Categories: Investment

As we purchased a major asset in suburban Brisbane this year, we wondered if our investor clients would join us on the journey.

Our observation of investor interest in the Sunshine State capital today is quite a turnaround on the sentiment last year. Looking at an asset we recently purchased from Stockland, located in Brisbane for $40million, with plans to undertake a large mixed-use development, the investor appetite well exceeded expectations.

The property consists of a dated retail building and a 6,400sqm b-grade office tower leased to a range of service related tenants situated across 1.3 hectares of land. But itis the property’s strategic location in a growing inner western suburb that will allow us to undertake a mixed use development, representing strong value from both an income and development upside perspective. Early stages of planning show that the development has the potential to be a $300million project. The location is comparable to some of the key suburbs in Australia like Chatswood in Sydney and Toorak in Melbourne.

Why the shift in investor sentiment on Brisbane?
It’s a confluence of factors. Certainly Sydney’s returns have been lacklustre of late so investors are looking elsewhere for opportunity. More broadly, the return of a Federal LNP government has given investors certainty. But for Brisbane specifically, some macro fundamentals are helping revive confidence: interstate population shifts have buoyed optimism, increased infrastructure spending is a positive sign (well overdue, some might say), mining has been reinvigorated, international students are flocking there and the reality is that Brisbane much-discussed apartment downturn has turned out to be far less dramatic than the jawboning that preceded it. That predicted death of Brisbane units was more like a long bout of the flu.

At White & Partners offices, we often discuss how investors would have responded to that Stockland purchase 12 months ago. They would have balked, we think.

We’ll keep you updated on progress in this newsletter in coming months.

More recently, they have been leasing and even buying the whole building. So, are they competitors to traditional landlords or allies? The flexible office solution sector has been valued at $960m, but how sustainable is it?

There’s a report out suggesting 30 per cent of Australia’s total office space will be classed as “flexible” by 2030. That’s an increase to 8.5 million square metres, from 505,000sqm today.

For our commercial investors, there’s a substantial debate to be had around the benefits and the challenges these flexible co-sharing tenants create. Ray White’s specialist Commercial Leasing division has some interesting insights from clients in recent months.

For some landlords, they see being able to attract co-working tenants at a time when the sector is booming as a strategic advantage. Tenants (often start ups, creative companies, and teams of millennials) are in abundance, and they’re attracted to no BG, no minimum tenure requirements, an established environment, broadly overall less risk and greater flexibility in the early days of a business’ life cycle.

The downside is that partially leasing to co-working spaces can be a deterrent for more established businesses, traditional tenants who prefer formal work attire and conservative work layouts. There’s also potential economic disparity between the fixed long-term nature of leases with these co-sharing companies (roughly 7 years) against the short-term arrangement with their co-working tenants. Particularly with chatter of economic uncertainty, the potential that these start-ups may forgo space if times are tough could result in higher vacancy rates.

This is probably why the likes of Wotso, WeWork and Victory are evolving their asset-light model of purely leasing space in recent months with a new intention to lease entire buildings or even owning outright, effectively removing the traditional landlord.

WeWork has the full occupancy of Mirvac’s prominent 20,000sqm tower 55 at Market Street in Sydney, and is in talks to buy the tower at 401 Collins Street Melbourne for about $80m. This is on top of WeWork already securing 320 Pitt Street in Sydney and Brisbane’s 25 King Street.

Sure, handing over a whole building to these organisation removes the issue of attracting other tenants, but the questions remains around how investors will react to acquiring a building with sole exposure to a single coworking subletting tenant? Will investors view in a similar light to a sole tenants of say IAG, BHP or CBA?

An interesting spin-off of this is owners sub-letting large spaces (say 1000sqm tenancies) within their buildings. GPT for instance has established Space & Co at 580 George Street in Sydney, while Dexus has unveiled similar facilities under the SuiteX banner.

Key questions landlords should consider before taking on co-working tenants:

• do they represent competition to other vacant space in the building?
• Will they be likely to attract or deter other non-shared space tenants?
• are they are a sustainable business moving forward?
• how much exposure is this sector is prudent?

 

Looking at our five largest residential apartment projects in Sydney, our initial observation is that risk is location specific and not correlative across the city. It’s also nowhere near as material as what the media is suggesting. Rather it’s marginally higher than normal market conditions.

Key observations:

• Finance is the most significant factor impacting settlement but it is not as severe as reported
• Foreign buyers and first home buyers are the biggest settlement risks
• Valuers are reluctant to agree to a sale price of an apartment acquired between 2016-2017 regardless if comparables support it or not. This is the most noticeable factor causing buyers grief around settlement
• Developers will need to revisit their target markets to focus on domestic & owner-occupiers.

Union Place, Jannali

Apartments: 89
Settlements: 80 out of 85 sold

In the Sutherland Shire suburb of Jannali we offered 89 apartments for sale as part of our Union Place project. Some 30 per cent of the apartments were sold to investors, all of which have settled. The vast majority of our buyers were owner-occupiers, many of whom are local to the area and it was a largely Anglo-Saxon buyers-base responsible for around 70 per cent of the purchases. To date, 80 of the apartments have settled with five not completed due to finance issues. These failed settlements were all first home buyers.

Interestingly valuations came largely inline with the acquisition price, even though majority were recorded in 2016 and 2017.

The Place, Ashfield

Apartments: 91
Settlements: 52 out of 80 sold

It’s a tale of two cities when you compare another of our developments. In the highly multicultural inner west suburb of Ashfield, White & Partners acted as the first mortgage funder for a developer who offered 91 apartments in a development called The Place. The fall-over rate on settlements has been much higher than Jannali, with some 30 per cent not finalising their purchase largely due to restrictions on foreign buyers in relation to money from China. Valuations were also off by 10-15% on acquisition prices achieved between 2016-2017.

Interestingly, buyers who purchased in 2018 all settled with no valuation or finance issues. Is this a sign that developers adjusted to market times by reducing their list prices and hence these purchasers not having an issue?

Across our other projects in Bondi, Epping and North Sydney, it represents the same story:

• If you acquired before 2018, you most likely will have an issue with valuation and hence finance
• If you are an FIRB buyer you are less likely to settle
• Owner occupiers are more likely than investors to settle
• First home buyers are most exposed to settlement risk

But this all said, overall it’s fair to say that based on our experience, there are enough settlements to keep the banks at bay and allow developers to hold their stock. An interesting observation moving forward is how long can developers hold, especially as the 50,000 apartments under construction in Sydney are due for completion in 2019.

In one line residual stock loans and purchasers are now more common than ever. Watch this space.

Private debt markets are thriving in a domestic credit environment where regulatory restriction is keeping banks from meeting demand for sub-investment grade loans including residual stock loans for instance, and non traditional borrowers. The stringent credit conditions APRA have imposed on our major banks has further deepened the need, demand and opportunities for private lending, particularly in real estate deals. As a result non-bank lenders like White & Partners are becoming crucial. The good news for borrowers in this market is that they now have multiple options to facilitate loans. And the great news for investors is the diversification opportunity in this high-yield asset class.

Despite being only four months into the 2019 calendar year, our debt book at White & Partners is currently sitting at over $300 million and has been active across all fronts, including origination, repayments and refinances. For instance on our land banks at Dural (NSW) and Ashfield (NSW), our loans have been and are being repaid via other NBLs, while another project in Sydney is being partly repaid from settlement of apartments in additional to a residual stock loan from another NBL. We have also been active in origination, including a $25m facility for a Greenfield Pub project in Sydney, a $20m commercial facility in Double Bay as well as extension of an existing loan in Bankstown for an additional 2 years.

Non-bank lenders, super funds and largely private equity firms, are filling the gap created by the increased constraints on the four major banks who once facilitated 85% (as at 2013 according to CBRE ) of commercial and residential real estate lending in Australia.

A number of private lenders, like White & Partners, with the ability to navigate and price complex deals, as well as competitively originate and service lender demand have increasingly occupied the private real estate lending space, taking advantage of the illiquidity of this asset class and the superior returns it delivers to investors.

A healthy private debt market is good news for investors. In an environment where yields are plummeting and investors are searching for attractive risk-return investment options away from equity markets, private debt is becoming an increasingly popular high-yield asset class.

Buyers expecting to sell at completion of a project – when theoretically the demand and prices should have increased – have had a tough time over the last few years, particularly in Brisbane. Serious oversupply in the inner-city apartment market, which some say still has about 10,000 more homes in the pipeline than it should, has been an ominous precursor to its southern cousin. But what is really happening in Sydney? We all watched the Brisbane off-the-plan market run into oversupply in 2017. Investors balked, apartment prices fell, and lending eased. About half of the resales in Brisbane’s off-the-plan market have not been profitable since 2015. But is Sydney more resilient? Our apartment exposure gives White & Partners a unique insight.

Now it’s Sydney’s test. A looming truckload of residential developments are due for completion in 2019, coinciding with decreased valuations and markedly stricter lending standards for borrowers who have already committed their deposit.New requests for bigger deposits from buyers before the purchase can be settled may result in defaults, and unsold apartments in the hands of developers. Brisbane suffered default rates between 10 and 40 per cent, with price reductions up to 40 per cent. Sydney’s settlement risk is yet to be seen.

White & Partners is involved in this sector of the real estate market through various divisions of our company. This includes 89 apartments in Jannali, 91 in Ashfield, and a duplex in North Bondi awaiting completion. Our specialist projects division headed by Eddie Mansour has another 169 in North Sydney, 42 in Caringbah and 41 in Gladesville.

White & Partners look forward to giving you a positive update in the not too distant future.

The Padstow Park Hotel sold on a passing yield of 8.5%, representing a 90% premium to the purchase price of $13.7 million in December 2014. The hotel’s strong financial performance, with targets achieved ahead of schedule, also allowed the asset to be sold 18 months earlier than planned. The temptation to capitalise on market conditions with historically low yields was strong and prudent.

As highlighted above, when compared to the sale of the Tennyson Hotel, an inner Sydney unrenovated gaming hotel with significant upside, the Padstow Park Hotel (which at the time of sale, was renovated and traded at close to its full potential) attracted less enquiries and fewer bidders on auction day. A brief statistical comparison of the two assets is provided below.

Whilst the above is a small sample size, throughout 2017 and even during 2018, there have been numerous evidence of hotels with clear upside transacting at yields sub 8.5%. This observation highlights either:

1. Publicans are strategic buyers who attribute value from their ability to extract upside in unrenovated/poorly managed hotels; or
2. There is strong belief amongst publicans that the high price paid is reflective of their ability to create greater value than the previous owners and other operators.

Whatever the reasons, investors in the Padstow Park Hotel achieved a strong result. JDA Hotels again proved their ability to enhance the income and capital value of an underutilised asset. And most importantly, the Padstow Park Hotel has been transformed into an attractive community destination, especially compared to its former days when it was known as the Barking Dog.

With land prices also appreciating, builders and developers have been looking for alternative measures to control construction costs, including products manufactured in China and modular. To better understand these options, White & Partners attended the April 2018 Canton Import and Export Fair in Guangzhou, China. Billed as the largest convention of its kind in the world, the fair displays the latest building products and construction techniques, connecting over 20,000 vendors with the international development community. We also inspected tiling, joinery and window factories in Shanghai, Foshan and Shenzhen. It was a short but fact filled trip which left us with several key impressions:

• Setups of the production warehouses were comparable with Australian standards
• Quality of the outputs we inspected was impressive and well presented
• Back offices for the Chinese manufacturers we visited were well resourced and worked across the entire supply chain from assisting with the import of goods to managing the quality compliance process post installation
• Price advantages, factoring in logistics costs, were at least 50% more favourable than compared products in the Australian market
• Australia was a key target export market and one which has the highest quality standards globally. Something to be proud of!

Sourcing products from China has the added benefit of passing through an established supply chain. Australian developers can also be assured with accountability, with many suppliers offering warranties on their products. The biggest question is if these suppliers can handle orders in large quantities. All prospective suppliers will say yes. However, we believe the only way this can be managed is if an Australian developer has a Chinese based supply partner who could oversee quality control and logistics. This would critically provide oversight into the supply chain.

High quality, low cost materials is an advantage many Australian developers and builders are beginning to exploit by importing from China. We know arbitrages are not permanent, particularly as China moves up the cost curve. But as the opportunity window remains open, we believe now is a good time to take advantage.

In September 2017, White & Partners, in partnership with JDA Hotels purchased the Allawah Hotel for $28 million.

The Allawah Hotel represents the 6th hotel acquisition for White and Partners over the past three years. Our continued interest in the sector revolves around what we believe are strong fundamentals including:

• Strong cash business with effectively no creditors
• Albeit tightening, yields still above historic lows and well above more challenging sectors such as retail
• Strong population growth in Sydney, especially in the Allawah catchment, compounded by no further competition and high barriers to entry (i.e. no new pubs)
• The continued trend of people eating out rather than at home, and
• The under-utilised nature of the airspace which can be developed.

Watch our Associate Director, David Mao discuss our strategy for the Allawah Hotel.

Last month signified a major milestone at Jannali, the first of the basement ground slabs were poured. The period leading up to it though, proved a challenge with much design work required to resolve an unknown issue arising from the flood study. The “easy solution” was to increase the height of the ground slab, which in turn would have had the undesirable impact of reducing the ceiling height of the new tavern.

To avoid this, numerous meetings, discussions and negotiations with council were held, not to mention engineering proposals from our contractor Duffy Kennedy to implement practical solutions to satisfy both council and the new owners of the tavern, JDA Hotels.

After months of proposals, a solution that made all parties somewhat satisfied: raise the ground floor of the tavern while increasing the height of the building to ensure the tavern is not compromised.  

The above highlights the importance of having a quality project team and builder to ensure such matters can be successfully resolved. While such issues like the “one in 100 year flood” seem like a long time away, the ramifications to achieving a design that ensures residents safety and practicality of a building, requires time…how much time is the unknown prior to construction commencing. Watch our projects director, Kimmo Pitkanen talk about our latest achievements on Jannali.

In March 2017, White & Partners acquired the GGH at a yield of 10.3%, significantly below comparable market prices. The discounted price reflected the discrepancy between the hotel’s licensed trading hours (3am) and the Council’s approved trading hours (midnight).

Following acquisition, White & Partners focused on aligning the license and approved trading hours to 3am. White & Partners achieved this by engaging appropriate acoustic and town planning consultants, to emphasis to Council that the discrepancy was merely an administration error from the previous owners.

No objections were lodged to the application, which was approved in a short period of 6 weeks.

On acquisition of the Hotel, the valuer rightfully discounted the hotel’s weekly revenue to account for the trading hour discrepancy which resulted in an acquisition yield of 10%. With the operating hours now aligned, the hotel should revert to market yields, representing an unrealised arbitrage of circa $3.5 million in value. Investors have also benefited from an unrealised capital appreciation.

At the same time, White & Partners has finalised:

• the hotel’s new design including a larger and new gaming room;
• a funky new bistro offering; and
• short term accommodation proposal.

The open plan design will also be styled to embrace the inner western Sydney vibe, which appeals to a diverse group of patrons and allows the hotel to capitalise on its excellent location.