_Canberra EOFY commercial market update

As we headed into the start of FY19/20, office transaction volumes (10m+) for the year to date (July 2019) were nearly on par with the previous full year in 2018, running just above $338 million. These results followed a formidable record year in 2017, where office transaction volumes almost topped $800 million on the back of large sales occurring. This was underscored with 50 Marcus Clarke setting a record price at $321 million.

In contrast, some investors focused on opportunistic value-add purchasing of assets that required either new leasing strategies or market repositioning. This value-add focus was buoyed by the Canberra office vacancy rate tightening to a six-year low at 11%, coupled with modest gross effective rental growth.

The healthy demand for both fully leased properties and value-add opportunities resulted in ongoing downward pressure on returns with average prime market yields falling below 6% and average secondary yields reflecting around 6.75%. We note that demand levels appeared to exceed supply given the comparatively low number of on-market campaigns and frequent off-market approaches, which in some instances resulted in deals being reached. The level of enquiry in the market from offshore and institutional groups suggested pent up demand.

Investment grade metropolitan assests were well sought after by both local and interstate investors during FY19/20. A recent ACT Government initiative to abolish Stamp Duty from 1 July 2018 for commercial properties transacting below $1.5 million created a heightened level of competition in this category, albeit with some negative pricing outcomes for properties priced slightly above the concession threshold.

The office market continued to perform well throughout the rest of 2019 with transaction volumes (10m+) reaching $473 million, which was more than double the 2018 total and 80% above the 10-year average ($407 million). Institutional buyers during 2019 included Centuria, Elanor Investor Group and Charter Hall. Average office yields continued to tighten in 2019 with prime average yields sharpening to 5.90% and average secondary yields reflecting 6.69%.

Recent market activity was highlighted with a new ACT yield record being set with the trading of the Nishi development at $255.75 million. This showed a passing yield of 5.31% and core market yield of 5.10%. Anecdotally, the wider investment market is now pricing modern office assets in core locations with WALEs exceeding 10-15 years below 5%. These assets are tightly held and rarely (if ever) trade in the open market.

Investment grade metropolitan assets continued to be well sought after prior to the emergence of COVID-19. Assets in the Canberra market were seen by interstate investors as providing good value for money, with investment yields showing higher returns compared with similar assets in higher profile markets. This premium in returns is generally around 50 bps to 100 bps higher. Investors continued to be highly motivated by lease covenants, WALE, age of improvements and potential future alternate uses.

A portfolio of 7-Eleven service stations, including five in the Canberra market, were competitively sough after in February 2020, going under the hammer for prices ranging between $2.775 million and $5.805 million. These properties were sold with 12-year leasebacks reflecting yields from 4.99% to 5.50%. A prior 7-Eleven service station portfolio auction in October 2019 included a high-profile asset on the fringe of the Canberra CBD in Braddon selling for $7.1 million, reflecting a passing yield of 4.11% with a 12-year leaseback.

Pre COVID-19, the development market in the ACT continued to be strong and robust for both commercial and residential. As land release is primarily controlled by the ACT Government via its Indicate Land Release Program, this somewhat moderates supply volumes in the market. Multi-unit residential development sites have continued to trade with recent land releases being less competitive.

With over 60,000 sqm of office space recently completed or under construction over five key developments throughout the ACT, the market is now absorbing new supply of office stock in 2020 and 2021. Recording in excess of 80% in pre-commitment leasing, these developments are set to include a mixture of Government and private tenants. Market sources indicate that these developments will set new records with gross face rents in excess of $600 per sqm in some instances.

High density residential development continues to grow with a consistent increase from 2015 of just below 1,000 units being constructed in developments four levels or above to 2,000 units in 2019. In 2020, the anticipated number of high-density units was expected to exceed 3,500 however through delays this has been revised to 2,300 units. The highest concentration of high-density residential units developed in 2019 are located in the Inner North (49%) followed by the City (27%).

Since the onset of COVID-19, office transactions have been well and truly down on the previous year’s performance. The lack of transactional activity is primarily due to extremely low inventory levels for both passive and value-add investors. There have been limited on-market campaigns this year and minimal off-market deals eventuating.

Notwithstanding the lack of transactions, institutional and private investor enquiry remains moderately strong. Secure Commonwealth Government assets have received considerable attention since COVID-19 impacted the market, and more particularly the prevalence of rental concessions for some private sector tenants. This enquiry has for the most part remained fruitless with existing owners preferring to hold at this time.

Value-add opportunities have also been scarce in the market. We understand that numerous groups have searched the market far and wide for suitable assets. These investors are typically seeking assets with high vacancy that are in core locations with reasonable tenant depth.

The closure of interstate borders and rental concessions is having a pronounced impact on the metropolitan investment market. However, assets with excellent fundamentals remain in high demand with pricing relatively unchanged. Conversely, properties with cashflow concessions and pending lease expiries are being priced accordingly.

The lack of inventory is driving sentiment in the core office market. Existing owners with Commonwealth and ACT Government tenants, especially those on long-term remaining lease agreements, generally believe the value of their assets have continued to strengthen throughout the existing COVID-19 market. This is primarily due to the comparatively low cost of capital and the perceived strength in rental returns derived from Government tenants. This sentiment is mirrored by the enquiry levels from both offshore and institutional groups.

Conversely, the sentiment for assets occupied by private sector tenants has deteriorated with cashflow concerns being the primary driver. Whilst there have been limited transactions to analyse this sentiment, there is a likelihood that a yield gap is widening between Government and private sector tenanted assets.

In step with the core office market, there have been comparatively low volumes of metropolitan investment campaigns with limited vendors willing to list their property in the current market. Investors are less willing to purchase secondary investment grade assets with the impact on pricing due to COVID-19 difficult to determine.

Investors with available capital are seeking assets with good fundamentals. The most desirable attributes vary from passive investments to value-add opportunities. Common to both investor profiles is the desire for core locations.

Vendors with core assets are eager to retain the cashflow from the existing leasing arrangements. The difficulty in trading core assets in the current market is finding new opportunities to deploy the funds to generate a reasonable alternative return.

Assets with rental concessions currently being provided are more difficult to strategically plan for divestment. The inherent reduced income has an immediate impact on the rental return of the asset, which is further compounded by the yield an investor is willing to pay for it. These assets therefore do not meet the traditional criteria for value-add opportunities, nor is the income currently strong enough to entice investors. Vendors with these properties are more likely to hold during COVID-19.

Throughout this period, we have shifted our focus to understanding individual client expectations to enhance their position in the market. This focus has involved more detailed investigations into each set of scenarios. Overall, we are providing more anecdotical commentary and strategic advice than ever before.

Looking ahead to the next 12-24 months, we expect Canberra to remain an attractive investment alternative for both offshore, institutional groups and private investors. This is because the Canberra economy is heavily reliant on the Commonwealth Government and Public Service, which in turn generally makes the local property market counter cyclical to more traditional property markets in Australia.

If you would like to discuss the Canberra commercial market in more detail, please get in touch with Sean or Joseph. You can read our full Capital Markets Year In Review here or watch the Investment Sales EOFY wrap here.