Australian Markets At A Crossroads

Source : The Business Times, July 17, 2008

By DAVID GREEN-MORGAN

AUSTRALIA'S commercial property markets are very much at a crossroads as we enter the second half of 2008. Investors are increasingly nervous as volatility in credit markets continues, banks of all sizes revaluate their exposure to the property market and new lending rules are imposed.

Within the capital markets, transaction volumes have dropped significantly with figures from DTZ Research showing a 26 per cent drop in Q2 compared to Q1 2008. This reduction in activity is occurring because Australia has yet to go through the mark to market exercise that has happened in the US and more dramatically in the UK.

Indeed, towards the end of 2007, there was a view held by many commentators that Australia was isolated from the tumultuous events overseas, protected by a strong economy based on the growth in commodity prices. However, the turn of the year saw a significant change in sentiment as many Australian funds with overseas exposure started to struggle, and this has now moved into the mainstream market.

The decline in volumes shows that many people are expecting a further fall in values, but with such a quiet market the fall in values could be exa-cerbated the longer the market remains in hibernation. Australia operates a financial year that ends on June 30, so the majority of investors are now going through the revaluation exercise which will show them exactly how much values have moved over the last six months.

This is a particularly difficult job for the valuers as such a quiet market provides little evidence of where prices sit today, but most observers agree that yields have moved out between 25 and 50 basis points for prime stock and even more for secondary stock. The days of yield convergence are over and the debate now revolves around how far the market will fall and when we will hit the bottom.

The salvation for Australian markets could be the low vacancy rates that currently exist in the major CBD office markets. Perth and Brisbane are leading the world with vacancy rates under one per cent, with Sydney, Melbourne, Canberra and Adelaide not far behind. Although leasing activity has slowed since the start of 2008, the fact that there is so little available office space means rental growth will continue in all markets until new supply becomes available.

That new supply may be further away than first thought as tighter credit markets and surging costs of construction make it even more difficult for developers to justify speculative new development. In many markets, unless construction is underway or close to beginning, projects may well be deferred until the market picks up again. The only exception to this is where a significant pre-commitment has been entered into, but many developers will not begin construction until at least 80 per cent of the building has been pre-committed.

Retail markets are holding up surprisingly well despite consumer spending slowing dramatically in response to rising fuel and food prices. High interest rates are also a significant headwind to the consumer and they are likely to remain so while inflationary pressures are prevalent in the economy.

During all this turmoil, it is the cashed-up private investor and equity buyers who are increasingly active in the market. Many of these investors have been priced out in recent years as values soared and listed property trusts expanded their asset base significantly. However, now that the tide has turned and debt is difficult to obtain, these investors who don't need access to debt and credit markets are increasingly active, especially at the smaller lot size. In Q2 2008, private investors made up over 50 per cent of the purchasers during the quarter, while listed and unlisted property trusts were net sellers.

It may be well into 2009 before we see any improvement in the market in Australia, as investors wait for the market correction to occur and stay on the sidelines until they are convinced that true value has returned to the market. Occupiers are also more cautious in their expansion plans, waiting to see if the worst is over before planning on any new space.

The writer is Asia Pacific research director, national research director, DTZ Australia