Significant opportunities, down under

Real Assets Research team
PDF 663.3KB
03 April 2017
  • 25 consecutive years of growth: services a major contributor – Australia is about far more than mining;
  • Sydney experiencing strong rent growth – likely to continue as demand outstrips supply;
  • Countercyclical opportunity in Brisbane: Perth some time away from recovery.

2016 saw Australia celebrate its 25th consecutive year of GDP growth. And, with average growth of 2.7% per annum forecast over the next three years,1 the end of the economic expansion is nowhere in sight. However, it is not just the length of this expansionary period that stands out, it is also the magnitude. Over the last 20 years, the Australian economy has grown faster than any of the G7 countries (3.2% p.a. compared to the G7 average of 1.9% p.a.)2 and now boasts GDP per capita second only to the US and Germany3.

A commonly held view is that Australia is an economy in transition, historically driven by the mining sector. While the ups and downs of the commodities cycle play a part in currency movements, the mining sectors’ direct economic contribution is much smaller than most people assume. In 1984, mining accounted for just 4% of GDP. By 2016 this had risen to almost 7%. Over the same period financial and business services grew from 13% to 21%. Add in other services, such as tourism, education etc. and the gap between primary and tertiary sectors grows wider still. While the economy may be transitioning, it is, and continues to be, a service sector based economy.

Population concentrated in State capital cities

Urbanisation is a global phenomenon but nowhere in the developed world is this more pronounced than Australia – three states, New South Wales (NSW), Victoria (VIC) and Queensland (QLD), which collectively represent 36% of Australia in terms of land area, account for more than 75% of the population and generate more than 75% of Australia’s economic output.4

In addition, the population is highly concentrated within the 8 state capital cities.5 Within VIC, 76% of the population6 live in the Melbourne metro area; in NSW, 64% live in Sydney. Brisbane, on the other hand, represents only 48% of Queensland’s population.6 Despite this, the state capitals of the three dominant states represent 50% of the national population.

It is no surprise that these main cities have also set the pace for job growth, further intensifying the concentration of economic activity. Between January 2007 and December 2016, the total number of people employed across Australia increased by an average of 181,600 per annum. Of this, 58% of new jobs were located in Sydney, Melbourne or Brisbane. Add Perth into the mix and this figure increases to 71%.7

More recently, the financial centres of Sydney and Melbourne have stood far above the rest. Between January 2015 and December 2016 total employment grew by 203,800 per annum. Sydney accounted for 28% of all new jobs, Melbourne 36% and Brisbane 9%. In contrast, Perth’s share fell to 2% as the city rebalances following the commodities boom.

Given the dominance of the state capital cities, by focusing on a small number of markets investors can secure exposure to Australia’s continuing growth and a range of potential investment opportunities.

Sydney: The growth story isn’t over yet

In a rare example of good timing by developers, Sydney’s latest development cycle peaked at the same time as strong growth in office employment. In fact, as office employment increased, supply in Sydney began its downward path, following the completion of the International Towers developments at Barangaroo, in the West of the CBD.

These developments have resulted in vacancy rising at the top-end of the quality spectrum.8 Among secondary stock, vacancy rates are at historic lows. This is partially due to the withdrawal of office stock to make way for the construction of the Sydney Metro. Between 2015 and 2018, office withdrawals could reach almost 600,000 sq m,9 much of which focuses on older offices in the Sydney CBD, particularly around Martin Place.

The net effect of this displacement of tenants, combined with strong underlying occupier demand, has created robust market dynamics. During 2016, net effective rents increased by 42% in secondary stock within Sydney CBD, compared to 22.5% for premiumquality space as occupiers priced out of the highestquality locations and buildings have rushed to secure space on long-term leases.

While net effective rents for secondary assets are increasing fast, a narrowing of the differential to premium space could support value-add initiatives on the poorest quality stock. Strong rent growth within Sydney CBD has also extended to other submarkets, such as the North Shore and, further out to the West, Parramatta. After experiencing strong tenant demand over the last two years, Parramatta has secured its position as a favoured submarket for many occupiers. With the development of new suburbs in the North West and South West of Sydney, as well as the new airport at Badgerys Creek, Parramatta could capitalise on its location well into the future.

Rents capped in Melbourne

The current development cycle in Melbourne appears to be on pause in 2017, before completions accelerate in 2018 and beyond. Within the CBD, net additions averaged around 70,000 sq m per year between 1970 and 2016, primarily driven by activity within the Docklands area. According to JLL forecasts, between 2017 and 2021, completions should average around 80,000 sq m per year. Melbourne remains the only CBD of the big four state capitals that is expected to see completions increase over the next five years and remain above the long-term average. Given the ease at which development can commence within the Docklands area, rents appear capped, as any further growth would merely accelerate new development. Low land values, relative to Sydney at least, are an additional driver of responsive developers. Given this curb to Melbourne’s rental growth, net effective CBD rents could begin to converge with those in Brisbane and Perth.

Brisbane’s recovery emerges: Perth’s lags

After suffering from exposure to the weakening resources sector, Brisbane has now begun to recover, with eight consecutive quarters of positive net absorption.10 Completions during 2016 reached around 77,000 sq m but should average just 6,200 sq m p.a. between 2017 and 2021, leading to the CBD vacancy rate peaking at 17% in 2017.11 While this remains high, low stock additions and recovering occupier demand is likely to result in net effective rent growth of 5.6% p.a. over the next five years, as incentives (and the vacancy rate) begin to reduce. Still, Brisbane remains a counter-cyclical market at present and carries more risk than Sydney CBD and its fringe submarkets.

Of the main cities, Perth represents the highest risk. Further away than Brisbane in its recovery, CBD vacancy is not expected to peak until 2018, when it could reach 25%, according to JLL forecasts. Within the Perth CBD, sub-lease availability, often regarded as a barometer of business confidence, increased throughout 2015 and into 2016, despite experiencing a slight decline over the second half of 2016. Nevertheless, sub-lease availability remains high at 5.1% of total stock, compared to the 20-year average of just 1.6%. Net effective rents are still falling and are unlikely to recover until 2019. Currently, incentives are growing, which is encouraging some occupiers to move from fringe locations to the, now affordable, CBD.

Understandably, given the strength of many Australian office markets, investor demand and competition for assets has pushed yields lower. Despite being the weakest of the four major office markets, prime yields in Perth stood at 6% at the end of Q4 2016, 30bps below the previous low of 6.3% during Q4 2007. Prime yields in Melbourne were 80bps below their previous low, at 5-10bps above prime Sydney yields (4.9%), compared to a 10-year average premium of 35bps. Given the differing outlook between these two markets, there appears to be either further upside to valuations in Sydney or potential weakness in Melbourne. At present, there appears to be little value in Perth, at least in the short-term, given its poor outlook.

Australian office markets offer something for everyone

In all, the Australian office market appears to offer something for everyone: strong rent growth and valuation upside in Sydney, early-stage recovery in Brisbane, a slight income premium in Melbourne and higher risk opportunities in Perth. Add in the value add angle through repositioning stock in Sydney, or taking on leasing risk, and the list of potential investments grows further.


1 Bloomberg Consensus forecasts, 4 April 2017
2 Average annual growth of G7 countries, 1995 to 2015, weighted by 2015 GDP
3 Relative to G7 countries. Source: OECD, data as at March 2017
4 Australian Bureau of Statistics
5 Sydney, Melbourne, Brisbane, Adelaide, Perth, Hobart, Darwin and Canberra, Australian Bureau of Statistics, data as at 2014
6 QLD has 5 cities, excluding the state capital, with a population of 100,000+, compared to 2 in both NSW and VIC. The Sunshine Coast, Gold Coast, Cairns and Townsville are tourism hubs; Toowoomba (78 miles west of Brisbane) is a major logistical centre and inland port
7 Australian Bureau of Statistics, 6291.0.55.001 Labour Force, Table 2, February 2017
8 Premium vacancy in Sydney CBD increased from 5.2% in July 2015 to 12.3% in January 2016: Property Council of Australia data as at February 2017
9 Knight Frank data as at September 2016
10 JLL data as at March 2017
11 JLL forecasts as at March 2017
Disclaimer: © 2017 AXA Investment Managers and its Affiliated Companies. All rights reserved. These pages are not intended as an offer or solicitation, or as the basis for any contract, for the purchase or sale for any fund or instrument. The information contained in these pages shall not be deemed to constitute advice and should not be relied upon as the basis for a decision to enter into a transaction or for any investment decision. The analysis expresses the views of AXA Investment Managers Real Assets Research and Strategy team and may be subject to change without notice. AXA Investment Managers expressly disclaims any responsibility for (i) the accuracy or completeness of third party data (ii) the accuracy or completeness of the models or estimates used in deriving the analyses, (iii) any errors or omissions in computing or disseminating the analyses or (iv) any uses to which the analyses are put. The information contained in this document may not be reproduced or circulated without our written authority.