In 2022 so far, the real estate market has continued to prove its resilience in the face of economic and geo-political uncertainty, highlighting tremendous collaboration and innovation across the industry.
Climate change, tax reform, foreign investment, cyber security and privacy continue to be areas of focus, with the added challenges of supply shortages, increasing construction costs and rising interest rates. MinterEllison’s real estate team is pleased to share 10 emerging trends which will be a feature of the sector throughout 2022, and into the following year.
Market volatility creates opportunities for organisations to innovate and work smarter, faster and better. As we enter a time of economic uncertainty and regulatory changes, real estate will always be a leader in the Australian economy with the public and private sectors driving activity.”
1. Interest rates will rebalance portfolios
While industrial assets remain hot property due to the continued demand for distribution facilities, the market is swinging towards traditional asset classes including office, residential and retail with a long-term view on maximising capital returns. The increase in interest rates is providing a new lens that is driving the re-balancing of asset classes within portfolios.
"The focus has returned to finding the right kind of asset, with the right risk profile, with continued competition for big trophy assets, signalling a move away from quick buys at any price. The shift sparked by interest rate rises is bringing some sensibility and logic back to buying property." Adrian Rich, Partner
2. Asset portfolios will need to be resilient
Clients are taking a longer term approach to their asset portfolio strategies. We anticipated a sell down of retail portfolios, however urban sprawl continues, and agile working is decentralising the focus away from the CBD to the suburbs. While this trend of hybrid working continues, we will continue to see strategic investments and repurposing of retail assets to meet suburban demand, with organisations responding by diversifying into mixed use communities.
A competing, but related trend driven by hybrid working, is the growth of the 'third space' - providing tenants with significant benefits outside of their actual tenancy and a flexible extension of their workspace. No one size fits all and landlords are looking at more bespoke solutions. Hybrid working is here to stay, but the adaptability of commercial space is yet to be fully realised.
"Much about the way we live, and work will be transformed as our cities and urban centres reshape their purpose with a keen focus on liveability, sustainability, resilience and affordability." Carla Deluca, Partner
3. Adapting the risk curve for greater returns
Developers are choosing to play more broadly within the industry, increasingly moving up the risk curve to create greater returns on their investments. We are seeing an increase in developers engaging in fund-through transactions which traditionally has been the play of property financiers and investors. Existing owners will continue to be under threat from new entrants and takeovers by larger players looking for scale to deploy significant amounts of capital. The current market conditions present opportunities to sell amongst the wealthy individuals, corporates and private players, and there will also be competition from international capital sources who continue to regard Australia as an attractive market to invest.
4. Strategic REITs and the tax landscape will impact certain asset classes
Platform plays continue to be a focus with high profile strategic REITs entering the market. Many of our clients are seeking exposure to emerging asset classes such as build to rent, health, data centres, land lease, and student accommodation.
The tax landscape continues to impact certain assets. For example, in the build to rent sector, each state and territory has different frameworks around development opportunities, eligibility for government concessions and rebates. Similarly, at a federal level, build to rent is currently impacted by the cost of foreign investment withholding taxes, however the new federal Government has indicated it is open to reforming the withholding tax rates that presently impact the sector. Additionally, in NSW the Government's expanded scope of existing Stamp Duty is having wide ranging impacts and risks for our clients. A recent article covered NSW stamp duty changes.
5. Housing affordability requires innovative solutions
The current economic conditions bring heightened attention to housing affordability, which impacts not only the younger demographic and first home buyers, but also reaches older generations contemplating retirement and how we can have regard to both. The current demand for residential property is still at an all-time high, with added complexity of limited availability, higher interest rates and an increase in construction costs, which is putting pressure on small home builders.
6. International investors are taking a cautious approach
While Australia remains a stable and attractive market, market volatility is driving a more watchful and cautious approach for international capital. This is an expected market response to the current geo-political, post pandemic and economic uncertainty. The recent increase of Foreign Investment Review Board fees is also influencing the flow of international capital.
While many investors are taking a 'wait and see approach' to these conditions, we are also seeing investors looking to fund creation, fund through arrangements, capital partnering or having full ownership of an asset, albeit through a more discerning lens, rather than simply entering into co-ownership agreements, which became increasingly more common throughout the pandemic.
7. Skills and supply shortages will impact developments
As deals become more complex, and timeframes tighter – clients are competing for advisors with the requisite experience, capacity and skillset. This is compounded by the shortage of skilled labour, specifically in planning and government departments which is stalling development approvals. This challenge is not limited to government, but also impacts the private sector with small home builders increasingly under financial stress due to fixed price contracts that are no longer profitable with the increase in construction costs. The re-opening of Australia’s borders may, over time, ease some of the skill shortage pressure.
8. The role of climate change in valuations
Climate risk is a key consideration, impacting how assets are financed, procured, and marketed. Organisations are looking to procure and develop climate resilient assets and are conscious that green ratings and carbon efficiency will continue to have a material impact on property valuations. There is an immediate and growing impact on increased capital and operational expenditure in light of accelerating climate risk resulting in more clients requiring advice on due diligence, reviews of governance and risk management systems and project lifecycles frameworks to ensure they remain 'fit for purpose' in the management of dynamic ESG risks and developments in financial reporting frameworks. This includes implications for valuation methodologies imposed by the International Sustainability Standards Board.
9. Digitalisation and new technologies will create efficiencies
COVID-19 has accelerated the need to digitise at an industry and organisational level. The need to reduce costs and streamline efficiencies fuelled creative and innovative digital solutions including automation, artificial intelligence, and digital twin modelling. The digitisation of the real estate industry presents an uncapped opportunity for enhanced efficiency and innovation at a time of growth; however, organisations must be proactive about managing risks that come with these rapidly evolving technologies – including by ensuring robust data governance and addressing cyber challenges.
10. Organisations will need to focus on their cyber risk profiles and data management
Organisations are increasingly focusing on their cyber risk profile and need to look beyond simply the risk of data breaches and consider cyber as part of their holistic risk management approach. They must ensure their structures for risk and cyber management are aligned and that they have implemented and maintained robust governance to mitigate and monitor risks to their digital and physical estates. This will help organisations be more efficient, gain insights into risks and threats and ensure they obtain the reputational benefits of being an industry leader in cyber protection.
Clients must have enhanced governance management to ensure appropriate data retention and destruction policies are in place to mitigate the legal and reputational risks arising from holding outdated or unnecessary information. Tenants now expect flexible lease terms that accommodate agile work models, which may result in the increased use of data, including personal information, by landlords to focus on tenant satisfaction.
The real estate industry bounced back with a boom post pandemic, only to enter another complex environment, however I'm confident that our clients will fiercely find new and innovative ways to deal, invest, develop, finance and reshape their portfolios.”
There are challenging times ahead, but we know that from challenge, innovation grows. The real estate industry will continue to show its resilience and creativity during the remainder of 2022 and beyond.