Commercial real estate in 2023: Industrial rides out the storm as office and retail suffer
For commercial assets, 2023 was a generally gloomy year with a few bright sparks.
While industrial real estate proved the asset class most resilient to the interest rate hikes, office rents fell, and retail continued to struggle, although there were some glimmers in the gloaming.
Among them were the unveiling of the tallest mass timber tower in Melbourne by global developer Hines and work finally starting on the old West Olympia Theatre in Sydney’s Paddington to turn it into a buzzy new hotel, cafe, restaurant, wellness and entertainment precinct.
“This year has been a challenging time for all asset classes, with higher interest rates, uncertainty and inflation,” said Ben Burston, chief economist and head of research and consulting at Knight Frank. “Industrial has been better able to withstand the pressures with really strong rental growth, so investors are still keen to increase their exposure to industrial assets.
“They continue to want the core sectors of office and retail but the living sectors are also performing well, like Build To Rent, student accommodation and retirement living, because of the shortage of rentals.”
At Ray White Commercial, head of research Vanessa Rader also admits it’s been a tough year, with industrial proving “the best of a bad bunch,” she said. “We have the catchline ‘Survive to 2025’, which feels appropriate as it will take a while to improve.
“Income returns continue to maintain, albeit slightly behind 2022, but capital returns have seen the greatest change impacting the total return results for most asset classes this year.”
Rader’s figures also show industrial as the star performer when rising rents are factored into the long-term total returns, showing a 1 per cent increase to bring total returns to 5 per cent this year.
The tourism market is doing well, too, with even higher total returns of 5.3 per cent, driven by a jump in occupancy and daily room rates for accommodation after the return of international visitors.
That healthy outlook has encouraged a flurry of new hotel construction and openings over 2023, with the newest set to be Australia’s first 25hours hotel development precinct, a joint venture between Central Element and Boston Global Group, scheduled to open in December 2024 in Paddington.
For the office market, the challenges since COVID-19 are still there, impacting vacancies, effective rents, incentives and yields, making it the loser of 2023, recording declines in capital value of 9 per cent over the past 12 months.
Retail showed an overall result of -3.8 per cent, although the medical sector has fared well with a 4.2 per cent rise in returns against a loss in capital growth, bringing total returns to 2 per cent.
The landscape is incredibly uneven, however, says JLL’s Real Estate economist Ronak Bhimjiani. Shopping centres relying on stores that sell discretionary items are faring less well than those selling non-discretionary goods or those with childcare centres.
“Discretionary spending has been coming down and will continue to do so, with interest rates staying high,” he said. “At the same time, non-discretionary spending has resumed and is moving higher. Neighbourhood centres are also doing reasonably well.”
Yet the national results do conceal pockets of staunch performance. In the office market, for instance, Queensland is performing well, according to Rader, with the Brisbane, Sunshine Coast and Gold Coast CBDs proving the standouts. “There’s been so much investment in infrastructure with the upcoming Olympic Games,” she said.
“There’s been a big uptake in offices as the population continues to increase, too, and there haven’t been huge amounts of stock added compared to Sydney and Melbourne. And there has been that flight to quality, with premium and A-grade offices showing higher occupation rates, although rents are lower and incentives are at a historical high.”
That appetite for higher-grade buildings with better sustainability credentials, partly to satisfy ESG requirements and partly to attract staff back to work, has benefitted developers like Hines, which has just finished the latest of its 27 global mass-timber offices and the first of its portfolio in the Asia-Pacific, the 15-storey T3 Collingwood.
Built using 2358 cubic metres of cross-laminated timber and a further 874 cubic metres of glue-laminated timber from Victorian-based manufacturers, its design reduces carbon emissions by 34 per cent compared with concrete and steel construction, as well as creating a work environment that’s said to foster creativity and spark innovation.
“There’s been some negative talk about office, but our view is, if it’s a high-quality, sustainability-focused building that delivers a lot of amenity, inside and out, then we’re seeing good demand from tenants and investors,” said David Warneford, country head of Australia and New Zealand at Hines.
“They are positioning themselves for the next 10 to 20 years to bring people back into the office and restore the balance. The young generation coming in especially is prioritising ESG. We’re always looking for opportunities for new towers.”
In some areas of Melbourne, however, there have been steep rises in vacancies and a lot of sub-leased stock in the market, advises Burston.
“But then the eastern core of Melbourne and the northern part of Sydney’s CBD have both performed well and we’re seeing rents rise for good-quality buildings. Buildings offering better amenity, in better locations and newer assets with improved sustainability credentials have benefitted. Brisbane and Perth are also in growth mode.”
Retail is simply continuing its now decade-long battle of survival, Burston believes. The challenges include the move to online shopping, overseas market competition, interest rate rises and cost of living increases.
“But we are hopeful for 2024,” he said. “We won’t see an immediate turnaround, but we hope by the second half of next year that some of the big questions around inflation and interest rates will have been answered, and there’ll be more certainty in the market. Yet, history suggests that now is a good time to enter the market for better returns.”