November 28 2023
This is a guest article by independent analyst, Keillen Ndlovu
Arriving In Sydney
I was last in Australia in 2018, before the world economy was effectively rest by the pandemic. Landing at Sydney Kingsford Smith Airport, one of the world’s oldest airports, after an 11.5-hour flight from Johannesburg, and adjusting to the 9-hour time difference, everything looked and felt the same, except the taxi and Uber pick-up points had changed and were not easy to find. Given the phenomenal growth of this economy, I’d have expected more. I guess the reason is that the current airport can’t grow further, and there’s a new one being built in Western Sydney at a cost of $11bn which will open in 2026.
Australia exposure for SA REITs
Australia makes up about 7% of the South Africa listed property index by assets. Notably, that’s bigger than the UK which is at 4%. The exposure is mainly through Growthpoint Properties, via its 64% stake in Growthpoint Australia. Redefine Properties had Australian assets through Cromwell and the Journal Student Accommodation Fund, but it has since sold those interest, as did Emira Property Fund, which sold its stake in Growthpoint Australia. Burstone Group (formerly Investec Property Fund) recently announced an acquisition of Australian industrial assets with Australia’s Phoenix Property Investors. Burstone is doing this through Irongate Australia Fund Management, a joint venture with Irongate Australia, formerly Investec Australia Property Fund and since delisted from the JSE. Irongate and Burstone have a 20% stake in the transaction.
SA Listed Property Index Weighted Geographical Split
Source: SBG Securities July 2023
Many Prime Ministers and strained relations with China
It’s fascinating that Australia has had seven Prime Ministers in the past 10 years, with three of them not lasting even a year in power. Australia has become less exposed than previously to China over this period. According to ANZ Research, Australia’s two-way goods trade with China has fallen from a peak of 36% to 30%. Part of this results from strained political relations from America to Taiwan issues and, further affected by Australia, blocking the 5G roll out by Huawei, a Chinese Telecoms giant. China, in turn, slapped embargoes on some Australian products.
GDP, Interest rates, and inflation
The Australian Bureau of Statistics (ABS) states GDP rose 3.4% in 2022-23 as of June 2023. In fact, Australia has the highest GDP and population growth rate forecast compared to major developed countries like the US, UK, Canada, Germany, and France. The Reserve Bank of Australia (RBA) recently raised the cash rate (interest rates) by 25 basis points to 4.35%. Most analysts expect the next meeting on the December 5 to be the peak at 4.6%. According to the Australian Financial Review (AFR), Australia’s policy rate is well below peers like the US benchmark midpoint at 5.37% and the UK at 5.25%. ANZ Research reports that although there has been a sharp decline in excess payment on mortgages, many of those in debt have savings to fall back on. The latest numbers from ABS show that inflation is at 5.4%. The RBA target is 2% to 3%. The target seems unlikely to be achieved until 2025.
Employment and mining
Here’s one of the interesting statistics. There are 14.15 million people employed in Australia. The mining industry has only about 200,000 employees, yet mining makes up about 15% of its GDP. Unemployment is at 3.6% as of September 2023, according to ABS.
Growing population led by immigration, including students
The population grew 2.2% to 26.5m over the past year to March 2023 according to the latest Australian Bureau of Statistics (ABS) figures, with net overseas migration accounting for 81% of the growth. Students comprise 49% of the net overseas migration figure, followed by permanent migration at 21% and visitors at 19%.
The AFR recently reported that the annual migrant population had hit over half a million so far this year versus the targets set at 315,000. So, the full-year number is likely to be well above this. This will push up rents further. There are more than 1-million people on a student visa, temporary graduate visa, or former students on a COVID visa, according to immigration expert, Abul Rizvi.
According to data by JLL Research, the population is likely to grow by 2,1-million people between 2023 and 2026. CBRE data shows that the population will increase by 14% by 2030, and Cushman and Wakefield forecasts 3.35 million additional people by 2032.
House prices keep going up
According to ABS, the mean price of residential dwellings is $912,700 (R11,3m). Data from Domain Group shows that house prices were up 5.1% year on year to September 2023, and the quarterly change saw a deceleration to 1.9%. Prices for units were up 2.7% annually and 1.8% quarterly. House prices have almost recovered from the downturn, possibly reaching record-high levels by the end of the year. The growth could be limited by new supply, higher rates, and lower affordability as buyers struggle with unavoidable costs such as school fees and health insurance. To build costs almost 30% more than the current values. This constrains supply, and it is near decade lows and 40% below 2017, according to CBRE research. It costs about 30% to rent versus own in this environment. The CBRE Apartment Rent and Vacancy Outlook shows that rents now exceed $600 per week for two-bedroom apartments in major precincts. Net yields on apartments are 3% to 4%. Lower interest rates will further support capital growth as supply will be insufficient to keep up with demand. The residential sector has less than 2% vacancies, and that’s predicted to fall to less than 1% in the next few years.
The industrial sector has the lowest vacancies globally
According to CBRE, the industrial sector is experiencing record low vacancies of 0.6%, with rents growing at double-digit levels, although starting to moderate. Cushman and Wakefield’s research shows that 90% of 2023’s new industrial developments have been taken up, and over 50% of the industrial developments coming up in 2024 have been pre-committed, i.e., tenants have signed up for the space.
The retail sector has held up despite COVID
The retail sector has done well despite COVID-19, higher interest rates, and mortgage payments. Retail sales are almost 30% above pre-Covid levels. The supply of new retail space is limited, and higher construction costs make it even more of a challenge for developers. Online shopping makes up about 13% of retail sales. Luxury retail is trading very well, and demand is good from high-end retailers, with more brands expected to set up shop. It’s almost like the rich are getting richer, and the poor are getting poorer, according to Knight Frank. The national vacancy rates have fallen to 6.2%, the lowest since 2009, according to JLL. Large shopping centres are performing best, with vacancies below 2.5%, whereas CBD retail has around 14% vacancies.
Offices remain the unloved sector
The office market remains the least loved sector. CBD office vacancies are 12.8% on average, with Sydney at 11.5% and Melbourne at 15%, according to Property Council of Australia. Practically, and given the regulations, only about 2% of vacant office space can be converted to residential space.
The lease incentives in the office space are much higher to attract tenants. They stand at about 25% of the total value of the lease and can be as high as 35%. In comparison, the industrial market is lower at about 10%.
Sub-leasing is a concern as corporates are reducing space due to working from home/hybrid working, consolidation, excess space, and cost reduction due to rising interest rates.
The banking sector contributes the highest amount of sub-leased space in the CBD, with 33% of the total, according to CBRE. JLL estimates that almost 3% of the office space in Sydney is being subleased.
The shift back to the office is taking longer, but it’s better than last year. Landlords and companies are coming up with amenities and attractive workplaces to lure workers back to offices, such as kitchens, gyms, yoga classes, dry cleaning, wellness facilities, bicycle rack facilities, dryer rooms, shower areas, lots of lockers, breakout areas and quiet rooms.
Environmental targets are a priority
Green buildings have become a requirement and are measured using the National Australia Built Environment Rating System (NABERS). NABERS provides a rating from 1 to 6 stars for energy efficiency. The higher the rating, the better the ability to achieve higher rents. Growthpoint Properties Australia has a rating of 5.2 stars, for example, and targets net zero emissions by 2025. This target is in line with almost three-quarters of landlords in Australia.
Growthpoint Australia and listed property sector valuations
We visited assets owned by Growthpoint Properties Australia (GOZ) in Sydney, Melbourne, and Adelaide. GOZ has a $4.8bn portfolio split into 65% offices and 35% industrial assets. The government considered an A-grade tenant, accounts for 40% of office space with leases averaging 10 years.
As at June 2023, the vacancies were 7%, and are higher than the Australian REITs (A-REIT) average. The weighted average lease expiry is 6 years, and 71% of the debt is hedged for an average of 3.4 years. Gearing is at 37%, higher than the sector at about 30%. GOZ owns a 15.5% stake in Dexus Industria REIT.
Like their Growthpoint Properties, GOZ ventured into the funds management business called Fortius which they acquired in 2022. Like in South Africa, the market is anxious to see how this will grow and what returns it will bring to GOZ. GOZ had distribution payout ratio of 79% of FFO, in line with the 75% to 85% target. The distribution guidance of 19.3 cps for FY24 vs. 21.4 cps delivered in FY23 represents a 9.8% decline. The FFO guidance of 22.5 cps to 23.1 cps for FY24 vs 26.8 cps achieved for FY23 represents a 16% to 13.8% decline respectively. This is one of the lowest earnings guidance in the sector. Assuming 22,5 cps FFO, the payout ratio will jump from 79% to 85% perhaps to cushion investors from the big decline in FFO.
The Net Tangible Asset Value (NTA) is 400 cps , and the share price is 227 cps (November 24 2023). That’s a discount of 43% to NTA largely due to its big office exposure. The forward yield is over 8% and it’s higher than the Australian 10-year bond yield at about 4.5%.
Citi Research points out that the A-REITs are trading at a discount to NTA of about 25% after the recent rally and is offering a forward yield of about 6%.
Flying back to Johannesburg
The flight from Sydney to Johannesburg was much longer. This is due to the high-altitude wind that blows from west to east. The flight was 14 hours long (2.5 hours longer than from Johannesburg to Sydney). It was direct and during the day and had no Wi-Fi. This means that I was disconnected from the rest of the world. I took the time to think about how long the Australian house prices will keep increasing. When interest rates decrease, will house prices rise even faster? How will the government cope with high population growth, housing shortages, and rising rents? Yes, it’s a big boost for the economy and consumer spending, retail, office, and industrial sectors, but where will the new people be housed? Will wages keep up with rising rents? What happens to inflation? Will students keep going to study in Australia, or will people looking to move to Australia eventually start elsewhere as housing becomes less affordable? Could the government limit the foreign student numbers at some point, and how will the economy handle this given education is such a big export for Australia? In the meantime, this model is working for Australia and seems to have some years to go.
Keillen Ndlovu is an independent property analyst. He was recently on a self-funded analyst visit to Australia with Growthpoint Australia. All reference to dollars ($) are to Australian dollars.
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