MIRVAC GROUP economic and direct property market...

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MIRVAC GROUPeconomic and direct property market outlook quarter 2 2008

2008UPdAte

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1 WhAt’s neW And WhAt’s ChAnGed sInCe the PReVIOUs RePORt? 2 MARket hIGhlIGhts 6 1.0 eCOnOMIC OVeRVIeW 8 2.0 OffICe MARkets 11 3.0 RetAIl MARkets 15 4.0 IndUstRIAl MARkets 18 5.0 hOtel And tOURIsM MARkets 20 6.0 ResIdentIAl MARkets 24 7.0 MIRVAC InVestMent IndICAtOR ClOCks

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WHat’S neW and WHat’S cHanGed Since tHe preViouS report

Globaleconomicoutlook

> Global growth forecasts have been progressively downgraded since q4 2007.

> the imF currently forecasts that the global economy will grow by 3.8 percent in 2008 and 2009, around 1.25 percent lower than in 2007.

> the european growth outlook is deteriorating. a uS recession (albeit “mild” as described by the imF) looks increasingly likely during 2008, but so far asian economies have remained relatively insulated.

> reflecting the continued strong growth prospects for china and other asian economies, mineral and energy prices remain high. as a result, growth remains strong in the middle east and in other commodity-producing regions.

theaustralianeconomy

> Growth forecasts for 2008 have been pulled back to around 3.1 percent according to the australian Financial review quarterly survey of private sector economists. inflation is forecast to rise to 3.7 percent in the year to June 2008 and remain above 3.0 percent through to mid-2009.

> Wages remain contained across the economy, although the construction sector recorded wages growth of 4.7 percent through 2007.

> australia’s terms of trade are around 50-year highs and are widely expected to rise further as agricultural prices rise.

> the continuing strength of commodity markets puts further pressure on Victoria and new South Wales to attract investment and retain labour in competition with the high growth states of queensland and Victoria.

thefinancialenvironment

> the official cash rate was raised by 50bp during q1 2008 and now stands at 7.25 percent. this is widely expected to be the cyclical peak, even though headline inflation is forecast to breach the 3 percent upper target limit over the next few quarters.

> credit spreads widened dramatically during q1 2008, with some retracing evident towards the end of march 2008, in line with trends in the uS and uk financial markets. despite energetic action by central banks, wholesale inter-bank markets continue to suffer from illiquidity and sparse pricing information.

> re-intermediation is putting pressure on banks’ balance sheets and forcing them to limit lending activities.

> the steady rise in the cost of capital will flow through to all sectors of the economy, not only real estate.

realestatemarkets

> So far, non-residential real estate values show little sensitivity to the new financial conditions. investment returns (income plus capital growth) were 18.1 percent in the year to december 2007 according to the pca/ipd performance index. We continue to expect capitalisation rates on secondary grade assets to rise, but evidence to support this is limited so far.

> construction activity in residential markets remains close to a cyclical low of around 150,000 dwellings pa. With underlying demand estimated at around 180,000 dwellings pa the accommodation shortfall is growing steadily and is now reflected in sharply rising rents. as a result rents and investment yields on apartments are rising, foreshadowing a return of investors to the housing market.

economic and direct property market outlook q2 20082

market HiGHliGHtS

> Global growth is forecast to slow from 4.8 percent in 2007 to 3.8 percent in 2008 largely due to a weaker performance by the uS economy 1.

> the uS economy is likely to record at least one quarter of contraction during 2008 under the impact of high energy prices and a slump in dwelling construction. europe is also experiencing a slowdown. However, growth in asia and other energy and commodity producing countries will continue to underwrite global trade and commodity prices, with positive implications for the australian economy.

> the australian economy is forecast to grow at 3.1 percent in 2008. Business investment, non-residential construction, rising export volumes and a modest recovery in dwelling construction will be major contributors.

> the global credit shock initiated by rising delinquencies in the uS residential subprime mortgage market will continue to reverberate through 2008. the impact is now global and the impact of the rising cost of debt is not confined to the real estate sector.

> during q1 2008 credit spreads widened sharply, sharemarket volatility has spiked and liquidity drained from inter-bank debt markets. From late march 2008, however, signs have emerged of a return to normality. credit spreads have narrowed slightly and sharemarket volatility has moderated.

> liquidity remains a problem for the banking system despite energetic efforts by central banks to pump prime credit markets.

> rising interest rates, wider credit spreads and the end of capitalisation rate compression all signal a harsher investment environment. So far, evidence of capitalisation rate decompression is absent from the australian non-residential real estate market.

> High quality assets, supported by (i) low levels of debt, (ii) stable cash flow and (iii) experienced management will continue to command market support.

> investors and lenders can look forward to higher investment yields, offset by lower capital growth. lenders will recover interest margins as aggressive competitors exit the industry. debt providers will require a greater level of pre-commitment before approving projects, thus constraining supply.

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fInAnCIAl MARkets

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the eCOnOMy

Asset VAlUes And PROPeRty RetURns

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> the S&p/aSX 200 a-reit index fell 14.6 percent through q1 2008. at the end of q1 2007 the sector was trading at a 17.7 percent premium to nta, a 15.3 percent discount to net asset Value (naV) and a 2008 distribution yield of 7.2 percent 2.

> the decline in unit values reflects a sharp re-assessment in the value attributed to trust assets in offshore markets such as the uS and uk, a discount for entities with high levels of debt and a re-rating of corporate activities such as development and funds management.

> Sustainability of earnings, lease and debt expiry profiles and quality of assets now attract attention from analysts and investors. on many indicators, such as yield premium to real bond yields and premium to discounted value the overall a-reit sector is in “buy” territory.

> the chronic under-supply of accommodation shows no signs of abating. indeed, with underlying annual demand of around 180,000 dwellings nationally the housing backlog looks set to get worse. the housing backlog is forecast to rise to more than 200,000 dwellings in 2009 3. Vacancy rates in all capital cities are around all-time lows; rents are rising.

> Housing affordability is low by some indicators but first home buyers remain active in most metropolitan markets. House and apartment prices are therefore likely to continue rising through 2008, even though the steady increase in interest rates over the past three years combined with sharp rises in petrol and some food prices, will limit housing demand in some mortgage-belt markets.

> Houses and apartments in higher price ranges continue to attract strong buyer interest; sharemarket performance and longer term demographic factors account for the strength of this market sector.

> underlying demand for office accommodation remains strong although white collar employment growth has slowed since mid-2007. this probably reflects a shortage of recruits and office space rather than slackening demand.

> nationally, cBd office vacancy rates average 3.9 percent, the lowest level for twenty years. as vacancy falls and rents rise, construction activity has accelerated sharply, although at this stage supply additions do not constitute a threat to rental growth.

> major tenants seek accommodation that meets stringent environmental, security and technical requirements as well as specialised attributes such as large floor plates. therefore the rapid obsolescence of older office buildings is at least partly offsetting the supply impact of new construction. rising obsolescence and an ageing office stock implies the current office construction cycle may extend for several years.

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ResIdentIAl MARkets

lIsted PROPeRty tRUst (A-ReIt) seCtOR

OffICe MARkets

1) imF forecasts 2) uBS investment research estimates 3) anZ Housing Snapshot, april 2008


market HiGHliGHtS

> demand continues to exceed supply, opening the way for a rise in room rates and occupancy.

> international tourism is sensitive to the strong australian dollar, the slowdown in global growth as well as rising fuel costs. Growth in visitor arrivals from asia (india, korea and china) is offsetting a slowdown in traffic from europe, Japan and north america. domestic travel is increasing, with particularly strong growth recorded in some regional markets where the mining boom, the rural recovery and expansion of air travel are stimulating visitor numbers.

> Business travel is likely to slow through 2008/9 as economic conditions tighten. three and four star hotels, as well as serviced apartments, are less exposed to economic downturns as companies move to cut costs.

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RetAIl MARkets

IndUstRIAl MARkets

hOtels And tOURIsM

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> population and wages growth, tax cuts, rising personal wealth and high levels of employment provide a strong platform for retail sector performance. retail spending and credit card use are slowing under the impact of twelve consecutive increases in the official cash rate since 2002. However, retailer profit margins expanded during 2007.

> the decline in consumer and retail spending growth rates represents a return to trend levels rather than a cyclical slowdown.

> competition between shopping centres will intensify as additional space comes on stream and capitalisation rate compression ceases. investors in retail assets will discriminate carefully on the basis of location, management and demographic profiles.

> the major themes of 2007 – logistics, location around transport nodes and proximity to markets – will continue during 2008.

> Strong import growth (10 percent forecast for 2008/9) and infrastructure investment will continue to support demand for industrial space. pressures to cut distribution costs remain intense. High fuel costs, higher interest rates and rising wages are an incentive to invest in large, well located distribution facilities.

> 2007 probably marked the end of the yield compression phase, although developers remain active and continue to seek opportunities to add value, often on sale-and-lease back and construction of purpose-built facilities. rental growth will slow in some markets as additional supply come on stream.

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> the aggressive valuations recorded in non-residential markets in recent years are in the process of being reversed. capitalisation rates are rising. the uk non-residential real estate market has recorded a loss of around 16 percent since the peak in mid-2007 4. the slowdown in the uk economy adds to pressure on industrial and retail real estate values.

> Financial markets are contracting in the aftermath of the uS subprime shock, leading to a reduction in demand for office spaced in the city of london. a reduction of 20,000 financial services jobs over the next two years has been forecast 5.

> residential markets are recording a slowdown in activity and widespread price falls. rental markets remain reasonably buoyant because potential homebuyers prefer not to commit while prices are falling. Fundamentally, however, the uk housing market remains undersupplied, particularly in the london and South-east region, so a recovery seems only a matter of time.

> the key risk is that financial market volatility and a re-pricing of risk will flow through to the real economy and put a serious brake on growth.

> the two key transmission mechanisms are a rise in the cost of capital, which will discourage business investment, and a fall in consumer confidence and wages growth, which will discourage retail spending.

> australia is better placed than many other countries to confront these difficulties because economic growth remains strong. asset values, company balance sheets and lending practices in australia have been relatively conservative; risks are therefore mainly concentrated on secondary grade assets, where capitalisation rate compression has been greatest, and on highly leveraged investments, including construction projects. as the re-pricing process proceeds across non-residential real estate markets investment opportunities will emerge.

> residential markets are recording a slowdown in activity and widespread price falls. rental markets remain reasonably buoyant because potential homebuyers prefer not to commit while prices are falling. Fundamentally, however, the uk housing market remains undersupplied, particularly in the london and South-east region, so a recovery seems only a matter of time.

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> the uS economy is flirting with recession. aggressive reductions in the Fed Funds rate and a 150bp fall in the ten-year treasury rate are providing valuation support to non-residential markets. opportunistic investors are emerging as real estate values fall.

> many residential markets are working through the problems of oversupply, falling house prices and rising mortgage delinquencies. 2008 will be a difficult year for owners and investors in the uS real estate sector.

> real estate debt and equity markets have similarly been adversely affected by the market downturn. Spreads across cmBS and other security markets widened sharply from mid-2007, although recent indications are that the widening phase has now ended.

InteRnAtIOnAl MARkets: UnIted kInGdOM

InteRnAtIOnAl MARkets: UnIted stAtes

RIsks

4) cBre estimate 5) centre for economic and Business research limited


1 economic oVerVieW

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1.1 yields,capitalisationratesandinflation

the headline inflation rate was 4.2 percent in the year to march 2008. the inflation rate is expected to remain above the reserve Bank’s 2 to 3 percent target band through most of 2008. reflecting the higher expected inflation rate as well as tighter monetary policy settings, ten-year bond yields have risen by around 40bp since q3 2007 and are now around 6.10 percent. real (inflation-indexed) bond yields in contrast have declined by 35bp and are now around 2.25 percent. the gap between the a-reit yield and the real bond rate has correspondingly widened to around 540bp which suggests that the listed sector is now “cheap”. capitalisation rates on direct real estate show little movement at this stage. However pressures are building and we expect that cap rates on secondary grade assets will rise over the second half of 2008. prime grade asset cap rates have recorded less compression and are therefore less vulnerable to a re-pricing of risk. in addition, most of these assets are tightly held and values will be further supported by a strong economy delivering continuing rental growth through 2008 and 2009.

1.2 consumptionandretailspendinG

rising interest rates, high petrol prices and the rising cost of rental accommodation are a partial offset to the many positive drivers of consumer and retail spending – rising real wages, high levels of employment, tax cuts and rising house prices in most capital cities. However, consumer confidence has fallen sharply since the end of 2007 and consumer credit growth has slowed. retail turnover growth is likely to moderate to around 5 percent through 2008/9, close to the long-run trend. the broader category of consumer spending, which includes the cost of motor vehicles use as well as services such as health, rent and education, is likely to grow at a faster pace.

1.3 constructionandinvestmentspendinG

With capacity utilisation close to a cyclical high, companies continue to invest heavily, though a high proportion of this spending is attributable to the mining and energy sectors. input prices for the manufacturing sector rose by 11.9 percent in the year to march 2008, providing an added stimulus to invest in productivity improvements. non-residential construction activity, which has risen massively over the past two years, is probably close to a cyclical high, although the pipeline of work-to-be-done shows no sign of declining. residential construction activity is rising from its cyclical trough of mid-2006, but dwelling approvals running at an annual rate of around 167,000 points to a modest upturn. dollars spent on alterations and additions accounted for close to 95 percent of new dwelling construction in q4 2007. typically this level has been associated with a revival in new dwelling construction expenditure – in 1986, 1996 and 2001.

1.4 employmentGrowthandwaGes

Wage increases remain comfortably around the 4 percent level, although growth has been stronger in the construction and mining sectors. employment is at all-time highs and the unemployment rate close to forty-year lows. a record level of skilled migration is helping to reduce cost pressures in the labour market, albeit at the price of increased cost pressures in the rental accommodation market. inter-state migration continues to favour queensland and Western australia, though the number of inter-state migrants is significantly lower than was recorded a few years ago. the rapid rise in house prices and apartment rents in perth and Brisbane probably accounts for the slowdown in inter-state movement. an economic slowdown through 2008 will alleviate, but not eliminate, cost pressures in the labour market.

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2 oFFice marketS

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2 marketdrivers

the downward trend in office market vacancy continued through 2007. office market vacancy reached an 18-year low in January 2008 6. With the exception of Hobart and canberra, total vacancy for all cBd markets fell over the twelve months to January 2008. the largest falls were recorded by the two largest office markets in australia, Sydney cBd and melbourne cBd, down 4.2 and 3.6 percentage points respectively (see table 2.1).

Strong company profits are associated with subsequent business investment and white-collar employment growth. australian companies have been enjoying strong company profits for the past few years, translating into a steady increase in demand for office space. as business budgets and investments rise, new strategies to grow their business typically take six to twelve months to come into effect. as a result, absorption levels usually lag company profit growth by a similar timeframe. if this trend continues, demand for office space is expected to remain strong for at least another twelve months.

notwithstanding the current market conditions are the tightest they have been for many years, the supply pipeline in some markets is a potential source of concern. For instance, future supply in the Brisbane cBd is high with over 300,000 sqm of space (around 17 percent of stock) currently under construction. a further 86,000 sqm is approved, 316,000 sqm of plans submitted and 196,000 sqm proposed. the perth cBd office market is in a similar situation with over 193,000 sqm of space (around 15 percent of stock) currently under construction, an additional 177,000 sqm of space approved, 17,000 sqm of space submitted and 24,000 sqm of space planned.

major tenants are seeking accommodation that meets modern environmental, security and technical requirements as well as specialised attributes such as large floor plates. a number of government departments and large companies now require that new office accommodation meets specified environment standards. For instance, the department of the environment and Water resources australian Greenhouse office released a guideline on the energy efficiency in Government operations (eeGo) policy in 2007. the policy required new office accommodation leases and major refurbishments (greater than 2,000sqm in tenanted area and with a lease term longer than two years) to achieve a 4.5 star rating under the australian Building Greenhouse rating (aBGr) Scheme. the state government of Victoria requires that all new Government offices achieve a 5 Star environmental rating from 2007. the implication is rapid obsolescence of older office buildings, largely offsetting the supply impact of new construction.

the first three months of 2008 saw a high level of financial market volatility, followed by mergers and staff-shedding by major financial institutions in the uS and uk markets. despite the strength of the domestic economy, the local market is not immune to the global credit crunch. downsizing by at least some financial services providers seems inevitable over the remainder of 2008, while others will review expansion plans. the implication is lower white collar employment growth and a reduced in demand for office space. at this stage the impact of the credit crunch on the broad outlook for australia’s office markets appears to be marginal. However we expect that tenants will exercise greater caution before initiating expansion plans; developers and financiers will similarly apply stricter criteria in committing to future developments.

marketperformance

the office sector further consolidated its strong performance in 2007. overall, the pca/ipd investment performance index reported a total return of 22.3 percent in the year to december 2007 for the australian office market. the cBd office market sub-sector recorded 23.3 percent, comprising an income return of 6.4 percent and 16.0 percent capital return. non-cBd office markets recorded 16.4 percent in the year to december 2007, of which income comprised 7.5 percent and capital growth of 8.4 percent.

it is evident that a significant proportion of the total return was generated from yield compression, creating temporarily high capital growth in most markets. credit spreads have widened sharply, sharemarket volatility has spiked and inter-bank debt markets are experiencing low liquidity. as stability returns through 2008 we expect to see some retraction of credit spreads from current extreme levels, although there will be no return to the tight spreads prevailing in early 2007. as capital values stabilise or even decline in some markets, property owners and investors of office assets will find it increasingly difficult to sustain current high rates of return.

table 2.2 reveals the structural change in the composition of office sector investment returns over the last ten years. prior to the wave of yield compression that took place from 2002, income yield contributed 55 to 72 percent of the total returns of premium to d grade office assets. the tightening of yields and high level of institutional investment into the sector has reversed this trend. a breakdown of the national cBd office market returns by grade shows income returns only account for 24 to 30 percent of the total return for the year to december 2007. total returns have more than doubled for premium, a and B grade assets, while the total returns of c and d grade assets are 8.2 percentage points higher (see table 2.2). We expect that returns will revert to the long-term pattern over the next year.

6) pca estimate


2 oFFice marketS

table 2.1

CBd OffICe MARket PROfIles net total Absorption total Vacancy 12 months total stock Vacancy factor to Jan 08 Markets (sqm) (sqm) (%) (sqm)

January 2007

Sydney cBd 4,733,997 374,264 7.9 143,880

melbourne cBd 3,600,939 287,085 8.0 167,588

Brisbane cBd 1,758,285 29,854 1.7 68,128

canberra region 1,652,383 30,050 1.8 66,150

perth cBd 1,273,858 11,542 0.9 29,432

adelaide cBd 921,314 60,833 6.6 28,489

Hobart cBd 336,925 6,567 1.9 7,534

Australian CBd 14,327,561 802,861 5.6 515,365

January 2008

Sydney cBd 4,684,723 172,471 3.7 105,325

melbourne cBd 3,680,173 163,582 4.4 202,737

Brisbane cBd 1,747,770 11,667 0.7 7,672

canberra region 1,898,934 41,046 2.2 235,555

perth cBd 1,280,920 6,317 0.5 12,287

adelaide cBd 946,397 40,355 4.3 45,561

Hobart cBd 340,134 7,404 2.2 2,372

Australian CBd 14,579,051 442,842 3.0 611,509

Source: property council of australia

table 2.2

OffICe seCtOR PeRfORMAnCe deCOMPOsItIOn (% PA)

sub-sector Income return Capital return total return

year to december 2007

australian cBd premium grade 6.1 18.1 25.2

australian cBd a grade 6.5 14.7 22.0

australian cBd B grade 6.7 17.3 25.1

australian cBd Grade c & d 5.9 13.1 19.7

ten years to december 2007

australian cBd premium grade 6.5 5.1 11.9

australian cBd a grade 7.3 3.0 10.5

australian cBd B grade 7.9 4.0 12.2

australian cBd Grade c & d 8.3 3.0 11.5

Source: pca/ipd index

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3 retail marketS

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3 retail marketS

figure 3.1

national retail turnoVer

figure 3.3

Victoria retail turnoVer

figure 3.5

SoutH auStralia retail turnoVer

figure 3.2

neW SoutH WaleS retail turnoVer

figure 3.4

queenSland retail turnoVer

figure 3.6

WeStern auStralia retail turnoVer

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AUSTRALIA 10 YEAR AVERAGE (6.17%)


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AUSTRALIA NEW SOUTH WALES 10 YEAR AVERAGE (5.18%)

AUSTRALIA VICTORIA 10 YEAR AVERAGE (6.44%)


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AUSTRALIA QUEENSLAND 10 YEAR AVERAGE (7.61%)


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AUSTRALIA SOUTH AUSTRALIA 10 YEAR AVERAGE (5.99%)


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AUSTRALIA WESTERN AUSTRALIA 10 YEAR AVERAGE (6.57%)

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3 marketdrivers

retail spending and credit card use are slowing under the impact of twelve consecutive increases in the official cash rate since 2002. according to the latest retail trade data, sales fell by 0.1 percent in February, matching the weak data reported in January. the decline in consumer spending growth however, represents a return to trend levels rather than a cyclical slowdown. of the major states, retail turnover growth remains above the long-term average annual growth in new South Wales, queensland and South australia. the most notable slowdown occurred in Western australia where annual retail turnover growth fell to 2 percent for the year to February 2008 compared to 12.8 percent growth a year earlier. the australian retailers association expects consumer spending to grow at 4 to 4.5 percent this year.

Consumer sentiment is sharply lower compared with last year, reflecting sharemarket volatility during the first quarter of 2008, along with fears of further rises in interest rates to kerb rising inflation. the melbourne institute Westpac consumer confidence survey released in april 2008 shows consumer sentiment fell 1.3 percent, close to a 15-year low. another market survey, the roy morgan consumer confidence index, fell to an 18-year low in april 2008. despite the decline, 65 percent of respondents to the roy morgan survey believe the domestic economy is in good or excellent shape.

Retailer margins continued to expand during 2007, recording the highest operating profit to sales ratio this decade for non-food retailers (9.5 percent), or averaging 7.2 percent for the year. the margin for food retailers was also high at 8.3 percent for the quarter, averaging 6.6 percent during 2007 according to the aBS. typically, higher sales are leveraged over relatively fixed costs, so the rise in inflation has aided the profitability levels of food retailers in recent years.

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FOOD NON-FOOD 10 YEAR AVERAGE (5.9% FOOD/6% NON FOOD)

on a seasonally adjusted basis, the ratio of operating profit to sales was 7.3 percent for non-food retailers and 6.7 percent for food retailers. the ratio of operating profit to sales has been well above the long-term average of 6 percent for non-food retailers and 5.9 percent for food retailers. this is not surprising considering the strength of consumer spending on the back of record levels of employment, with household income growth consistently outpacing expenditure in recent years. improving trade terms and significant opportunities for better sourcing efficiency have also helped increase operating margins. it is likely, however, that retail margins are near peak considering the slowdown in retail spending in early 2008.

figure 3.7

retail operatinG marGin to turnoVer ratio (quarterly Sa)


3 retail marketS

marketperformance

Growth in population, wages growth, tax cuts and high levels of employment provide a strong platform for retail sector performance.

retail sector total returns have declined from a cyclical peak return of 17.8 percent in december 2006 to 14.2 percent in december 2007. income returns have been declining steadily to a historical low of 6.1 percent pa in december 2007. the long-term average income return is 7.6 percent pa over the last 10 years and even higher at 8.1 percent pa over a twenty year period. the falling income returns have largely been offset by cap rate compression, accounting for significant capital gains in recent years. a notable slowdown in investment activity occurred during the latter part of 2007 though, and key market indicators all point towards an end to the compression of yields.

retail has consistently ranked as the top performing sector in the pca/ipd index over an extended period. Going forward, capital growth will be harder to sustain. However, retail sector investment returns are probably now close to a sustainable level. institutionally held retail centres should be able to command higher rents given the capital that has been invested to improve the quality of these assets. Widening retailer profit margins will also support rental growth. tax cuts, rapid population growth, rising wages, tax cuts and high levels of employment all provide stimulus for consumer spending and retail turnover. as indicated in our q1 2008 report, sub-regional centres are an out-performing sub-sector – a trend likely to continue through 2008.

table 3.1

RetAIl seCtOR PeRfORMAnCe deCOMPOsItIOn (% PA)



regional centres 5.8 5.0 11.0

Sub-regional centres 6.2 8.0 14.6

neighbourhood centres 6.0 5.8 12.1


regional centres 7.6 4.7 12.5

Sub-regional centres 8.5 5.8 14.7

neighbourhood centres 9.0 6.2 15.6


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4 induStrial marketS

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marketdrivers

the major themes of 2007 – logistics, location around transport nodes and proximity to markets – will continue to play during 2008.

demand for industrial space has been heavily influenced by the rapid rise in international trade volumes. technological advancements and infrastructure investment have allowed industrial space users to improve supply-chain efficiencies.

import volumes have been growing in excess of 10.5 percent pa for the past five years (see figure 4.1). the strength of import volumes is supported by two factors. First, the commodity price boom and rapid growth of industrial output across asia have caused a rapid shift of productive resources away from manufacturing and towards sectors where australia has a comparative advantage – services and mining. this translates into increased consumption of imports and, in the longer term, growth in export volumes. the trend will continue as export volumes are projected to grow at a steady pace, increasing by a further 11.7 percent in 2008 and 8.5 percent in 2009. Secondly, the strong australian dollar has helped boost import volumes, making imports cheaper.

exports on the other hand, have been growing at a much slower pace, averaging around 2.4 percent pa for the past five years. a major turnaround is forecasted over the next few years as a major boost in export volumes is anticipated between 2009 and 2013 (see figure 4.2) from non-rural exports, in particular, the export of resources such as coal, iron ore, gold and lnG. However, exports of bulk commodities have limited impact on the demand for industrial space.

Infrastructure spending has also had a significant impact on demand for industrial property. rising fuel costs are proving an incentive for logistics and distribution businesses to invest in large, well located distribution facilities to maximise operating efficiencies and minimise transport and labour costs and reduce the demand for working capital.

figure 4.1

auStralia – trade Volume ForecaStS (1981 – 2017)

figure 4.2

auStralian eXport ForecaStS (1981 – 2017)

figure 4.3

auStralian import ForecaStS (1981 – 2017)

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$ BILLION (REAL PRICES) FORECAST

Source: Access Economics

TOTAL EXPORTS TOTAL IMPORTS

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NON-RURAL EXPORTS SERVICE EXPORTS

RURAL EXPORTS

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TOTAL IMPORTS IMPORTS OF SERVICESIMPORTS OF GOODS

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4 induStrial marketS

17

investment by state and federal governments in infrastructure has been rising steadily as they move to catch up with rapid growth in demand and, in many cases, upgrade existing facilities. across australia, a number of major infrastructure projects are underway which will further add to the appeal of key industrial zones in the major capital cities. Victoria’s road system has undergone major upgrades in the last decade. access to the city has vastly improved with the construction of a major heavy vehicle route through the centre of the city. a ring road was also built to provide access to all of metropolitan melbourne and links to major regional centres such as albury, Ballarat, Bendigo and Geelong. other infrastructure projects are underway to further enhance access to industrial zones. For instance, in the north, the F2 Hume Freeway (craigieburn Bypass) will link the metropolitan ring road to the Hume Highway. in the east of melbourne, there is the extension of the eastern Freeway which extends east from Blackburn to maroondah Highway in ringwood. on completion, this freeway will link to the mitcham-Frankston tollway (eastlink) connecting the outer eastern suburbs with the outer southern suburbs. infrastructure projects in queensland include the north South Bypass tunnel, the northern link tunnel, expansion of the Gateway Bridge in Brisbane and the tugun to tweed Heads bypass

supply of industrial facilities will remain high over the next two years. over 2 million square metres of new industrial space is forecast to be added along the east coast of australia in the next couple of years. 45 percent of the new space will be in central outer western Sydney and Southern Sydney, 36 percent in Southern Brisbane and the remaining 19 percent will be in melbourne 7.

marketperformance

table 4.1 provides a decomposition of investment returns for the three main types of industrial properties – high-tech centres, warehouse facilities and distribution centres. income returns have fallen for all three types of industrial properties. overall, income yields across industrial real estate have been declining over the past decade, in common with trends in other market sectors. the decline in yields has been accompanied by a temporary boost to capital returns. However industrial yields appear to have now stabilised. yields are now around 7 to 8 percent, which would seem to be a sustainable level for prime, institutional grade industrial assets. capital growth of around 5.5 to 6 percent reflects a combination of inflation and real growth in rents during 2007.

rental growth is likely to ease over the next twelve months in many Sydney and melbourne industrial areas as new supply comes on stream. in our view, 2007 probably marked the end of the yield compression phase for the industrial sector. despite this, current levels of total return are sustainable as developers remain active and continue to seek opportunities to add value, often on sale-and-lease back and construction of purpose-built facilities. investment spending by industrial companies remains strong and, in the longer term, containerisation and improved rail transport links will put a premium on facilities adjacent to transport hubs such as airports and harbours. the rapid growth of industrial real estate markets around asia implies that australia will face greater competition in the provision of storage and distribution facilities.

table 4.1

IndUstRIAl seCtOR PeRfORMAnCe deCOMPOsItIOn (% PA)



High-tech centres 7.8 5.7 13.8

Warehouse facilities 7.3 6.7 14.4

distribution centres 7.3 6.4 14.2


High-tech centres 15.9 5.8 22.3

Warehouse facilities 9.3 4.3 14.0

distribution centres 9.5 3.4 13.2


4

7) Jones lang la Salle research forecasts


5 Hotel and touriSm marketS

5

19

5 marketdrivers

Visitor numbers are growing overall but with significant inter-regional differences. While Western australia and queensland are recording sharp increases in business and tourism traffic there are also substantial differences within States. our previous report identified regional markets that are recording strong growth in visitor numbers as a result of the farming recovery and the mineral boom. in addition, expansion of air travel to smaller population centres is stimulating activity.

Supply of cBd hotel accommodation remains limited by competition from office and residential end uses which offer developers higher returns. according to Jones lang laSalle Hotels, 2,031 rooms were under construction in november 2007, equivalent to a 2.4 percent increase in room supply across the ten australian markets. in addition, a further 4,251 rooms, equivalent to 4.9 percent of existing stock, are classified as “rooms likely proposed”. melbourne is the market with the largest increase in the number of rooms under construction, followed by the Gold coast. the proposed new hotel at melbourne’s crown casino accounts for 650 additional rooms. after melbourne, darwin is the market with the largest percentage increase under construction.

From the investment perspective, the impact of the uS subprime crisis has been reflected in a downturn on the pipeline of hotel transactions after a record year in 2007. in addition, the global growth slowdown and corporate belt-tightening has been accompanied by a reduction in business travel. long-term demographic trends, such as the growth of the retiree market and the expansion of out-bound travel from asian markets will provide partial compensation for the cyclical downturn in traditional business travel. the asia-pacific region is seen to be relatively isolated from the uS subprime contagion and is attracting a growing inflow of investment capital. middle east investors are increasingly prominent in the region and the Beijing olympic Games is likely to further lift the profile of the region as a tourist destination.

marketperformance

High levels of occupancy in hotels and serviced apartments are allowing operators to increase room rates. overall, revpar growth of 5.1 percent was recorded for the sector (see table 5.1). the serviced apartment sector is showing particularly strong growth, both in supply and in occupancy. revpar increased by 6.4 percent in the year to december 2007. the growth in this sector probably reflects a combination of short term cyclical factors – corporate cost-cutting – as well as longer term demographic factors. markets such as perth, with a large fly in-fly out workforce and limited office space availability, are natural markets for serviced apartment operators.

the divergent growth in visitor numbers in different locations, as well as the steady shift in the sources of offshore visitors is likely to be reflected in hotel performance in the future. While the underlying supply-demand equation for the sector remains positive, we expect to see increased focus on high growth markets. three and four-star markets are likely to remain particularly strong as they are well positioned to capture high growth segments of both tourist and business travel markets.

table 5.1

hotels Motels and Guest houses serviced Apartments total

Quarter ended dec-06 dec-071 year % Change dec-06 dec-07

1 year % Change dec-06 dec-07

1 year % Change dec-06 dec-07

1 year % Change

establishments 823.0 833.0 1.2 2,479.0 2,484.0 0.2 893.0 918.0 2.8 4,195.0 4,235.0 1.0

Guest Rooms 80,560.0 81,372.0 1.0 86,859.0 87,683.0 0.9 47,753.0 49,262.0 3.2 215,172.0 218,317.0 1.5

Room nights Available (thousand) 7,369.6 7,453.9 1.1 7,922.2 8,042.2 1.5 4,385.7 4,524.1 3.2 19,677.5 20,020.2 1.7

Room nights Occupied (million) 5,387.2 5,381.7 -0.1 4,682.0 4,761.0 1.7 3,091.9 3,216.6 4.0 13,161.1 13,359.3 1.5

Occupancy (percent) 73.1 72.2 -1.2 59.1 59.2 0.2 70.5 71.1 0.9 66.9 66.7 -0.2

Accommodation Revenue ($mill) ex Gst 840.6 881.5 4.9 441.9 482.2 9.1 414.4 455.1 9.8 1,696.9 1,818.8 7.2

AdR ($) 156.0 163.8 5.0 94.4 101.3 7.3 134.0 141.5 5.6 128.9 136.1 5.6

RevPAR ($) 114.1 118.3 3.6 55.8 60.0 7.3 94.5 100.6 6.4 86.2 90.8 5.1


6 reSidential marketS

6

21

marketdrivers

the australian housing market is the tightest it has been for many years. Strong overseas migration has been the driving force behind the highest population growth numbers recorded in the last 18 years: total population increased by 318,500 people or 1.53 percent in the year to September 2007, generating continued demand for new housing. twelve consecutive interest rate rises since may 2002 have however stifled the housing market recovery. Supply remains well below underlying demand adding to the pent-up demand that has been building since around 2000 (see figure 6.1).

dwelling construction is generally considered to be in a cyclical downturn. However, as Figure 6.2 illustrates, the current cycle has been unusually mild by historical standards. typically, cyclical peaks and troughs in the annual change in residential building approvals range between 20 and 40 percent. the current cycle is considerably smaller with the annual change in approvals below 20 percent for the past five years. the widening gap between demand and supply is largely accounted for by strong growth in demand rather than a deficit in supply.

new South Wales is the exception to this statement. dwelling (apartment and house) construction in new South Wales has been hovering around the lowest on record. the weakness in the new South Wales housing construction sector is partly attributable to low levels of population growth. migration to queensland has been running at high levels and this migration is particularly prevalent amongst younger workers – potentially first home buyers.

a major contributor to the low level of residential construction in new South Wales has been the rapid rise in the level of duties and taxes imposed by the new South Wales State Government. For example, the pca has calculated that broad hectare development costs in north West Sydney rose by 24 percent pa (2000 to 2005) to $198,670, equivalent to 34.8 percent of a house and land package.

Faced with the high cost of constructing new homes and the high costs of moving, expenditure on alterations and additions has risen sharply, almost matching expenditure on new dwelling construction by the end of 2007. in previous cycles a surge in alterations and additions has been a trigger for a rebound in new dwelling construction. it remains to be seen whether that applies this time.

affordability is widely accepted as posing a significant barrier to entry to first home buyers. However, recent calculations by the rBa offer an alternative perspective on this subject (see Figure 6.3). Based on analysis of potential first home buyers incomes (rather than average wages overall) housing “accessibility” can be shown to be fairly close to twenty-five year averages, and well above the levels recorded during the early 1990s (see Figure 6.3). perth is a notable exception. these trends correspond, broadly, with evidence that first home buyers as a proportion of total mortgage borrowing is currently running close to long term trends, again with the exception of Western australia.

figure 6.1

reSidential market – underlyinG demand

figure 6.2

BuildinG approValS – HouSeS

figure 6.3

HouSinG acceSSiBility – proportion oF dWellinGS aFFordaBle For median FHB

6

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

–100

–50

50

0

100

150

200

250‘000s

Source: ANZ

COMPLETIONS UNDERLYING DEMANDSHORTAGE/SUPPLY

FEB 88 FEB 92 FEB 96 FEB 00 FEB 04 FEB 08

-60

-20

-40

20

0

40

60



Source: ABS

1982 1986 1990 1998 2002 2006

0

40

20

60

80

100

1994

PERCENT (%)

Source: RBA

SYDNEY

ADELAIDE

MELBOURNE

PERTH

BRISBANE

AUSTRALIA


marketperformance

yields in residential property have been trending downwards for over two decades. the spread in residential house yields between the major capital cities was around 2 percent during the 1980s. over this period, capital growth was low and rental returns contributed a significant proportion of the total return. However, the gap widened in the late 1990s to early 2000s (to almost 3 percent) when the Sydney residential market entered a boom and capital growth accelerated. Since 2002, however, residential yields began to converge as a result of a downturn in the Sydney market and capital values declined. at the same time, capital growth accelerated in the traditionally high yielding markets of adelaide and queensland. the december 2007 figures (the latest available) indicates the spread in yields between the states is just 1 percent according to the reia (see Figure 6.4 and 6.5).

2008 may see yields returning to the 4 to 5 percent range. recent analysis by australian property monitors, for example, has identified several suburbs where yields are reported to exceed 6 percent. until substantial new supply of residential property is delivered, the housing market will remain exceptionally tight and support continued rental growth in markets with severe housing shortages.

the story of the two-tier residential market remains in place, as shown by the income and capital return data released by the reia. until recently, Sydney was struggling with negative or very low capital growth recorded throughout 2004, 2005 and 2006. But early signs of recovery are starting to appear as capital growth returned to positive territory during the latter part of 2007. rents are also rising; rents for houses rose 12.7 percent in the year to december 2007. other dwellings also recorded double digit rental growth of 12.9 percent in the year to december 2007.

at the other end of the spectrum, the latter part of 2007 marked a sharp slowdown in the appreciation of house and other dwellings prices in Western australia, after growing in excess of 20 percent pa for the past five years. despite the sharp slowdown, price appreciation continues; house prices rose by 3.1 percent and other dwelling prices by 5.2 percents in the year to december 2007. the slowdown is by no means a reflection of falling demand for housing and the escalating cost of rental accommodation is evidence of this. on the contrary, the slowdown is mainly attributed to the rapid deterioration in housing affordability and low accessibility of housing to purchasers in this market.

other states are showing upward trending income and capital returns. High population growth has underpinned a strong demand for housing across the major states. coupled with the low supply of housing, the 2007 income and capital growth in melbourne, Brisbane and adelaide are well above the five year average annual growth rates.

6 reSidential marketS

figure 6.4

reSidential yieldS – HouSeS

figure 6.5

reSidential yieldS – otHer dWellinGS

DEC 89 DEC 91 DEC 93 DEC 01DEC 99 DEC 05DEC 03 DEC 07

0

3

1

2

4

5

6

7

DEC 97DEC 95

PERCENT PA (%)

Source: REIA

SYDNEY

ADELAIDE

MELBOURNE

PERTH

BRISBANE

DEC 89 DEC 91 DEC 93 DEC 01DEC 99 DEC 05DEC 03 DEC 07

0

3

1

2

4

5

6

7

DEC 97DEC 95

PERCENT PA (%)

Source: REIA

SYDNEY

ADELAIDE

MELBOURNE

PERTH

BRISBANE

23

6 figure 6.6

Sydney reSidential market returnS – HouSeS

figure 6.7

melBourne reSidential market returnS – HouSeS

figure 6.8

BriSBane reSidential market returnS – HouSeS

figure 6.9

adelaide reSidential market returnS – HouSeS

figure 6.10

pertH reSidential market returnS – HouSeS

DEC 89 DEC 95 DEC 07

-20

-10

0

10

20

40

30

50

DEC 01DEC 92 DEC 04DEC 98

PERCENTAGE PA (%)

Source: REIA, Mirvac Research

CAPITAL RETURN RENTAL RETURN


-20

-10

0

10

20

40

30

50


PERCENTAGE PA (%)




-20

-10

0

10

20

40

30

50


PERCENTAGE PA (%)




-20

-10

0

10

20

40

30

50


PERCENTAGE PA (%)




-20

-10

0

10

20

40

30

50


PERCENTAGE PA (%)




7 mirVac inVeStment indicator clockS

clocks represent a highly summarised perspective on complex markets. the sector returns clock indicates our assessment of the current position in the investment cycle of the major real estate sectors. importantly, a decline in expected investment returns does not equate to a fall in underlying values. the state clock summarises our outlook for the economic performance of the major states over the next twelve months.

figure 7.0 shows: > investment returns are trending upwards in the hotels

and commercial office markets. the hotels sector is in the early upturn phase as rising occupancy translates into rising room rates. in the case of the commercial office market, total investment returns exceeded 20 percent in 2007 for both prime and secondary grade assets. office markets are the tightest they have been for a long while, with national vacancy at a 20 year low (3.9 percent in January 2008). With a large volume of potential new supply in the pipeline over the next few years we believe the office sector is approaching the peak of the investment returns cycle.

> outlook for the industrial and retail sectors is less favourable as the impact of twelve consecutive interest rate hikes starts to bite and yields stabilise. investment returns on the retail sector declined during q4 2007.

> low vacancy, strong growth in demand and a steady build up in the national housing backlog will lead to another round of rental growth in the residential market during 2008. investors are likely to return to the residential market. While affordability has been falling, first home buyers remain active in most markets, providing support to house and apartment values.

figure 7.1 shows: > Western australia and queensland remain the strong

growth states, but momentum is likely to moderate from the high rate of expansion recorded in 2007.

> despite not being a direct beneficiary of the commodities boom the Victorian economy continues to perform impressively. no signs of a slowdown have emerged. South australia’s prospects are improving with expansion of the mining sector, a reduction in the rate of inter-state emigration and increased infrastructure investment by private and public sectors.

> the outlook for new South Wales remains subdued. investment in infrastructure (particularly transport) is likely to lift the growth rate during 2008. the population growth rate is accelerating. However, the state continues to face tough competition for capital and labour from its more dynamic neighbours.

figure 7.0 figure 7.1

RETAIL

HOTELS

OFFICE

INDUSTRIAL

RESIDENTIAL

121

2

3

4

56

7

8

9

11

10

121

2

3

4

56

7

8

9

11

10

WESTERN AUSTRALIA

SOUTH AUSTRALIA

VICTORIA

QUEENSLAND

NEW SOUTH WALES

A-ReIt australian list property trust

ABGR australian Building Greenhouse rating

ABs australian Bureau of Statistics

AdR average daily rates

bp basis points

Cy calendar year

eeGO energy efficiency in Government operation

GdP Gross domestic product

IMf international monetary Fund

IPd investment property databank

nAV net asset Value

ntA net tangible asset

pa per annum

PCA property council of australia

psm per square metre

RBA reserve Bank of australia

ReIA real estate institute of australia

sa seasonally adjusted

sqm square metre

ReseARCh dIReCtOR david Rees +61 2 9080 8739 [email protected]

ReseARCh AnAlyst Clara lee +61 2 9080 8341 [email protected]

ReseARCh AnAlyst dasha kruchkoff +61 2 9080 8518 [email protected]

diSclaimer: the information made available in this economic and direct property market outlook, including any expression of opinion or forecast, has been obtained from or based on sources believed by mirvac Group to be reliable. mirvac Group does not warrant the accuracy, completeness or currency of the information. mirvac Group and its related companies will not be liable for any inaccuracies, omissions or errors in the content nor for any loss or damage arising from action taken in reliance on the information.

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