I recently spoke at the Property Council of Australia’s Investment and Development Conference in Melbourne. I also spoke on a panel with local and foreign banks at the Real Estate Investment World conference in Singapore. On both occasions the topic was capital flows and funding markets, an area that is essential to understanding the dynamics of investment in commercial real estate. In preparation, I reviewed the official statistics in conjunction with my observations of transactions at Commonwealth Bank. The following are some key points.
Offshore demand remains very strong but…
- The size of the Australian commercial real estate market and the ability to acquire assets is inhibiting volumes. Total volumes have fallen because there are less commercial properties for sale.
- Using industry data we estimate that the percentage of commercial real estate sales to offshore participants fell from 52% in 2015 to approximately 45% in 2016.
- Australia’s relative attractiveness in the global commercial real estate market has declined marginally as asset valuations have firmed and 10-year bond yields have risen. In any global market, capital flows to Australia move with its relative attractiveness versus other jurisdictions.
- Capital restrictions in markets like China have yet to have a significant impact on the market as many enterprises have capital outside of China.
- An estimated US$13 trillion of central bank stimulus is buoying global liquidity. This is softening the impact of the narrowing spread between Australian cap rates and bond yields.
- Australia is seen as a resoundingly strong and safe place to invest in an increasingly unstable world with elevated geopolitical risks.
- We are seeing investments from Korea and growing interest from Japan alongside unabated demand from China, Singapore, Europe, North America and the Middle East. High net worth individuals and families, private companies and state-owned enterprises are increasing their presence.
- Offices still attract a disproportionate amount of capital, followed by hotels and industrial properties.
More sources of debt financing
- Offshore banks, particularly from Asia, have increased their presence in the market.
- Non-bank lenders are emerging as alternative sources of senior and mezzanine debt financing, particularly development finance. They are also active in filling the void created by domestic banks with respect to foreign real estate purchases. A number of funds have been established to target higher returns from segments of the market to which domestic banks are no longer increasing exposure. In the Federal Budget the Australian Government announced a planned legislative action to extend the powers of the Australian Prudential Regulation Authority to address growth in the non-authorised deposit-taking institutions space.
- Positively, major investors in Australian commercial real estate retain strong balance sheets. The leverage of Australian real estate investment trusts (REITs) has fallen from 38% in 2008 to 29%. Over the same period, bank debt, as a proportion of total debt funding, has dropped from around 75% to 50% as the REITs have turned to the debt capital markets for longer tenor and diversity of funding.
In previous real estate cycles the major domestic banks played a larger role in the supply of credit and were a key source of market discipline. It will be interesting to see how this cycle evolves given the greater presence of non-bank financiers.
Understanding the nature of the offshore investors and the sources of debt financing is fundamental to the planning of the cities of the future.
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 CBA estimate based on Jones Lange LaSalle, Colliers office transactions over $50m and CBA industrial transactions.
 Company reports, IRESS, FactSet
 Company reports, IRESS, FactSet