due to deriving income from a typical commercial lease structure, rather than a percentage of operator EBITDAR. Land also typically comprises a greater proportion of asset value, which can provide downside protection and aid long-term development or change of use potential.

 
Private Hospitals
Medical Centres
Lease term 20-30 years 5-15 years
Basis of income Percentage of operator EBITDAR, quoted on per bed basis Typical commercial lease structure, quoted per sqm
Tenant profile Single operator One or several tenants
Capital intensity Very high Moderate to high

Summarised from Exploring Australian healthcare opportunities, JLL (Jun-23)

An increasingly important part of the healthcare landscape

Medical centres are an increasingly important part of the healthcare landscape, representing efficient and fit-for-purpose facilities that can help alleviate the capacity constraints of hospitals and improve the sustainability of the health system.

We believe medical centres’ alignment with demand trends and Government healthcare spending priorities, together with attractive investment characteristics such as CPI-linked income and defensive land holdings, puts them in a favourable position compared to other healthcare property investments.

 

Footnotes
  1. Ramsay Health Care warns of hospital closures as costs blow out, AFR (Feb 29th, 2024)
  2. How much of Australia’s health expenditure is allocated to general practice and primary healthcare?, M. Wright; R. Versteeg; K Gool (Sep-21)
  3. Out-of-hospital models of care in the private health system, Australian Medical Association (Oct-23)
  4. There’s no place like home: reforming out-of-hospital care, Private Healthcare Australia (May-23)
  5. Health is the best investment: shifting from a sickcare system to a healthcare system, Australian Medical Association (Jun-23)
  6. Federal Budget 2023-24, Treasury (2023)
  7. Exploring Australian healthcare opportunities, JLL (Jun-22)
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April 22, 2024

March 2024 direct property market update

Economy

The disinflation cycle is in the ‘last mile’, where monetary policy is being finely calibrated and market expectations can move month-to-month with each new data release. This was reflected in the RBA’s stance at the March Board meeting, where Australia’s central bank arguably kept a foot in both the tightening and neutral camps. However, much of the market’s speculation is focused on when rate cuts will occur, rather than the genuine possibility of further hikes. As at the end of March, financial markets and the major banks were forecasting the first cut to occur in the final quarter of 2024.

Annual inflation was stable at 3.4% in February (data released March), with rent and insurance inflation remaining stubbornly high, and goods inflation continuing to be moderate. However it is the tightness of the labour market (services inflation) which will likely be the key determinant of the CPI path moving forward. On this front, the unemployment rate fell from 4.1% in January to 3.7% in February1. The magnitude of the decrease is surprising at first glance, but less unexpected when you look at the detailed data which shows a shift in the seasonality of the labour market. It is now becoming the ‘new norm’ for workers to end a job in December and not start a new one until February. Labour data has also shown more volatility month-to-month since the pandemic. Looking at the recent trend rather than the latest monthly print in isolation shows the labour market is gradually softening, with underemployment (people wanting more hours) at its highest level since December 2021 and leading indicators such as job vacancies falling (albeit from high levels).

 

Retail sales provide another indication of a slowing economy. While Taylor Swift’s recent tour boosted February spending on clothing, department stores and dining in New South Wales and Victoria (the locations of the concerts), annual nominal growth of only 1.6% was recorded2. Considering inflation is running above 3% and population growth of circa 2.5%, underlying consumption is very weak, showing that the cost of living is clearly biting. However, consensus expectations are that there should be some relief towards the end of the year as stage 3 tax cuts flow through, inflation continues to moderate, and interest rates potentially ease.

A part of the economy bucking the slowdown trend is housing; reflecting robust demand and constrained supply. CoreLogic’s national Home Value Index recorded its 14th consecutive month of growth in March, rising to new record highs each month since November 20233. There is a risk sustained house price growth may influence the RBA’s view of the appropriate rate path, however as previously stated, the health of the labour market will likely be a much greater focus.

Office

The office market recorded a positive result in the March quarter. According to JLL Research, national CBD net absorption totalled just over +33,000 square metres (sqm), the strongest result since March 2023. Sydney was the top-performing market after three weak quarters prior, while Perth was the only major CBD market which saw demand decline as a result of softening in the non-Premium grades. On an annual basis, net demand is still strongest in the smaller markets of Adelaide, Brisbane, and Perth.

 

The national CBD vacancy rate was flat at 14.7%, with every CBD market except Perth and Canberra recording an improvement in supply-demand conditions. While the softening in Perth was due to both new supply and weaker demand, the increase in Canberra vacancy was entirely driven by the addition of new stock (completion of a refurbishment). Nationally, Premium assets saw the greatest improvement in vacancy rate.

Prime net face rent growth (+1.4%) accelerated further compared to the prior quarter (+0.9%), with the Brisbane CBD and Adelaide CBD the top performers. Prime incentives were largely flat (+0.1%), with half of the markets recording minor increases (Sydney, Melbourne, Perth), offset by the other half recording minor improvements. This meant on a net effective basis, Adelaide and Brisbane recorded the strongest growth, with Melbourne the only market to head backwards.

 

Reflecting the continued softness in conditions, transaction volume for the March quarter ($1.0 billion nationally) was roughly in line with the quarterly average over the prior 12 months but 64% lower than the Q1 average of the previous five years. Having said that, it was the highest number of sales seen since December 2022, highlighting that the smaller end of the market remains more active than larger lot sizes. The lack of transaction activity reflects the sharp increase in cost of capital seen over the past 24 months. This has resulted in national CBD prime average yields softening a further 29bps over the quarter. The national movement in yields may not be directly reflective of individual portfolios or assets, given differences in the timing of valuation processes.

Retail

While annual rental growth remains soft, it is consistent and broad-based. According to JLL Research, across large discretionary shopping centres (Regionals) gross rental growth averaged +0.1% for the quarter and +0.5% for the year, with every market recording a similar result. Growth across Sub-Regionals was slightly stronger at +0.2% and +0.8%, representing nine consecutive quarters of rental increases. Neighbourhood centres also recorded growth of +0.2% for the quarter, taking annual growth to +0.6%. Sydney and South-East Queensland, which have the highest Neighbourhood rents per sqm, recorded slightly weaker growth than the other markets.

It was a very slow quarter for retail property transactions, with volume totalling just over $500 million. No Regional assets changed hands for the first time since September 2022, dragging the dollar value of activity lower. It was quiet across the other centre types as well, with Sub-Regionals the most active relative to the five-year average. While yields did expand further over the quarter, it was to a lesser extent than office and industrial reflecting the higher starting point of retail yields prior to the hiking cycle.

While yields did expand further over the quarter, it was to a lesser extent than office and industrial reflecting the higher starting point of retail yields prior to the hiking cycle.

Industrial

Gross occupier take-up softened materially over the quarter as inventory levels contracted and the broader economy slowed. Transport and Warehousing continues to comprise the greatest share of demand from an industry perspective, with Manufacturing take-up also remaining at a solid level. The big driver of the slowdown was Retail and Wholesale Trade, which saw demand fall by around 90% compared to the five-year average. This may reflect cautiousness from occupiers in the face of weak retail sales and declining global trade volumes, together with a ‘pause’ to expansion after substantial take-up during the pandemic. From a market perspective, Sydney saw the largest slowdown in demand, with South-East Queensland and Perth holding up well.

 

While rental growth is slowing from record highs, it remains well above trend, consistent with tight vacancy conditions. Melbourne saw the strongest growth, with Melbourne West the top-performing precinct nationally (+8.0% QoQ). Brisbane growth was robust in the infill Trade Coast precinct, while the land constrained South precinct was the top performer in Sydney. Rental growth in Sydney’s Outer Central West, where land is more abundant, was not as strong.

Almost 500,000sqm of industrial supply was completed in the first quarter of 2024. A further two million sqm4 of supply is slated for completion over the balance of the year, however construction delays may see timings slip. If all the projected supply is completed in 2024, it would represent the second highest level of completions in a calendar year behind 2022 (2.7m sqm). Projects are heavily concentrated in the land-rich, outer precincts, with 66% of expected 2024 supply to occur in just four precincts (of 22 nationally). Ongoing elevated levels of supply will likely lead to greater availability of space and a further softening of rental growth.

There was a rebound in transaction activity over the quarter, with dollar volumes exceeding the five-year average and hitting the highest level since September 2022. Activity was dominated by Sydney, in particular ISPT and Unisuper’s joint acquisition of a 280 hectare greenfield development site in Badgerys Creek. Consistent with other sectors, prime industrial yields expanded over the quarter along the East Coast, with the smaller markets of Adelaide and Perth unchanged. Sydney saw the greatest degree of softening, but still has the tightest yields nationally.

 

Outlook

The global economy is slowing but at a relatively measured pace, engendering optimism that a “soft landing” can be achieved. Australia’s economy is in a similar position, with inflation slowing but employment conditions remaining resilient. Markets are becoming more confident the rate hiking cycle is at or near its end, which should help ease uncertainty and improve liquidity for property later in the year.

While an economic slowdown is expected over 2024 and early 2025, a more significant contraction (i.e. recession) is looking less likely. Businesses will continue to review their space requirements as they adjust to hybrid working, though the balance between in-office versus remote is expected to shift back towards the office over 2024. Location continues to be an important driver of occupier preferences, combined with amenity and building quality (at a given price point).

How did the Cromwell Funds Management fare this quarter?

With the Cromwell Direct Property Fund’s property portfolio completely revalued externally in November and December 2023, no external revaluations were completed in the March quarter. With the revaluation process and half-year accounts released, the Fund recommenced accepting applications and offering the Distribution Reinvestment Plan (at a 5% discount) from 25 March 2024.

The Fund continues to experience positive leasing outcomes, especially in its Brisbane based assets. The strategy to build quality speculative fitouts and improving amenity with 3rd spaces has helped improve occupancy metrics, tenant engagement, and improving rental growth.

Both the Cromwell Riverpark Trust’s Energex asset (CRT) and Cromwell Trust 12’s Dandenong asset (C12) had solar panels installed. The installation is awaiting grid approval, and the work will help maintain (for CRT) and obtain (for C12) a 6-star NABERS rating.

Read more about the Cromwell Direct Property Fund: www.cromwell.com.au/dpf.

Past performance is not a reliable indicator of future performance.

Cromwell Funds Management Limited ACN 114 782 777 is the responsible entity of and issuer of units in the Cromwell Direct Property Fund ARSN 165 011 905.

Before making an investment decision in relation to the Fund it is important that you read and consider the Product Disclosure Statement and Target Market Determination available from www.cromwell.com.au/dpf, by calling 1300 268 078 or emailing invest@cromwell.com.au.

 

  1. Labour Force, ABS
  2. Retail Trade, ABS
  3. Hedonic Home Value Index, CoreLogic
  4. Projects with a status of Under Construction, Plans Approved, or Plans Submitted
About Cromwell Direct Property Fund

Read more about Cromwell Direct Property Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS and TMD in deciding whether to acquire, or to continue to hold units in the Fund.

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April 22, 2024

An essential and resilient sector: why healthcare property

Colin Mackay, Research and Investment Strategy Manager, Cromwell Property Group

 

The healthcare and social assistance sector is an essential and growing industry, accounting for 8% of the Australian economy1 and 16% of employment2. It is expected to see the biggest increase in government funding from 2022-23 to 2062-63, with government health spending per capita forecast to grow by 2.0% p.a. on an inflation-adjusted basis3. In this short article, we’ll provide a brief overview of healthcare’s key growth drivers, and why healthcare property presents a compelling investment opportunity for income-oriented investors seeking stability and diversification.

Demographic tailwinds

Growth in Australian healthcare is underpinned by several long-term demographic trends, which are spurring demand for care services. Firstly, Australia is forecast to experience the strongest population growth across developed economies over the next decade4. On top of broad-based population growth, there is an even more pronounced “population bulge” now sitting in the 65+ age bracket due to the post-war baby boom. Life expectancy is also rising, up from 78 years (men) and 83 years (women) two decades ago to 81 and 85 today, with the rising trend expected to continue3. These factors mean the number of people aged 65+ will more than double and the number aged 85+ will more than triple over the next 40 years. As we live longer, the proportion of our lives lived in “full” health is slowly declining, meaning a longer period of time where health services and care are needed per person.

People aged 65+ currently account for 40% of government health spending despite being only 16% of the population.

Rising disease incidence

Naturally, an ageing population also means rising disease incidence and complexity. People aged 65+ currently account for 40% of government health spending despite being only 16% of the population3, with 95% of those aged 65+ having two or more chronic health conditions, compared to 59% of those aged 15-444. This is being exacerbated by lifestyle factors, such as poor diets and lack of exercise, and improved medical detection and diagnostics, which are seeing the rates of disease incidence also increase on an age-standardised basis5.

 

Non-cyclical demand

Healthcare is a defensive, necessity service resilient to fluctuations in the economic cycle. Since gross value added data by industry has become available, healthcare has only contracted in 37 of 197 quarters, making it the second most consistently expanding industry behind Education, which has contracted in 25 quarters1. By comparison, cyclical industries such as mining and construction have contracted in 69 and 71 quarters respectively.

Volatility in healthcare demand is lower than in other industries, and growth has also typically occurred even during periods of recession or global economic disruption (e.g. the GFC). In fact, annual growth in gross value added has never been negative for more than one consecutive quarter, with the worst result (-5.0%) recorded during the COVID-19 pandemic when most health services were shutdown. Even during the pandemic, the sector experienced a sharper recovery than the broader economy.

Strong fundamentals

The healthcare sector in Australia is an essential and growing industry. Underlying demand is being driven by long-term demographic trends such as population growth, the ageing population, and longer life expectancy. Rising disease incidence and complexity add further to the growing need for healthcare services and facilities. Demand is non-cyclical and resilient to economic fluctuations, making healthcare property assets a compelling investment for income-oriented investors seeking stability and diversification.

 

  1. National Accounts, ABS (Dec-23)
  2. Labour Force, ABS (Feb-24)
  3. Intergenerational Report 2023, Commonwealth of Australia (Aug-23)
  4. 10-year average growth from 2024-33 based on UN median population projections for ‘More Developed Regions’ excluding Holy See
  5. National Health Survey 2022, ABS (Dec-23)
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April 22, 2024

March 2024 quarter ASX A-REIT market update

Stuart Cartledge, Managing Director, Phoenix Portfolios

 

Market Commentary

The S&P/ASX 300 A-REIT Accumulation Index continued its march higher in the first quarter of 2024, gaining 16.2%. Property stocks meaningfully outperformed broader equities in the quarter, with the S&P/ASX 300 Accumulation Index adding a lesser 5.4%. This outperformance was predominantly driven by the 33.6% return of Goodman Group (GMG), which is the largest component of the property index, with a weighting of approximately 36%. The median return of stocks in the property index was a lesser 6.2%. Of 33 stocks within the index, only five were outperformers.

During the quarter, companies under coverage reported financial results for the period ended 31 December 2023. In general (with some notable exceptions), financial results were marginally better than expectations, demonstrating the resilience of property income streams. Outlook statements tended to acknowledge uncertainty, as the future path of interest rates remains a key input into likely outcomes.

Retail property was one of the stronger subsectors in the March quarter. Results released in February’s reporting season showed solid sales growth within shopping centres and even more impressive were the much-improved re-leasing spreads. Owner of Australian Westfield shopping centres, Scentre Group (SCG) led the way, gaining 16.2%, whilst foreign owner, Unibail-Rodamco-Westfield (URW) also moved sharply higher, adding 14.8%. Peer, Vicinity Centres (VCX) underperformed the index, but performed strongly, up 7.3%. Owners of smaller neighbourhood shopping centres didn’t keep up with their larger competitors, with Region Group (RGN) lifting 5.8% and Charter Hall Retail REIT (CQR) finishing the quarter 2.8% higher.

Once again it was office property that was the laggard as elevated vacancy and incentives continue to create concern about the prospects of office ownership. Dexus (DXS) materially underperformed the index, up 3.0%. Centuria Office REIT (COF) was weaker still, adding only 1.9%, whilst GDI Property Group (GDI) lost 5.4%. Large capitalisation office owner GPT Group (GPT) also had a tough quarter, losing 1.5%.

Returns of property fund managers were mixed through the quarter. As previously discussed, it was GMG that dominated all comers. HMC Capital Limited (HMC) outperformed, finishing the quarter 17.7% higher, but much of its performance was tied to non-property funds management targets. Charter Hall Group (CHC) also performed solidly, gaining 14.2%. Centuria Capital Group (CNI) couldn’t keep up with peers, losing 0.3% whilst Elanor Investors Group (ENN) gave up 12.2%.

For some time, we have highlighted the disconnection between private real estate valuations and public real estate equity share prices. It is inevitable, given time, that this gap closes. This can occur through private market devaluations, share price appreciation or M&A transactions serving to close the gap (or some combination of those options). During the quarter we have seen a combination of all three, with valuations moving marginally lower, share prices moving meaningfully higher and we have also begun to see some M&A activity. Each of Newmark Property Group (NPR), Eureka Group Holdings (EGH) and Hotel Property Investments (HPI) received takeover bids or had strategic parties acquire large stakes in the companies. Each of these companies were amongst the few outperformers in the quarter. Should small capitalisation securities continue to underperform, we would expect M&A activity to be an ongoing feature of the market.

Market outlook

The listed property sector is in good shape and provides investors with the opportunity to gain exposure to high quality commercial real estate at a meaningful discount to independently assessed values. While share market volatility may be uncomfortable at times, the offset is liquidity, enabling investors to rebalance portfolios without the risk of being trapped in illiquid vehicles.

Rising interest rates have been a headwind for many asset classes, with property, both listed and unlisted, a particularly interest rate sensitive sector. The February reporting season saw stocks providing solid updates, with cautiously optimistic outlooks, based on the assumption that interest rates may have peaked. Long term valuations are driven by “normalised” interest costs, meaning the impact of short term hedges maturing is mostly immaterial. Should the forecast decline in interest rates eventuate, recent headwinds may dissipate and possibly reverse.

The industrial sub-sector continues to be the most sought after, given the tailwinds of e-commerce growth, the potential onshoring of key manufacturing categories and the decision by many corporates to build some redundancy into supply chains to cope with current disruptions. All of these factors are contributing to ongoing demand for industrial space, which is evident by rapidly accelerating market rents and vacancy rates at historic lows of around 1% in many markets.

We remain cognisant of the structural changes occurring in the retail sector with the growing penetration of online sales and the greater importance of experiential offering inside malls. Recent performance of shopping centre owners has however been strong, with consumers showing resilience. It is interesting to note the juxtaposition of very high retail sales figures despite very low levels of consumer confidence, no doubt impacted by rising costs of living. Importantly, we are also now seeing positive re-leasing spreads in shopping centres, indicating strengthening demand from retail tenants.

The jury is still out on exactly how tenants will use office space moving forward, but demand for good quality well located space remains. Leasing activity is beginning to pick up, and there has also been some transactional activity, albeit at prices typically at discounts to book values. Incentives on new leases remain elevated.

We expect to see further downside to asset values in office markets, but elsewhere expect market rent growth to largely offset cap rate expansion, particularly in industrial assets. Listed pricing provides a buffer to such movements.

About Stuart Cartledge

Stuart is the Managing Director of Phoenix Portfolios and the portfolio manager for each of the company’s property portfolios. Prior to establishing the business in 2006, Stuart built a strong track record in the listed property security asset class and has been actively managing securities portfolios since 1993. Stuart holds a master’s degree in engineering and management from the University of Birmingham and is a Chartered Financial Analyst.

The content above is taken from the Cromwell Phoenix Property Securities Fund quarterly report. Sign up here to be the first to access the latest report and to gain a deeper insight into the Fund’s performance.

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Research and Insights

Home Latest property industry research and insights
March 8, 2024

The power of AI in real estate: a paradigm shift

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Home Latest property industry research and insights
January 23, 2024

December 2023 direct property market update

Peta Tilse, Head of Retail Funds Management

Economy

Over the December quarter, interest rates were reasonably volatile both in terms of short and longer-term rates. The RBA increased interest rates by 25 basis points (bps) in November, taking the cash rate to 4.35%; its highest level since the end of 2011. The justification for the move was to bring inflation to target within a reasonable timeframe (i.e. by end-2025), rather than risk a prolonged overshoot and upwards shift to inflation expectations.

Subsequently, softer than expected inflation offshore and in Australia, together with dovish comments from central banks, helped take some of the heat out of bond yields through to December. Australian government 10-year bond yields decreased by 52bps over the quarter to 4.0%.

More recent data has shown Australia’s annual inflation pace slowing quite materially from 4.9% in October to 4.3% in November1. While there could be an uptick in Q1 2024 due to base effects and government subsidies rolling off, there was little in the latest data which would give the RBA cause for concern. Goods inflation continued to slow, and services inflation appears to have peaked. While dwelling and rental costs and insurance premiums rose further, dining out and household services eased. Overall, inflation is on track to undershoot the RBA’s forecast for the quarter, decreasing the likelihood of a hike in February.

cpi_forecast

While expectations of further cash rate hikes have diminished, 10-year bond yields remain approximately 40bps higher than a year ago2, putting pressure on debt costs and access to capital. The macro impact of interest rates continues to be the main challenge facing commercial property, despite bottom-up demand drivers remaining relatively resilient. This is being reflected in higher capitalisation rates (effectively the earnings multiple for property), and in turn putting downward pressure on asset valuations.

In further economic data, the labour market remains tight, however there are signs of softer conditions emerging. Unemployment increased to 3.9% in November (latest available data), the highest it has been since May 2022 and slightly above consensus expectations (3.8%)3. Hours worked was flat over the month leading to a higher underemployment rate, job ads declined, and there were more applicants per job – all signs of slowing. Positively, the increase in the unemployment rate has been orderly and driven by strong population growth (i.e. supply), rather than job destruction. In fact, annual jobs growth increased to 3.2%, with 104,000 jobs created over the quarter-to-date (65% being full-time), a positive for office space demand.

Office

There continues to be mixed demand readings between the major CBDs, largely aligned to the different industry compositions of the markets. According to JLL Research, national CBD net absorption totalled -59,000 square metres (sqm) across the quarter, the weakest result since March 2021. The resource-based markets of Brisbane (+9,000 sqm) and Perth (+7,000 sqm) both continued their run of positive demand, recording the strongest results of the quarter. Melbourne CBD recorded the weakest net absorption on a quarterly and annual basis, due to a couple of substantial A-Grade contractions in the Parliament precinct. It was the first quarter since March 2021 where Prime net absorption was weaker than Secondary net absorption.

net_absorp_dec23

The national CBD vacancy rate increased from 14.2% to 14.9% over the quarter, with the result following a similar pattern as net absorption. Brisbane CBD (-0.4%) recorded the biggest improvement in vacancy rate, while Melbourne CBD (+2.0%) deteriorated materially, due to the occupier contractions seen in the Parliament precinct. While headline vacancy remains elevated compared to the historical long-term average, particularly across Prime stock, the majority of CBD assets remain well-occupied (<10% vacancy).

total_vac_dec23

Prime net face rent growth (+0.9%) accelerated slightly compared to the prior quarter (+0.6%), with the Sydney CBD and Canberra the biggest improvers. Prime incentives were relatively stable across every CBD market except Melbourne (+1.0%) and Canberra (+0.3%). This meant that on a net effective basis, Melbourne and Canberra were the only markets where rents headed backwards over the quarter. Adelaide (+2.7%) recorded the strongest net effective rental growth, as Brisbane slowed after two quarters of very strong growth. Adelaide joined Brisbane and Perth as CBD markets where net effective rents are higher today compared to pre-pandemic.

rental_growth_dec23

Transaction volume for the quarter ($1.8 billion nationally) was roughly in line with the quarterly average over the rest of the year but was 66% lower than the Q4 average of the past five years4. The lack of transaction activity reflects the sharp increase in cost of capital seen over the past 18 months, and the gap between bidder and vendor price expectations which is taking time to align. It also reflects a lack of large transactions, with only one asset greater than $250 million changing hands during the quarter. This has been reflected in the total expansion of national CBD prime average yields to 120bps from peak pricing, with further expansion possible given the inherent lags in the valuation process.

Retail

There was a large rebound in retail sales in November (+2.0%), following a slow start to the quarter in October (-0.4%)5. November’s monthly growth was the strongest result since November 2021,when activity was boosted by post-lockdown reopening. It is important to note that Black Friday sales had a large positive impact, with spending surging across household goods, department stores and clothing. A decent portion of this spending was likely ‘brought forward’ from December, so Christmas data (due 30 January 2024) may be weaker.

Consumers remain under pressure, with Westpac’s measure of sentiment up in December but still at very pessimistic levels. While real disposable household incomes should improve in the latter half of 2024, elevated inflation and interest rates are expected to dampen per capita discretionary spending for some time yet.

retail_growth_nov23

Rental growth at large discretionary shopping centres continues to underperform though is positive. Large Format Retail was the top-performing sub-sector over the quarter, with rental growth benefiting from a lack of new supply across 2022 and 2023. This positive supply-demand dynamic saw Large Format vacancy decline over the quarter, while the other retail sub-sectors recorded slight increases.

It was a slow quarter for retail transactions, with volume totalling less than $1 billion. No large assets changed hands, following the sales of Stockland Townsville and Midland Gate Shopping Centre last quarter. As seen across most commercial property sectors, retail capitalisation rates expanded further over the quarter.

Industrial

Australia’s industrial market remains the tightest in the world, with a national vacancy rate of 1.1%6. The city-level figures are book-ended by Melbourne (1.6%) and Sydney (0.5%), while Brisbane saw the biggest increase in vacancy rate (+0.8%) over the second half of 2023. Vacancy has been rising in most offshore markets across the year and the trend has now reached Australia, reflecting ongoing supply and a softening of demand. While vacancy is increasing, it remains well below long-term average levels.

Softening of demand is consistent with a slowing global economy (hence lower trade volumes) and an unwinding of some of the e-commerce gains made through the pandemic years. However, net absorption continues to be positive, particularly in Sydney and Melbourne where newly developed stock is being readily taken up by occupiers whose expansion in prior quarters was constrained by limited availability. While the demand cycle is starting to slowly turn, low vacancy helped generate national super prime net face rental growth of 15% year-on-year as at 4Q23 (preliminary data)6. Prime incentives remain low compared to historical levels at around 10-15%.

Supply delivered in 2023 was elevated at around double long-term levels. Higher levels of supply are earmarked for completion in 2024, however delays due to planning, infrastructure servicing, and construction will likely see some of this development pushed into the following year (as was seen in 2022 and 2023). Ongoing supply will likely put upwards pressure on the vacancy rate, however solid levels of pre-commitment (already almost 50% across the East Coast) limit the risk of a blowout.

While investors remain relatively positive on the industrial outlook, as with other sectors, transaction activity was nevertheless muted. Volume over the course of 2023 was soft compared to recent record highs, but roughly in line with levels seen in the three years prior to the pandemic.

 

Outlook

The global economy is slowing but at a relatively measured pace, engendering optimism that a “soft landing” can be achieved. Australia’s economy is in a similar position, with inflation slowing but employment conditions softening but remaining resilient. Similarly, household consumption has slowed without falling precipitously. Markets are becoming more confident that the rate hiking cycle is at or near its end, which should help ease uncertainty and improve liquidity for property over the coming months.

These factors put the Australian commercial property market in relatively good stead from a demand perspective. While a slowdown is expected over 2024 and early 2025, a more significant contraction (i.e. recession) is looking less likely. Businesses will continue to review their space requirements as they adjust to hybrid working, though the balance between in-office versus remote is expected to shift towards the office over 2024. Location continues to be an important driver of occupier preferences, combined with amenity and building quality (at a given price point).

Capital continues to view Australia as a favourable investment destination given its attractive demographic profile, growth prospects, and relative social and political stability. As uncertainty abates and liquidity improves, transaction activity should increase. The best opportunities will present where sentiment has become dislocated from market fundamentals.

How did the Cromwell Direct Property Fund fare this quarter?

On 27 October 2023, Cromwell announced the termination of the proposed merger between the Cromwell Direct Property Fund (the Fund) and Australian Unity Diversified Property Fund, as a result of deteriorating market conditions.

Given market dynamics for Australian real estate markets, and in particular potential movement in office asset valuations, the Board decided it appropriate to externally revalue the Fund’s assets to identify if any values may have moved materially owing to the nature of the assets and market circumstances. The Fund’s gross asset value experienced an 8.9% decrease. While partially offset by rental growth, this decline is mainly attributed to elevated interest rates and a softer capital market in the second half of 2023, which led to a 72bps expansion of the Fund’s weighted average capitalisation rate, which now stands at 6.87%.

Despite the valuation decline, the Fund’s asset portfolio continues to experience positive leasing activities, particularly in Brisbane. The Fund has improved occupancy (on a look-through basis) to 96.4% as of December 31, 2023.

Effective 14 November 2023, the Fund temporarily suspended new applications and ceased to offer the Distribution Reinvestment Plan (DRP). These measures will be in effect until the valuation process concludes and the audited financials for the half-year ending 31 December 2023, are released. It is anticipated that applications and DRP will be reinstated in early 2024 as this process completes.

During the quarter, the Fund implemented new hedging which lifted the hedge ratio to 51.7% against drawn balance, and produced a weighted average hedge term of 1.85 years as at 31 December 2023.

Cromwell remains committed to unlocking property value through proactive asset management, aiming to navigate the cyclical downturns in the commercial property market.

Read more about the Cromwell Direct Property Fund: www.cromwell.com/dpf.

Past performance is not a reliable indicator of future performance.

Cromwell Funds Management Limited ACN 114 782 777 is the responsible entity of and issuer of units in the Cromwell Direct Property Fund ARSN 165 011 905.

Before making an investment decision in relation to the Fund it is important that you read and consider the Product Disclosure Statement and Target Market Determination available from www.cromwell.com/dpf, by calling 1300 268 078 or emailing invest@cromwell.com.au.

 

  1. Monthly Consumer Price Index Indicator, November 2023 (ABS, Jan-24)
  2. Capital Market Yields – Government Bonds (RBA, Jan-24)
  3. Labour Force, Australia, November 2023 (ABS, Dec-23)
  4. Real Capital Analytics, Jan-24
  5. Retail Trade, Australia, November 2023 (ABS, Jan-24)
  6. Australia’s Industrial and Logistics Vacancy Second Half 2023 (2H23), CBRE (Dec-23)
About Cromwell Direct Property Fund

Read more about Cromwell Direct Property Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS and TMD in deciding whether to acquire, or to continue to hold units in the Fund.

Learn more