A commercial real estate services group has unpacked some of the biggest trends it expects across the Australian market in 2021.
In its latest research paper into the Australian and New Zealand investment market, global business JLL has said that the unpredictable and uncertain nature of the post-COVID economic recovery will present a diverse range of opportunities and risk for real estate investors this year.
According to JLL, a number of themes will emerge in 2021, while other trends seen elsewhere will become stronger and more relevant for real estate investors.
1. Bond yield convergence and the implications for real estate return expectations
Government bond yields have followed a downward trajectory over the past 30 years. Potential GDP has lowered for mature economies and central banks have been largely successful in managing inflation.
In 2020, retail and to a lesser extent office sector valuation were negatively impacted by income risk and a reduction in short-term rental growth assumptions.
However, real estate valuations are determined in relation to a risk-free rate, and the decline in the risk-free rate will normally pressure market risk premiums to compress.
Over the long-term, JLL has observed a close relationship between property market discount rates and government bond yields. The correlation coefficient in Australia is between 0.85 and 0.90.
“We believe it is important to formulate a view on the potential movement of the risk-free rate over the investment horizon,” JLL said.
“The first phase of an assessment should be to review the yield curve – a curve which plots bond yields over differing maturities and provides an insight into future interest rate changes. While the yield curve in Australia and New Zealand has moved out post the Pfizer vaccine announcement, it remains relatively flat implying a low interest rate environment.”
One of the legacies post-COVID-19 is the expectation of an extension of the low-interest rate environment.
JLL believes that investors will form views on the appropriate risk-free rate and implied market risk premium for different sectors and geographies.
“A number of investors will be concerned that the unprecedented policy measures will be inflationary and interest rates will rise, while others believe the lower for longer thematic will remain prevalent over the next decade,” JLL has said.
2. Cross-border investors views of Australia and New Zealand
According to JLL’s assessment of several macro variables, Australia and New Zealand are attractive relative to other mature economies.
The main limitation for offshore capital sources seeking to build a diversified portfolio of scale in Australia and New Zealand is the limited size of the investable universe.
“We surveyed top investment leaders from 38 global and regional investors on how COVID-19 is impacting their strategic investment decision-making. One of the questions provided to investors was a view on their investment intentions for major Asia Pacific geographies through 2021.
“The results for Australia were positive with 50 per cent of investors planning to increase their exposure and only 7 per cent looking to down-weight their real estate holdings in Australia,” JLL revealed.
3. The evolution of real estate debt capital markets
According to JLL, an opportunity has emerged for alternative lenders to become more active participants in the Australia and New Zealand commercial real estate lending market.
Commercial real estate debt is providing lenders with comparatively stronger risk-adjusted returns compared with corporate bonds or equities. But while a number of alternative debt investors take on greater risk than traditional banks, they can still target higher returns while sitting with the security of a first mortgage.
“Lending on core assets was historically dominated by the domestic banking sector. We have seen a number of international commercial banks explore strategies to grow market share in this cohort of the lending market,” JLL opined.
“Global pension/life funds are exploring core lending opportunities in Australia and New Zealand as they seek geographical diversification in their commercial real estate debt exposure.”
JLL explained that non-bank lenders are particularly relevant to investors with assets that are considered transitional – short-term income issues, capital expenditure requirements or development opportunities.
“The expansion of these type of debt funds ensures that investors/developers now have access to a wider variety of alternative and increasingly attractive finance products,” JLL said.
4. The rise of real estate investment alternatives
According to JLL, the real estate alternatives universe covers all sectors with the exception of the mainstream commercial real estate sectors of office, retail and industrial and logistics.
JLL’s investment case for real estate alternatives is supported by long-term macro-economic and demographic trends, the weight of capital seeking real assets and portfolio diversification benefits.
“Diversification is the cornerstone of modern portfolio theory and occurs between lowly or uncorrelated sectors or asset classes,” JLL said.
Noting that mainstream commercial property sectors are intrinsically linked to economic growth, JLL explained that real estate alternatives are less correlated with the broader economy.
“The resilience of most real estate alternatives sub-sectors was highlighted by high rent collection rates throughout COVID-19 and it has expanded the pool of investors seeking exposure to those sub-sectors,” JLL said.
JLL said that while the real estate alternatives investable universe is limited in Australia and New Zealand, a number of early adopters have already entered the market.
“The resilience of most of these sub-sectors through COVID-19 has strengthened the investment thesis, and we expect to see a more diverse range of capital sources explore established assets and development opportunities in 2021,” JLL said.
5. ESG considerations will increase in relevance
ESG factors are becoming more significant in the real estate sector as they quantify the sustainability of non-financial impacts of investments and are viewed to have a positive influence on long-term return and risk profiles. According to JLL, the COVID-19 pandemic has led to a sharper focus on ESG criteria and investment.
The most visual element of ESG in the real estate sector is environmental considerations.
The real estate industry is estimated to account for 30-40 per cent of global carbon emissions and a number of real estate investors have made public statements about minimising their carbon footprint.
According to JLL, organisations will gravitate towards assets with strong sustainability attributes, creating a potential pool of pre-commitment tenants for developers and an opportunity for investors to refurbish/reposition existing assets.
“The sustainability journey starts with developers seeking to source building materials within a specific radius and ensuring that a high proportion of waste is diverted from landfill and composted or recycled,” JLL said.
“In the office, retail and industrial & logistics sector we are seeing the adoption of solar panels and wind turbines to generate energy. Furthermore, rainwater harvesting is becoming more prevalent in the industrial & logistics sector for use in toilets and exterior water taps.”