Savills Weekly Cut: Volume 1

You will find that financial market and political situations will be referred to, as we believe property as an asset class is influenced by broader market forces and political and economic events and circumstances. We look forward to your feedback.

Bushfire Crisis Economic Impact

Australia has been hit by the worst and earliest bushfire season since and including Federation, with catastrophic impacts to lives and property. To date, 30 lives have been lost (sadly we lost another 3 with a jet water bomber crashing in the Snowy Mountains Thursday afternoon killing its American crew), over 2,100 homes have been razed and approximately 10m hectares have been burnt. The Californian fires in 2018 devastated ~800,000ha and the Amazon fires in 2019 ~900,000ha.

There have been over $1bn ib insurance claims (expected to increase), however many homes are uninsured, and many businesses and employment have been affected if not destroyed and ceased. It’s hard to estimate a near term impact to GDP, but early estimates are between -0.2 to -0.5% spread over Q4/2019 and 1H/2020 (year on year September GDP was +1.7%). The main drags to GDP will be in farm production, private investment and tourism, however local employment and business continuity will also negatively impact local GDP for these fire affected regions for a number of quarters. There will be positive impact in the ensuing quarters as insurance, the Federal Governments initial $2bn (expected to increase) in aid and residential construction filter through the economic system, however Savills Australia would estimate this could have a 6-12 month lag, due to bureaucracy and resources. 

STR (Smith Travel Research) reported their preliminary hotel performance data for Dec 2019, with a meaningful negative impact on tourism in the Sydney drive region (2hrs north, west and south of Sydney) as a result of the bushfires between Nov and Dec. STR found a -14.7% yoy fall in room nights sold, occupancy down -14.5% to 52.2%, average daily rate down -18.4$ to AUD$194.74 and revenue per available room down -30.3% to AUD$101.48. Separately, Sydney Airport numbers for Dec were released, down -0.4% in Dec, again with the bushfires and air quality blamed. Domestic passenger numbers grew +1.3% in Dec, however international visitors fell -0.6% driven by UK -3.8%, US -0.4%, Japan -6.1% and Canada -5.3%. Consensus has the impact of the bushfires to be a negative of -0.2% to -0.5% to 1H/2020 GDP, however this impact could grow if tourists don’t come back through the year. According to government department Austrade, tourism contributes 3.2% to GDP and 4.9% to employment (2016-17 data).

Donations to the bushfire affected areas and communities are approximating AUD$500m, however there is an emerging frustration that charities are being slow to distribute. It is expected Government initiatives and claims will exceed AUD$4bn in time, however the economic impacts in the affected regions will be large and elongated, hindered by red-tape, planning permissions and people themselves in their decisions to rebuild or sell. 

The human, environmental and property cost is immense, with the sheer magnitude of the devastation approximating the land area the size of England being hard to fathom. In support of those who have been affected by the devastating fires across Australia, Savills has set up a Bushfire Appeal.

Global Equity Markets at all time highs

Global asset markets are at or near all-time highs, supported by all-time low interest rate regimes of the major central banks and reinforced by Central Bank commentaries that rates will be low for longer. The S&P500 is trading on a forward 12mth PE of 18.6x vs the 5yr average of 16.7x and 10yr average of 14.9x. The 12mth trailing PE is 22.2x vs 5yr average of 19.8 and 10yr average of 17.6x. The Australian equity market is trading at all-time highs with the ASX200 is trading on 20.4x PE and the All Ords on 21.1x PE vs 40yr average of 15x and 4.1% dividend yield (right on the 40yr average).

At the World Economic Forum in Davos overnight, the IMF noted they expect global growth to rise an estimated 2.9% (3% prev at Oct) in 2019 to 3.3% (3.4% prev) in 2020 and 4.4% (4.6% prev) in 2021. The downward revisions are due to some negative surprises to economic activity in a few emerging market economies, notably India. They note “on the positive side, market sentiment has been boosted by tentative signs that manufacturing activity and global trade are bottoming out, a broad-based shift toward accommodative monetary policy, intermittent favourable news on US-China trade negotiations, and diminished fears of a no-deal Brexit, leading to some retreat from the risk-off environment that had set in at the time of the October WEO. However, few signs of turning points are visible in global macroeconomic data.” They also highlight that global financial conditions remain accommodative to stimulate growth. We will see, but certainly rates aren’t going up any time soon, with risks still to the downside.

The ECB kept rates unchanged, with its benchmark deposit rate at negative 0.5% and its main refinancing rate at zero. ECB President Christine Lagarde said the risks to growth remain to the downside but was less pronounced as uncertainty around trade waned (reference to the signing of the phase one U.S.-China trade deal). She also noted the weak inflation outlook would keep monetary policy highly accommodative for a prolonged time…rates low for longer.

Capital moving into non-vanilla property ownership 

Interesting article in the AFR regarding low interest rates driving more structured Real Asset and Real Estate transactions, including sale and lease back arrangements, that free up company balance sheets. Examples are Charter Hall’s $840m acquisition of BP fuel and convenience properties, Centuria’s $236.2m Arnott’s factories and NorthWest Healthcare acquisition of Healthscope’s $2.5bn hospitals portfolio. Of course there already exist petrol station AREITs, with Viva REIT the largest with an enterprise value of AUD$4.6bn (I assisted in this IPO in 2016). These are examples of passing the property off to property investors via REIT structures, and the operating companies carry out their day to day operations with their balance sheets freed up. I would point out that this was done in the last bull market where Myer and David Jones both sold down their property assets and that didn’t turn out so well for them, by not recognising and subsequently losing control of their primary asset…their face to their customer base. The challenge this time will be operating companies recognising their customer base can be fickle and that REIT structures answer to a different set of shareholders and operate to a different set of objectives.

We have seen our client base move down this route and we have reacted by setting up a Capital Advisory business unit, advising on debt structuring and capital raising services sourced both domestically and internationally. This is somewhat a departure from the traditional real estate broker, but it is something our clients are looking for from property specialists. It also dovetails well with our commercial sales and investment business lines, alongside fulfilling an investment demand for indirect property investment, particularly debt investments where traditional equity investors are turning to at this point in the cycle as part of a diversification play.

CBUS pulls trigger on Melbourne

It is reported that CBUS will go ahead and develop a slightly smaller office tower at 435 Bourke St, Melbourne. CBUS will build a 49 floor (originally proposed to be 58 floors), 59,000sq m (1,300sq m floor plates) office on the corner of Bourke and Queen, commencing end of 2020 for completion.

Kaufland pulls out of Australia

Two years after buying its first store site and 6mths after starting on it’s second, the business has decided too hard and is leaving. It said it has “decided to undertake an orderly withdrawal from the Australian market. The company will be concentrating its business on its European core markets in the foreseeable future.” “The future of Kaufland’s existing Australian investments, including properties purchased for retail outlets and distribution infrastructure, will be discussed with the relevant parties in coming days.” Clearly the incumbent supermarkets have a stranglehold on the industry. Click for Kaufland press release.

While on Retailing

Shopping Centres Australia announced the wind-up of its unlisted fund, selling 5 assets (~$70m) to private investors, highlighting our thematic that Privates and Syndicate investors remain aggressive to buy retail exposed to non-discretionary spending. Is this an emerging sign of a two-speed retail asset environment, where centres exposed to fashion etc or discretionary spending will continue to struggle for trade turnover and hence be subject to rental reversion over time and also struggle to find a taught market price? We believe yes and it has been the case for 12 months now, supported by lower funding costs and a freeing up of capital (both debt and equity) to certain investors. But is this generating GDP growth? We don’t think so, but it highlights re-arranging the deck chairs as yield-hogs chase income investments.

Another example, although on the opposite side of the ledger, is the report of Blackstone selling Melbourne’s Brimbank Plaza Shopping Centre to a Mulpha JV (20% Mulpha/80% Chinese investors) for ~$150m. In 2016, Vicinity bought the asset for circa $162.68m as part of a wider portfolio of Clifford Gardens Shopping Centre in Toowoomba and Forest Hill Chase Shopping Centre in Melbourne for $613.3m. The report states income of $12.3m, suggesting an initial cap rate of 8.2%. This is the second go Mulpha has had at this asset after first due diligence in July 2019 at a reported price of ~$160m. Click for link to article.

Lendlease to sell another Retail asset

The AFR is reporting that LLC, via APPF, is looking to sell its 50% share in Brisbane’s blue chip mall Westfield Carindale. At 30 June 2019, valuation has 100% at AUD$1.706bn, with the listed Carindale Property Trust (CDP) valuing its share at AUD$840.1m or 4.75% cap rate. It will be interesting if CDP/Scentre looks to buy the other half, but you would have to think APPF has already tried this. The asset would have strong appeal to international buyers, especially from Asia where they can source cheap margin debt and have a currency advantage.

Retail of the Future

Listed European REIT Unibail-Rodamco-Westfield (URW) has published an interesting report on their view (based on survey data) of Retail and how the Mall may evolve over the next decade. While URW is UK/Europe/US facing, their findings can be related to the Australian consumer and Retail/Mall offerings…ultimately, the developed world consumer is beyond borders and nationality. URW break their views into 5 trends:

1)Anti-Prescription - Frustrated shoppers reject prescriptive retail experiences based on inaccurate data, in favour of free-range browsing and impulse shopping. URW data suggests the consumer prefers to physically browse, than be dictated to by digital/online algorithms that assume consumer intent and interests. A by-product of In-house browsing is impulse buying…again not likely via digital consumerism. “Digital brick” retailing will develop where an online retailer will embrace physical, but use their stores to offer different stock and fresh ways to experience their brand eg Netflix and Spotify.

2)Upside-Down Retail - 2025 is forecast to be the tipping point year when more than half of retail square meterage will be dedicated to experiences rather than product. URW data points to the consumer demanding experience, means 40% of retail space will be dedicated to experiences, with surveys supporting the consumer will pay more for a deeper brand relationship and experience. Experiences can encompass escapist via gaming in “escape rooms”; and studios for podcast and video production; promoting new technologies retailing; customisable clothing; furniture rental services and virtual reality holiday experiences. Another thematic URW fund is educational, where entrepreneurs can practice selling, market testing products and ideas.

3)Self-Sustaining Stores - Retailers will reimagine their business models from the bottom up, to create factory stores that are 100% self-sustaining. The whole supply chain will collapse down to the point of sale. I’m not so sure how this relates to a Mall and rents, however URW data highlights consumers want to see evidence of sustainably and conservation and will pay more and prefer to support socially aware companies over others. Essentially a self-sustaining store requires a business model that locates everything at or near the point of purchase. These stores are essentially factories on-site. This is an expensive business model, so harder to see efficiencies.

4)Retail Surgery - Retail outlets will become more like doctors’ surgeries, diagnosing our precise needs based on fact, not presumption. This is an interesting one as it presumes consumers are prepared to provide personal data from shopping habits all the way thru to body scanning, DNA, saliva testing and biometric data. Essentially shopping would become a personal consultation. Not sure I will buy into this, given I opted out of the Federal Govt centralised medical data bank, My Health Record.

5)Locally-Morphed - Retail spaces will morph to fit their local environment and community, providing everything from local brands to nostalgic community experiences. URW believes an international brand will offer local product to fit the consumer’s immediate environment and the individual communities they serve? This will see greater brand recognition loyalty and price premium versus more generic offerings. This could include retail environments to offer nostalgic social clubs, such as gaming cafes for board games and social events for the local community and common areas that replace backyards as communities densify.

The read-through of this report is that retailers need to evolve their interaction with the consumer and adapt and embrace omni-channel retailing. Poor retailing will be that where the in-store is a throw-back to 1990’s of shelves of product and unskilled shop assistants. Successful retailing will be experiential, informed, consultative, locally relevant, and upskilling congregational hubs. The Mall will need to adapt with investment into technology; accept higher turnover of tenants and seasonality tenants and; non-traditional consumerism meaning rent will need to be determined not just from sale of goods but also from sale of services. Hub locations will be even more valuable with access to population density and improving socio-economic demographics. Community space will also be in demand…so in the future do we pay for time in the roof-top parkland as we do for car parking?

Aussie Employment improves driven by part time, however underemployment remains stubbornly high at 8.3%

Employment fell to 5.1% in Dec 2019 (5.2% Nov), up 28,900sa (full-time up 300 and part-time 29,200), with the participation rate steady at 66.0%. Over the past year, employment has grown 2.1% or 260,900 people vs the 20yr average of 2.0%. NSW, VIC and QLD saw employment growth, while SA, WA and ACT saw marginal falls. Yes people are being employed, however there is still a large underemployment rate of 8.3%, meaning there is still slack in the economy despite record low interest rates. This is further evidence that rates have stopped working for the economy and that fiscal policy is required to promote GDP growth.

NAB Cashless Retail Sales Index

The NAB survey (measures all cashless retail spending by consumers using debit and credit cards (both in person and online), BPAY and Paypal) found that Dec sales growth was down on Nov and Oct, suggesting Dec ABS Retail Sales will be down -0.1% and that the Black Friday and Cyber Monday sales promotions in Nov brought forward retail sales from Dec. This won’t be a great result for retailers who have had tough times, and may result in more retailer closures/bankruptcies. Coupled to this could be the negative drag from the bushfires. The NAB survey found that “household goods, department stores and clothing and footwear all saw strong November prints but are (based on our forecasts) likely to fall in December, consistent with Christmas spending brought forward.”

Westpac Melbourne Institute Index of Consumer Sentiment

The WMI consumer sentiment index fell -1.8% to 93.4 in Jan 2020 from 95.1 in Dec 2019. It was expected to fall given the impacts of the bushfires, but perhaps the fall wasn’t as great as its potential… WMI note that the Queensland floods in 2011 saw sentiment fall 5.8%, however from a much higher index level of 111.0 suggesting current sentiment maybe tough to get much worse, given it averaged 89 over a 15mth period post the GFC from Mar 2008 to May 2009.

Consumer Sentiment Index

The low recording is consistent with generally low spending levels, but is perhaps contradictory to a stock market trading at all-time highs. The index recorded declines in all components (except time to buy a dwelling reflecting how interest rates are only helping one part of the economy now), despite the easing’s in rates, highlighting that monetary policy is no longer having a meaningful economic impact, unless you have a mortgage and then you continue to make the same repayments and not divert to other spending. This begs the question why markets are still pricing in a 40% chance of another easing on the first Tuesday in Feb.

Coronavirus becomes a global markets risk

Global markets started to react to the new animal-to-human respiratory disease as it started to spread internationally. Asian Equity markets started to sell off in particular, with investor rotation into western markets and risk-off bonds.

Why are markets concerned? Back in 2002/03, SARS (Severe Acute Respiratory Syndrome) killed 800 people and infected 8,000 across 37 countries. It was thought to be contagious from animals to humans. Early reports on coronavirus is that while it originated out of a meat market in Wuhan China, it maybe also human to human transferable. 

While SARS appears to be a more dangerous virus at this stage, markets are cautious as in 2002/03 there was negative economic impact on tourism and consumption patterns, where Singapore and Hong Kong fell into recession. According to the Asian Development Bank, the cost of SARS in terms of lost GDP in nominal terms for East and Southeast Asia was about USD$18 billion or 0.6% of 2003 GDP. Financial market reactions were felt more in Asia through their stock markets, rather than other asset classes. That said China is now a far more important economic force today, than what it was in 2003, so the economic impact of a full bore pandemic could be far more severe.

The World Health Organization, at this stage, has decided to refrain from declaring China’s coronavirus outbreak a global emergency.

China Coronavirus Stats

• Epicentre Wuhan as well as another 7 cities are locked down by Chinese authorities
• 18 Deaths
• >647 cases across 23 Chinese provinces including HK and Macau
• 1 Case in Brisbane
• 1 case in Washington DC
• 1 case in Japan
• 1 case in Thailand
• 1 case in Singapore
• 2 cases in Vietnam

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