Capital raising capacity

Singapore’s capital raising capacity is well established with more than US$1 trillion raised through debt and equity issues in the decade through to 2015. According to the Singapore Exchange (SGX), listed companies raised 50% more funds through the secondary market than at initial public offering stage.

While the SGX had a market capitalisation of around US$640 billion at the end of 2016, just over half of Australia’s US$1.21 trillion, Singapore had a substantially greater proportion of foreign listings, with overseas companies making up around 37% compared to just 6% in Australia.

Singapore’s bourse states it is “the world’s most liquid offshore market for the benchmark equity indices of China, India, Japan and ASEAN…Headquartered in AAA-rated Singapore, SGX is globally recognised for its risk management and clearing capabilities.”

Location equals connectivity

The Singapore Economic Development Board (EDB) also points to the nation’s status as a global transportation hub, with the world’s busiest container ports and airport linkages to 330 cities in 80 countries, along with the most extensive network of free trade agreements in Asia.

A nation of just 5.6 million, Singapore is taking advantage of its central location and building on its potential, with initiatives such as ‘Smart Nation’ seeking to foster technological improvements across a range of areas, from business productivity to health, transport and the environment.

“As an open economy, Singapore is impacted by global forces – geopolitical tensions, potential threat of anti-globalisation, and technology disruptions across many industries…But Singapore has strengths and achievements that place the country in a good position to succeed,” the government’s ‘Smart Nation’ initiative states.

For a republic founded a little over 50 years ago, Singapore today is well on its way to becoming a global financial powerhouse and one of the world’s premier investment and wealth management destinations.

Office property markets

Cyclical factors will have a greater influence on prices in office property markets than that of rising interest rates on yields. The key is to invest in strong leasing markets with prospects for strong rental growth.

Sydney remains the pick of the markets. Demand has been improving moderately but with development virtually stopped and stock availability declining due to the Metro rail project and increased residential conversions, falling vacancy rates have meant strong rises in effective rents as leasing incentives reduce.

Vacancy rates are forecast to be less than 5% for the next three years, driving further rises in net effective rents and property prices. However, strong capital growth over the last year has reduced prospective returns. There are still opportunities for investment, and this is the phase where repositioning, major refurbishment or new developments can generate returns, but each opportunity needs to be examined on its own merits.

Last year, demand for office space was moderate in Melbourne. But, unlike Sydney, there has been plenty of development to satisfy requirements. In the short term, Melbourne will be hit by a weakening of demand as it absorbs the loss of the remaining car manufacturers and many associated suppliers, as well as a slowdown in residential construction.

Once that shock is absorbed, however, Melbourne will recover. It still retains many of the advantages—notably cheap land for residential, commercial and industrial property—which gave it a competitive advantage over Sydney in the provision of back-office services for national operations. Melbourne office demand will grow slightly more strongly than Sydney in the next decade but rent and property value growth will be inhibited by the plentiful availability of sites.

The Brisbane economy is still suffering from the continuing loss of demand from mining services. In the boom, 25% of Brisbane’s office space was occupied by companies servicing mining. Demand will be hit further when the inner Brisbane apartment market turns down.

Medium term, the prospects are good as Brisbane will benefit from strengthening activity in tourism, education services and agriculture. The short term will be difficult due to the existing oversupply of office space with little prospect of a substantial improvement in demand to absorb it. The vacancy rate is currently above 15% and will still be above 10% at the end of the decade.

The Perth economy is collapsing under the weight of the end of the mining boom. Investment has further to fall and the economy will stay weak for some time. During the boom, half of Perth office space was occupied by companies servicing mining. Much of that demand is now gone and the vacancies will take a decade to absorb. Rents and property values will fall a lot further.

Adelaide is suffering from weak demand and oversupplied office space. Although the worst may be over in terms of demand-side weakness, there is no prospect of sustained growth for a couple of years as the local economy deals with the closure of the GM Holden plant. The patrol boats, frigates and submarines projects will help but not until the end of the decade.

Canberra remains a difficult market. We are coming to the end of the period of substantial oversupply and A grade vacancies have tightened everywhere except at the airport, where there is still plenty of space. However, new construction is about to get under way in Civic, while some secondary properties lie vacant and are difficult to lease.

Industrial property markets

The years of strong investment returns from industrial property are coming to an end, with the period of falling interest rates that had underwritten firming yields and strongly rising asset values now over.

Softer future yields will have a negative impact on valuations and also on construction feasibility, requiring higher pre-lease effective rents to underwrite the financial feasibility of development projects. The transition to higher rents will be relatively smooth, though the risk is that it may take a year or longer. If this occurs, falling vacancies would eventually deliver the necessary step-up in rents.

Industrial property development is running close to demand. Ready availability of land and development competition is keeping a lid on residual land prices, rents and property values, suppressing a cyclical upswing. That makes it less risky but slightly overvalued in relation to market hurdle rates.

Property markets update:

Office markets

The Sydney office market has gone from strength to strength, with tightening leasing markets driving effective rents, firming yields and further property price growth. With strong business growth forecast to come, we believe that the Sydney office market has further to run, and even at substantially higher prices, on a five-year horizon Sydney commercial property is (broadly speaking) undervalued in relation to forecast expected returns. These conditions point to the possibility of a 1980s-style boom.

The strength of the Victorian and Melbourne economies has resulted in upgraded growth forecasts, with a flow-on to the office market. The loss of the motor vehicle industry and parts of the power industry have had an impact, but the economy and employment have been good over the last year, suggesting continued strong, albeit lower (than Sydney), growth in Melbourne.

For 20 years, Melbourne has had a comparative advantage over Sydney. Readily available and cheap land for residential, industrial and office developments has contained rents and property values, making it a more cost-effective place to situate back-office functions for national operations. That will continue to boost the demand for office space and we have increased our forecasts of demand, rent and price growth in the Melbourne market.

Development phase

The Sydney and Melbourne office markets are entering a substantial development phase which will change the logic of office investment. Over the next ten years, 3.3 million square metres (sqm) of office space in Sydney and 2.3 million sqm in Melbourne will be built. Given that some of these developments will be refurbishments, net additions will be circa 2.4 million sqm in Sydney and 1.5 million sqm in Melbourne.

This development phase and net additions of this quantum will eventually have an impact, and five year forecast returns are much stronger than ten-year forecast returns for both Sydney and Melbourne. Repositioning and exit strategies will be needed to manage this cycle.

Canberra, Brisbane, Perth and Adelaide Office

The Canberra office market should see strong prospective returns over both short and long terms. Canberra’s oversupply is easing, particularly for better quality space in Civic. However, the risk to be considered is that Canberra remains a dominant tenant, two-tiered market.

Despite strong recent sales, it is early for countercyclical investment in the Brisbane, Perth or Adelaide office markets. They face a period of weakness before they absorb the excess stock created during the boom.

Other asset classes

Amongst other property classes, weak retail sales growth and the impending arrival of Amazon have heightened emerging concerns about the strength of retailers and centre returns for retail property. The property risks are heightened for weaker centres, but returns to strong centres should remain solid.

The world economy is still recovering from the effects of the global financial crisis

The GFC didn’t come out of the blue. It followed a ‘financial engineering’ boom which drove significant global over-investment. All being well it was always going to take a decade to absorb the excess capacity created during that investment boom. This has dominated world economic outcomes since.

Weak world growth and fears of financial after-shocks drove central banks to print money and lower interest rates. As many central banks have discovered the hard way, cheap money doesn’t necessarily stimulate investment where it makes no sense to do so.

Nevertheless, broadly speaking the world economy is tentatively on a path to slow and gradual recovery.

• The US is growing again, with low unemployment. Fiscal policy initiatives and/or lower corporate tax rates from the new Trump administration will help further.
• Europe is on a more difficult path with different national economies growing at different speeds.
• The UK recovery, post-GFC, was aided by the low pound. Now, with uncertainty surrounding the implementation of Brexit, further falls in the pound will help cushion any additional negative shocks.
• And then there’s always the fear that China’s growth will unwind.

Though these are all serious issues they will have relatively minor impacts on Australian outcomes. Australia’s current problems are primarily domestic.

The start of a long phase of rising interest rates

Global growth, even tentative growth, brings back to the table the prospect of a long phase of rising interest rates. That comes after a long phase of falling interest rates, which has left interest rates worldwide at unsustainably low levels.

The US Federal Reserve is leading the world into the phase of rising interest rates. The Fed’s second interest rate rise last December has confirmed the process. What we don’t know is how quickly rates will rise and by how much. The consensus is that they will rise slowly but each rise will have a disproportionate impact given the low starting point.

In Australia, given the buffer between Australian and US rates, the RBA will keep cash rates low while the economy remains in transition, at least until US rates rise to Australian levels. The impact on bond rates however is more immediate. With little margin between Australian and US rates, we expect Australian bond rates to track US movements. This has already begun.

Important source of diversification for real estate investors

In the current low-yield environment, pension funds and insurance companies are looking to diversify into commercial real estate as a way of accessing reliable, long-term liability-matching returns that used to be provided by the gilt of corporate bond markets.

While most of these institutions have invested in real estate for many years, most likely as part of a traditional core strategy, the level of sophistication in today’s real estate industry means that by moving up the risk curve to core-plus and value-add strategies, these investors are now able to access much higher yielding opportunities.

We estimate that a typical core strategy in Europe should be able to provide in excess of 8% total returns while a value-add strategy will generate between 12% and 14%.

For these investors, Europe is an attractive opportunity not only because of its size, but also because of its structure. As well as being the second largest commercial property market in the world, it is also one of the most heterogeneous, providing investors with access to a collection of idiosyncratic markets, each with its own unique profile of cities, buildings and tenants.

There are currently some really good opportunities in selected European markets to turn good quality assets into core real estate that will generate reliable income and some capital return. For example, we have identified some reposition to core opportunities for shopping centres in parts of the Netherlands and France. In Germany, the spread between prime and secondary office CBD yields is at a long-term high.

Most people who have worked in the industry or have had property exposure for long enough have lived through the highs and lows of various economic and political cycles, and experienced the effects, both positive and negative, on their real estate investments. The political events unravelling in Europe and elsewhere today are no different. The one truism to remember is that life goes on, and property markets endure!