Global correction in commercial property ‘headed Australia’s way’

Financial Review, Nick Lenaghan

A price correction in commercial real estate that is gaining steam in the American and European markets will soon make its way into Australia, according to the research head at Heitman, a real investment platform with more than $78 billion ($US53 billion) under management globally.

As Heitman’s head of global investment research, Mary Ludgin is in a good position to gauge how rising rates and inflation are playing out through the property sector and how big institutions are shifting their investment strategies in response.

The first sign of prices shifting has been an expansion in yields or capitalisation rates, commonly known as cap rates in the sector.

“Definitely there has been upward pressure on yields around Europe and the US. I would imagine that would translate here as well,” Dr Ludgin told The Australian Financial Review during her recent visit to Australia.

While a price correction was already under way in the shopping centre sector before the emergence of COVID-19, this was exacerbated through the upheavals of the pandemic period. Indeed, some investors would argue that the sector had now been oversold, Dr Ludgin said.

But signs of a correction are emerging across commercial real estate classes more broadly, even for those with low vacancy levels and high rental growth, she said.

“Now it’s across the board, even in industrial and logistics, which is the strongest of the property types. Price correction has happened across the board.”

Brakes on big deals

Whether and when a correction in commercial property values will take place are questions that have dominated discussion in the local market for much of this year. Listed property stocks as a sector have given up close to 22 per cent so far this year, a retreat that is yet to make itself felt in the direct market in a meaningful way.

Instead, major deals have gone into a pause, and the fourth quarter of this year is shaping as the second slowest since 2016. Transactions have stalled as sellers and buyers wait out what most expect to be a reset in prices. But with fewer deals being struck, there’s less evidence to support fresh valuations.

Nevertheless, Dr Ludgin and her team are charting what the new contours of investment will be, as capital adjusts to an inflationary world.

Some important themes underpinning a post-pandemic strategy are already apparent: onshoring of economic activity as the world de-globalises and a demographic shift toward older populations, along with the impacts of migration and climate change on real estate.

“We’re observing a taking away of institutional portfolio share for office and retail and [a] shifting into alternatives that can either provide resilience during periods of recession or that can hedge inflation,” Dr Ludgin said. Passing inflation through to tenants has become paramount in the current economy, she added.

“We’re watching investors bulk up in their exposure to sectors that have shorter-lease terms, like self-storage, like hotels and like residential [for rent].”

Heitman manages about $1 billion of global capital invested in Australia. About $5.9 billion of its global assets under management come from Australian sources, including super funds. Many of those investors are looking for what they cannot easily access in the Australian market, such as medical offices, self-storage or rented residential, Dr Ludgin says.

“They’re accessing, fully developed, rented residential. They’re investing in that meaningfully in the US. That’s part of what Aussie super funds have been eager to acquire, even as that sector develops in Australia.

“They’re investing in Europe as well, where there are some deep pools of for-rent residential in Germany, in the Netherlands and France and in Ireland and the UK.”

She said that as central banks around the world fought inflation with tighter monetary policy, economic slowdowns became more likely.

“It may push the globe into contraction. That’s a scary moment for investors across the board.

“What real estate investors have learnt is that these periods of economic correction often translate into pricing correction in individual asset classes. What comes next is a great period of opportunity.”