Australian Property Market Predictions 1

What next for Australian Property Markets as the COVID-19 pandemic continues?Following on from commentary earlier this year, the Australian Property Institute asked some of Australia’s most experienced commentators to update their predictions for the property market, as COVID-19 continues to have impact across the country.

The usual candidates for the shape of economic activity following a shock are: the letter U, indicating a gradual recovery, the letter L (in the downturn for a long time), V (a quick snap back to pre-crisis conditions) or W (double-dip recession).

However, we anticipate the recovery will be a back-to-front J shape. The inverted J illustrates an initial recovery after hitting bottom, after which the economy settles into an extended period of bumpy, sub-par growth. We think the J shape reflects the fact that it is likely to be quite some time before we see unemployment as low as 5% again and a long time before we see the economy fully recover and grow at (or above) trend (of around 2.6% per annum). It also accounts for the risks of further outbreaks and lockdowns, as highlighted by Victoria recently.

National accounts data published last month revealed the economy shrank 0.3% in the first quarter of this year. This was the first contraction in nine years and sets Australia up to record its first recession in 29 years. The largest fall in GDP in this downturn will have occurred in the June quarter and we expect this contraction to be around 7%. Output this calendar year will be sharply weaker; we anticipate around 4% weaker, before growing by 3% next year. The good news is the period of contraction may be relatively short and limited to the first half of this year, although the Victorian situation raises the risk it could be longer.

Although the COVID-19 crisis has plunged the world into its deepest downturn since the Great Depression, the impact in Australia to date has not been quite as profound as first thought, due to our success in suppressing the virus. We reopened the

The Australian Economy

We asked Besa Deda, Chief Economist at St. George, to talk about the impact of COVID-19 on the overall economy.

Out of nowhere, COVID-19 has caused the biggest economic downturn since the 1930s. As more data becomes available, the complexity of the path to recovery is being revealed. Like traffic following an incident on the road, the economy is going to be in the slow lane for some time. The pace of recovery will be determined by consumer confidence – confidence that the pandemic is being well contained and that the economic outlook is improving.

Besa Deda, Chief Economist St. George,

Angie Zigomanis, Director at Charter Keck Cramer

Andrew Shields Interim General Manager Real Estate Institute of South Australia

Zelman Ainsworth, Director, CBRE

Kate Gray, Director, Research Colliers International

Sass J-Baleh, Head of Industrial and Logistics Research JLL Australia,

Australian Property

Market PredictionsJULY 2020

economy earlier than expected, therefore the downturn has not been as deep. The complication of course, is the uncertainty, including setbacks such as the current spike in Victorian infections. There are also risks associated with stimulus measures ending. The recent decision to extend the JobKeeper scheme, albeit in a refined form, is a positive development. JobKeeper has helped mitigate the rise in unemployment.

The unemployment rate rose to 7.4% in June - the highest level since late 1998. Without JobKeeper the unemployment rate would be far higher and we believe it has further to rise. We see the peak being at around 9% later this year. The participation has fallen dramatically since the pandemic hit, despite some recovery in June. If we assumed the participation rate stayed the same, the unemployment rate would have been 11.4%. You have to go back more than 40 years (beyond the data available) to get an unemployment rate that high.

Rising joblessness is contributing to consumer caution. The Melbourne Institute and Westpac Bank Consumer Sentiment Index for Australia indicated that consumers are pessimistic about the outlook. After partially recovering in May and June, consumer confidence fell again in July, driven by worries about rising infections in Victoria and NSW.

Consumer caution is hurting traditional bricks-and-mortar retailing, especially in the CBD. Online spending has accelerated amid the pandemic. But the outlook over the next few years for retailing remains a soggy one with higher unemployment and household incomes under pressure.

Higher unemployment will also soften the demand for office space, as unemployment rises. Demand is also likely to be softer because many employers will find that it is cheaper to continue having staff work from home, even after the pandemic passes. The weaker demand for office space will partly be offset by the end of hotdesking. Older buildings may witness higher vacancy rates and may become white elephants, especially in the CBD.

The World Health Organization has indicated that a vaccine readily available to the world is still 2.5 years off. Even if a likely candidate were found, testing for efficacy and safety still needs to be done. So, in reality we are likely to have to learn to live with the virus for some time. People will have to continue to practise social distancing and the pandemic will cast a shadow for some time.

If there is a silver lining, it is that some of the ways COVID-19 has changed how we work and how we live are for the better. It’s paving a way for people who may previously have been required to commute to work, or who have previously been denied working from home options. Employers are becoming more flexible and this should also benefit people living in regional parts of Australia.

2Australian Property Market Predictions

COVID-19 has changed how we work and how we live are for the better. It’s paving a way for people who may previously have been required to commute to work, or who have previously been denied working from home, options.

Australian Property Market Predictions 3

Angie Zigomanis said uncertainty around the government support programs and the shutdown of international borders is affecting the residential property market

The main short-term impact on residential property is people don’t know where they’re going to be in 12 months’ time. They’ve seen friends forced onto JobKeeper or JobSeeker, so I suspect many are holding off on purchase decisions.

The other thing affecting the market is the shutdown of international borders. There’s been a spike in vacancy rates over the past few months and landlords are having to discount rents to become competitive. The inner-city property market is most affected, and that market is more concentrated in Melbourne than in NSW or Queensland. NSW rental bonds data reveals there’s been a drop in new bonds and a pick-up in bond returns in the past few months.

Australia’s two biggest student markets are China and India. Opening up the borders might start with China, but India is another big market and our borders are likely to stay closed to India for some time, and to our next two or three top student markets, which include less advanced countries.

In terms of mortgage distress, the Government urged banks to be lenient and the banks have offered a period of mortgage relief for people who are financially distressed. Nearly 500,000 households have asked to postpone their mortgage payments.

In terms of forced sales, it’s hard to say how many would be brought to the market, especially given the mortgage relief that is currently being offered to otherwise stressed households. Banks are aware that a high number of

mortgagee sales will place downward pressure on prices, so will try to keep this from happening. Certainly the number of properties on the market and sales volumes has fallen.

Prices started to decline about mid-April. May was the first complete month of decline since this time last year and since before the Federal election, but prices haven’t been dropping away sharply. Melbourne’s had the largest decline and Melbourne and Sydney is where we’d expect the markets to be most constrained because they are the markets most exposed to the collapse in international migration. Falling rents are mostly occurring in the inner-city markets, the big apartment pockets around universities, for example, are the ones taking blows.

Short-term rentals are another part of it, especially in the inner city where there were a lot of people posting their properties on AirBnB or Stayz. Obviously if the borders are shut, that source of income is closed off so those landlords are now seeking longer term domestic tenants.

We’ve just done some numbers on apartment completions for each capital city. This year is a big completion year in Melbourne. Apartment completions in Sydney have started to fall away but the numbers are still relatively high, it’s probably another 12 months before they start falling off more dramatically.

Brisbane had its peak about two or three years ago, and apartment completions had already been falling away. It has been digesting the oversupply of apartments so now has more of a demand problem. Melbourne still has some supply issues and in Sydney it’s probably a combination of demand and supply.

Tourism is probably the biggest risk as I suspect Australia will, until things become a lot better, insist on a two-week quarantine period once borders are initially re-opened unless you are coming from certain countries. You’re not going to come for a two-week holiday if you’re going to spend all your time in quarantine.

A lot of those markets and sources of property occupants, whether it’s from a tourism perspective or from a tenant perspective, are likely to be largely shut down until at least 2021 and possibly beyond.

Australian Residential Property MarketsAngie Zigomanis, Director, Research and Strategy at Charter Keck Cramer and Andrew Shields, Interim Operations Manager of the Real Estate Institute of South Australia talked about their expectations for Australian residential property markets.

Australian Property Market Predictions 4

Notwithstanding circumstances in Victoria, Australia looks to be handling COVID-19 better than say the US or the UK, so we’re likely to be a more attractive foreign investment destination than some other countries. That’s a positive for overseas migration down the track, and for overall economic conditions in Australia.

In the broader residential market, the supply pipeline across the country has started to ease off over the last couple of years. It was getting shut down by the change in bank lending criteria that came about following warnings from the regulator and from the Banking Royal Commission and the resulting falls in prices. The number of new projects coming to the market has actually already declined significantly, and this will come through in diminished supply after the current construction pipeline is worked through.

I expect that 18 months from now, production and completion levels are going to be at a level that’s closer to what’s going to be demanded from the low-level of population growth. The market was already heading down ahead of the COVID-19 setback, so that’s a positive and will help current stock to be absorbed more quickly.

Notwithstanding circumstances in Victoria, Australia looks to be handling COVID-19 better than say the US or the UK, so we’re likely to be a more attractive foreign investment destination than some other countries. That’s a positive for overseas migration down the track, and for overall economic conditions in Australia.

One of the unknowns is what will happen when people come off support measures like JobKeeper and JobSeeker in September. It is likely that the government will adopt some system of tapering these measures in the following months. However, if the economy does not begin to recover, there will come a point where the Government is going to run out of things to throw at this problem.

The Government incentives are also interesting for the housing market. The Federal Government HomeBuilder program is temporary and unlikely to provide a significant economic boost, while State Government incentives to first home buyers incentive may have a short-term impact but you can only be a first home buyer once and demand will fall away once the incentives expire. There are still many unknowns with the outlook for the housing market, dependent on the pace of reopening the economy after lockdown and extent of recovery in the economy afterward.

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Andrew Shields is seeing only a very small percentage of the South Australian residential property market affected by COVID.

The COVID situation has been an interesting journey, almost a roller coaster, where we’ve seen a massive dip in activity as the pandemic unfolded from a health to an economic crisis. But we’ve also seen some recovery, better than predicted from a business point of view. Our agencies are capitalising on JobSeeker/JobKeeper and the Government has put in more incentives around the new build and renovation markets, so we’ll see how that unfolds.

We’re going into fairly unchartered waters with the Government stimulus packages being walked back over the next couple of months. We’re hoping those packages are retained a bit longer to help with recovery. We also have concerns about a second wave, because of what we’re seeing in Victoria and other countries throughout the world. On another level, structurally, the South Australian Government pushed through some land tax reforms last year which are now implemented and we’re yet to see the impact on our market.

The cloud does have a silver lining however in that while supply has been limited, what has been achieved in the market is high yield to prices. From that point of view there’s still activity and the prices being obtained by sellers at the moment are very good. We’re also seeing growth in prices on the property management side of the business, which weren’t as affected by COVID as residential sales. They’ve gone from strength to strength.

South Australia is very different from the eastern states because our property management and sales markets are structured differently. The eastern states are more dependent on foreign investment, and investment in general, certainly in their CBDs. South Australia is a smaller, more conservative market.

We’re seeing only a very small percentage of the market affected by COVID. Probably the only bump in the road is CBD apartments because we don’t have students from the universities and that changed the market dramatically. CBDs are having to look at how they position their properties in respect to rents but even pre-COVID there were always higher vacancy rates in the CBD. It was never really wonderful because of the supply/demand scenario which was very different to the rest of Adelaide Metro and regional South Australia.

Looking ahead, Adelaide will see transactions continue. People will still want to buy and sell, so they will transact but the level of transactions might be at lower levels which will stimulate the market in respect to pricing. There will be high-level demands, so we’ll still see good prices and because of limited supply, people might have to pay a bit more for the property they want. Moving into spring, obviously it’s hard to call, but I think we’ll see similar markets to what we’ve experienced over the last month.

We hear about the V recovery, the U recovery, the W recovery and various other recovery models but it’s really difficult to tell. What I can see is that there will be sectors in the market that continue to perform well. It’s just the volumes that are the concern and that is the biggest challenge moving forward. If you look at data throughout Australia, supply is an issue everywhere.

Overall, we have challenges ahead but I think we are resilient enough to cope with them going forward.

Australian Property Market Predictions 6

Zelman Ainsworth says a lot of retailers and landlords have now adjusted to the market shock and have learned to adapt to a new way of doing business.

There is a fair share of challenges and you can’t deny that, but what we’re finding is that retailers that have open lines of communication via multiple channels with their customers are the ones finding a way through it.

The retailers that are relying on customers just walking through a store, buying a product and leaving, they are the ones that are feeling the pinch. Online retailers know everything about the customer, because in order to be a customer you have to fill in your details, so they know what you’re doing before you make a purchase. They know who you are, where you’re from, what your size is, your marital status and all the rest of it. You could walk into a shop, buy something and they won’t even know your name.

If retailers are not working on both ends of that spectrum and creating open dialogue and regular contact with customers, it’s going to be really challenging to keep customers loyal. What they don’t want to do is get into a situation where they are chasing prices.

With COVID there is a new way of doing business and everything has been reset, everything.

How staff are perceived and employed, how rent is paid, when rent is paid, everything is open for discussion. It is actually quite exciting because there are massive changes in the retail market that keep evolving on a weekly basis, globally and with that comes opportunities.

Australian Retail Property MarketsZelman Ainsworth, retail real estate specialist and Director of CBRE Asia Pacific and Kate Gray, Director, Research at Colliers International, talked about how COVID-19 is affecting Australian Retail Property Markets.

A lot of retailers are stripping down their businesses to keep the parts of it that work and letting go of the parts that don’t, or repairing and adjusting the parts that don’t. Customers are the biggest part of that. A restaurant, for example, should be led by customers. It’s not about a price war, because they should already be making margins, it’s about a service experience.

Everyone is saying that it’s online that’s winning, but it’s not. It’s the convenience factor. If you can connect with your customers in a meaningful way, the price is so secondary. It is when you’re not connecting that people go, ‘oh I’ll just go with the second taxi that pulls up’.

So it’s relevance, relevance, relevance and relevance that is the number one priority and it’s like any other relationship business relationship you’d have. If you’re not in contact with your customers, if you’re not in contact with your business relationship, how do you expect to do business?

High Street retail in the city and suburbs are still going to be the winners. Our team at CBRE has done nine leasing deals in the suburbs this month [June], when on average we would do four or five. A lot of people are working from home, being around home and our team is finding that there’s a huge uptake in people being reunited and reintroduced with their local suburbs. People are supporting small business, avoiding the crowds, avoiding driving places,

all these elements, all these bits and pieces, are changing customer behaviour and routines.

We are seeing a big uptake in retailers looking to take spaces in places with existing fit-out, because capital is hard to come by. If tenants can go in and turn the tap on and start trading, that’s a real win. That’s been interesting to see and we’ve done quite a few leasing deals with those sorts of arrangements.

For retailers, it’s literally about reinventing yourself and staying relevant within the market, it’s the only way right now, everything else is secondary to that. It’s like any other relationship you have, business or personal. The more you communicate, the more relevant you are, the more important your relationship is. Any relationship can fall apart with a lack of communication and relevance.

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Kate Gray says while a high volume of business tenants have been profoundly impacted by COVID, some retailers are actually doing extremely well

The mandatory Code of Conduct for landlords and tenants was enacted nationally in April. Since then, all states have legislated it within their respective Acts. While each state is slightly different, the Code has given tenants and landlords a platform to negotiate rent reductions or waivers. If a business qualifies for JobKeeper, it is covered by the relevant Act and cannot be evicted for not paying rent.

A high volume of business tenants, particularly those that have been mandated shut and/or have restrictions on trade – for example, food, beverage, fashion – have been impacted. The Code allows these tenants to get through an impact period.

However, we do expect more administrations. There have been quite a few in the past six months, the majority in clothing and footwear, although there has been a bit of a recovery in footwear sales. It’s hard to determine how much that’s going to impact the retail property market but we do expect to see a short-term impact.

The recovery in footwear sales may reflect the fact that if you look at the payroll data, the JobKeeper programme has given some younger people a big pay increase. The whole $1,500 is passing through to them when they might previously have only worked

occasional shifts earning a few hundred dollars. This increase represents discretionary spending for them, which they are using to buy things like air pods, shoes and clothing.

Retail trade figures around department stores have also been under pressure, although they have seen a big boost in online sales. Myer shut down during March/April but they had fairly sustained lower sales prior to COVID and were already struggling.

CBD retail, and those that rely on public transport, have been dramatically hit, particularly in Melbourne and Sydney. There just isn’t the same CBD workforce in the cities. We haven’t seen that flowing through to vacancies yet, but we expect to.

However, there have been some positives which we haven’t seen widely reported. The adoption of online retailing has been significant. Retailers like Kogan and Temple Webster which had good online platforms before COVID have accelerated their growth through these periods.

Woolworths has also done very well. They have a 57% market share online. Neighbourhood centres, which have stores providing essential needs – supermarket, butcher, baker, pharmacy – have held up well, right across Australia.

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The other area that has held up well has been large format – electronics, furniture, homeware, hardware. We expect that area of retail will be far more resilient than most would have thought, and therefore values in that sector have held up well.

The largest risks have always been the biggest centres, particularly ones that don’t have high foot traffic. Vicinity Group and Scentre Group, which own some of the biggest shopping centres in Australia, have seen enormous valuation write-downs, of between 11-13 per cent.

However, these assets are high-quality and therefore there’s still a depth in the market to buy them. We will see some fall in value but the dire predictions we’re hearing are unlikely. Usually, values don’t fall 40-50%, that’s very rare. A lot of large retail owners have much lower leverage than they did during the GFC, so the pressure on them to sell is a lot less than it was then – and even then, we didn’t see huge amounts of sales.

All these things are cyclical and once the health crisis has passed, and revenue starts returning, then demand will return. There’s also opportunity for newer, innovative retailers to start coming into the market. We usually see that after a recession, which we’re having now.

Retailers that are true to their customers, that are agile and nimble and have a business structure that allows them to adapt quickly are the ones that are going to survive and thrive in this environment because they’re the ones really meeting current consumer needs.

COVID will create a large level of disruption. How we shop has changed and it probably won’t go back to where it was. Online penetration is high and will come back as restrictions are lifted, but some of it will stick.

Longer term, there is always going to be a need for retail. The balance between how much is online and how much is in store, and how much need a tenant has for floor space will be interesting. There might not be as many stores.

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Sass J-Baleh, Head of Industrial and Logistics Research JLL Australia.

The industrial and logistics sector is the only sector right now that is maintaining its performance. The sector is still strong in terms of occupier demand and investment activity.

We’ve just finalised our second quarter statistics for take-up and they reveal that there’s actually been an increase in take-up activity, mainly due to expansion within the food logistics sector and eCommerce.

In the short term, and in the long term, it’s always been about food logistics and historically, we’ve always seen that, it’s not an up-and-coming trend. Australia specialises in food production and that will ramp up even more. Coupled with that is the take-off of eCommerce. The overall eCommerce penetration rate is currently over 10%, according to National Australia Bank figures – see chart below.

Australian Industrial Property MarketsSass J-Baleh, Head of Industrial and Logistics Research at JLL Australia, remains positive about the outlook for industrial and logistics growth

Figure 1.0 Australia eCommerce growth

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In terms of the total dollar spend on online retail sales – in the past 12 months the spend was AUD 34.2 billion, much higher than last year at AUD 30.5 billion and the year before.

Online supermarket retail activity has historically been quite low, but there’s been a change during COVID. Consumers who have probably never shopped online before, have started to during the pandemic. This trend will continue and activity is likely to be much higher. We are therefore going to see major supermarkets like Woolworths and Coles ramp up their eCommerce logistics and supply chain to meet their online platform offering.

Online retail supermarket penetration rates in Australia are quite low at around 3-4%. However, during the pandemic, Woolworths and Coles closed down some of their retail shops in order to fulfil online orders.

This trend could flow into other retail businesses as people opt to purchase online rather than go into stores in order to limit human interaction. Some of these changes in behaviour will remain and represent structural changes that may be long term.

The structural tailwinds from eCommerce will continue in the medium to long term, and the food logistics sector,

Figure 2.0 Australian discretionary vs. non-discretionary retail spend (% change rollig 12mth)

Discretionary Non-discretionaryTo note: as at May 2020Source: NAB, ABS JLL Research

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particularly in the cold storage space, will continue to ramp up over the next decade. It’s all about non-discretionary retail spend. The demand for consumer staples is relatively inelastic. If we have a recession – and we’re likely to head into a technical recession with second quarter growth going into negative territory – people will still require food and basic medical supplies, so all that will continue. That’s why the sector has been relatively resilient during the pandemic.

Some people talk about bringing back onshoring for manufacturing. I don’t think we’re going to see a huge trend there, but we might see it in certain sectors for example, medical manufacturing.

It is a good lesson learned. Having an agile supply chain network is the ultimate goal, however this also needs to be balanced with supply chain risk management.

The most interesting trend going forward, in the medium to long term, is going to be on inventory levels. Businesses might hold more inventory which would be a bit of a reversal of what’s been happening for the past 20 years whereby inventory has been shrinking. It’s all about risk mitigation. The share of costs associated for holding inventory is quite large, but if something like COVID happens again, it’s about having the buffer stock in order to meet demand. So, we might see a trend in particular sectors, for example in the pharmaceutical and food industries, increasing their average inventory levels. Again, that translates into potentially more warehouse space requirements.

It is a good lesson learned. Having an agile supply chain network is the ultimate goal, however this also needs to be balanced with supply chain risk management.