27 January 2011 – Sustainability has finally made it as one of the big six trends for 2011 and will become a key divider between the “haves” and the “have nots” in the commercial market, according to leading researcher Kevin Stanley of CB Richard Ellis.

Mr Stanley, executive director, global research and consulting for CBRE  has named sustainability fourth on his list of the six big trends for 2011.  “Sustainability will have a bigger impact from now on,” he said.

“Sustainability may have struggled for priority during the global financial crisis and post the failed Copenhagen negotiations but as this new property cycle picks up it will grow in importance, becoming a central and permanent feature of the industry.

“The next round of commercial developments now being designed and approved will all feature high on the well-developed sustainability ratings scale.”

And Mr Stanley includes in his forecasts advice for developers to start planning new projects now, given the two to three year turnaround for construction.

Another big driver, of course, is mandatory disclosure. “The recently-introduced disclosure system is fast elevating the issue of sustainability to a new level of transparency.  It will accelerate obsolescence in a stronger property market, splitting it between the have and the have-nots and those buildings which can make the grade and those which can’t.”

The six big trends forecast are:

  • Rents will start to rise
  • Yields will start to compress
  • Mining will start to drive property again
  • Sustainability is here for good this time
  • Development comes back to life
  • Niche property sectors are back.

Overview
The improvement in property markets post GFC has been very gradual.  It will continue to take time for the cycle to unfold, for debt-ridden properties to be sold at a new pricing level and for business expansion to proceed at a pace sufficient to make a difference to property indicators such as vacancy and rents. Investors are also expected to be slower to return in enough numbers to give pricing a more positive direction.

But 2011 would be a better year than 2010, just as last year was better than 2009.  To go back, first we must move forward and the cycle is moving slowly – that will be its nature.
It will be held back by fragile confidence, uncertainty and a high cost of debt.

Still, we should be thankful we’re in the Pacific Region, linked increasingly to Asia, for the recovery is set to move at a slower pace in the USA and Europe.

Other feature of this cycle is that it’s all mixed up. That’s what makes it interesting.  It’s not easy and sometimes downright misleading to use generalisations to describe the position of different sectors, markets and their forecasts.

Nonetheless, we think stronger trends and issues will emerge in 2011, some cyclical, some structural.  We’ve pulled out six we think will be the defining issues and trends of the year ahead.

Highlights from the five other top trends forecasts by Mr Stanley follow.

Office rent rises begin
Tenants might not want to hear it, but owners have been waiting over two years for rents to rise. We think the process has already begun. In the third quarter of 2010, leasing incentives started to move down in the Melbourne CBD office market.  We think this represents the first step in the recovery process which will grow in strength in 2011 and spread to Adelaide and Sydney, before reaching Brisbane and Perth a year or so later.

Office rents will rise in response to relatively low vacancy in Melbourne, Sydney and Adelaide, which will start to fall this year as business continues to expand.  This will lead to improved income returns in the office sector and push it to the top of the total return rankings for the year ahead.

But the retail sector may not be so lucky.  The sector remains challenged by low growth in turnover, selective purchasing and a rush to internet shopping from overseas, thanks to the high dollar.  Although confidence will eventually return for shoppers, certain interest rates would need to have stopped rising and the dollar to have eased to discourage e-retailing.

We don’t expect to see stronger upward pressure on rents until the second half of the year and even then, it will be too late to post a strong growth rate for 2011. Yields were also less likely to compress significantly for the larger centres in 2011. Although yields for smaller centres, sub-regional and below could start to compress this year on the back of increased trading, as a sector overall there was unlikely to be any significant change in total returns in 2011 from retail.

The sector is recovering quickly, again driven by the bigger markets of Melbourne and Sydney.  This should be enough to see rents stabilise in early 2011 before showing a small rise before the end of the year.

Yields start to compress
It’s hard to imagine now, but sometime in 2011 yields will compress across most sectors and markets, marking the beginning of the new value cycle. We think the outlook will improve sufficiently during 2011 for this to occur and higher levels of bidding from a larger number of onshore investors will encourage it.  It won’t be aggressive yield compression. We forecast between 15 and 30 basis points, depending on the sector and the market.

How can this happen, with the cost of debt rising?  Most sectors, except the larger retail centres, have enough spread to allow for a small level of compression and still remain in positive spread to a high cost of debt.

The use of equity remains high in major deals in any case.  Given the capital raising which has occurred over the past two years it’s likely high levels of equity will continue to be used, especially by REITs’ acquiring real estate in 2011.  Even a small compression in yield will be important in placing upward pressure on values.  The pace of yield compression is likely to accelerate in 2012 as the market outlook and trading activity continues to improve and the cycle gathers more momentum”.

Mining drives property again
Construction and investment in the mining sector is set to increase substantially in 2011 particularly in the oil and gas sector.  It will assist the performance of commercial real estate by increasing the demand especially for office space, particularly in Perth and Brisbane.  We think this demand for more office space, outside pre-leasing requirements is already starting.  It will have the impact of starting to see vacancy fall from relatively high levels in Perth and Brisbane.

The longer this mining cycle continues the more chance it has of spreading its impact to other Australian cities, including the bigger business centres of Melbourne and Sydney as well as the mini resources centre of Adelaide.” The income being generated by the mining sector would also spread to retail property in 2011 through higher consumer spending backed by increased employment, wages and dividends.

Development returns to life
The completion of new commercial property developments is reaching a very low point in the cycle.  The relatively quick-to-approve-and-construct industrial buildings are picking up quickly on the back of rising pre-lease requirements, which are being readily met by eager developers.  We expect to see a higher level of industrial property completions in 2011.

However, both office and retail are reaching a very low point in the cycle.  Given the time-line for approval and construction can be as much as two to three years, 2011 really ought to be the year for developers to be look ahead and getting ready for the next cycle.

The delay in facilitating new development through the GFC means 2011 and 2012 will be very low years of development completions in most markets.  This, in turn, will help tighten vacancy and push up rents.  But growth in the economy inevitably means more commercial property will be required and the time to gear up for this will be 2011.

The property industry is getting better at the timing and nature of development to match the demand for it, but more could still be done to improve product delivery with lessons to be learned from the last development cycle.

Niche property is back
Over the last couple of years, niche property was a dirty term.  Pubs, child care, retirement homes, all have hit the headlines as asset values were written down and properties hit the market.  Yet the underlying demand for most of these property types has never stopped growing. For example, the population continues to age, leading to demand for retirement facilities and birth rates have just reached record highs pointing to a greater need for child care places.

Given the low point in the valuation of these assets and that the demand for most continues to rise, this year would be an excellent time to invest in quality niche assets.

editorial@thefifthestate.com.au