Commercial real estate and alternative property – trends and opportunities for savvy non institutional $5 million – $50 million property buyers looking for diamonds in the rough

Commercial real estate (CRE) refers typically to three categories of revenue generating real estate which are office, retail/hospitality and industrial property.

‘Alternative’ property refers to CRE falling outside those three categories such as child, health and aged care centres, self storage facilities, service stations, co-living properties, boarding houses, purpose built student housing and build-to-rent (BTR) properties. A further attraction is that some alternative properties are eligible for land tax exemptions as well as bonus floor space ratios.

Delayed until yesterday’s confirmation of Trump’s Trifecta (about which we make no further comment), in this our October 2024 Newsletter we sample in no particular order, five trends in all three CRE categories providing a range of buying opportunities as well as planning, regulatory, operational and other risks.

Trend 1: Bricks and mortar retail is back

As veteran property commentator, Robert Harley wrote in the 13 November 2024 AFR:

“Australia’s big shopping centres have been the quiet performers of 2024.Despite the cost of living pressures and the challenge of online shopping, retail rents are now rising in the best centres, and, as the long-term falls in value stabilise, total returns in the malls have bettered those in the office towers or, surprisingly, in logistics.

Underpinning those shifts, for retailers and investors, is the key property factor, the lack of new supply.

[According to] Trevor Gerber, the chairman of the $9.5 billion Vicinity Centres:

 “the fundamentals of Australian retail property continue to be favourable, supported by population growth, strong employment, the increasingly symbiotic relationship between physical retail stores and online, and [my italics] with limited investment in new retail supply.”

Others agree: as reported last month in The Urban Developer:

“Australia’s grocery giants Coles and Woolworths are leading the revolutionary charge, rapidly harnessing robotic technology and artificial intelligence across their supply chains.

In doing so…they are providing a glimpse of what the future may hold beyond the walls of their sprawling fully autonomous, lights-out warehousing and distribution facilities—otherwise known as “dark sheds”.

Consumers’ rising expectations and the escalating need for speed of delivery in the digital age have become a self-fulfilling prophecy… Coles property boss Fiona Mackenzie told attendees at The Urban Developer Commercial Real Estate Summit in Sydney [on 16 October 2024]…Significantly, while many people thought the rise of such technology would be the death of bricks-and-mortar shopping, 96 per cent of Coles’ transactions remain in-store …Its store sizes, however, have “incrementally and organically got smaller” (our emphasis).

So, where is the opportunity for non institutional CRE buyers reading this Newsletter?

Let’s begin with this graphic from the Harley article from which we have zoomed in to the graphs for 2024 – 2026 showing a near disappearance by 2026 of new non large format retail supply in CBD, neighbourhood and regional locations and a reduction in sub regional supply.

Former CEO of multi billion dollar global Cromwell Property Group, Paul Weightman identified succinctly the opportunities in an insight packed podcast with Alan Kohler reported in the Intelligent Investor on 24 October 2024:

“…[W]hat we’ve seen over the last 20 years has been a market that has embraced online shopping, a move from online platforms to distribute as much as they can online but a realisation that an online strategy itself isn’t enough. If you look at the cost to online retailers and distribution they’re quite significant and a lot of retailers are now moving to a dual strategy of having online and bricks and mortar offerings. I think you’ve got to look at retail as being multiple asset classes rather than a single asset class. Discretionary retail is going to be affected by economic conditions, daily needs retail less so…At the end of the day if you look at retail as being a class of social infrastructure that people need to have access to for their daily needs, for their shopping, there is value in a lot of existing retail property simply because it can’t be replicated in a cost effective fashion and because it’s protected by planning regulation. If you’ve got a piece of social infrastructure that is currently valued at a fraction of its replacement cost and can’t be the subject readily of competition. It’s going to become more valuable, it’s going to cost a lot more to build a new facility, it’s going to be difficult to actually replicate it. I think as a result of that you’re going to see rents progressively rise in the retail sector over a period of time…I think the smaller to medium shopping centres and subregional will be fine because of their sort of nature as social infrastructure assets offering daily needs requirements.” (our emphasis).

Trend 2: Industrial real estate contracting closer to urban in fill locations generally and those with multi level potential in particular

In contrast to our pre COVID matters where finding and buying industrial property in outer Sydney and close to motorways was almost impossible, our in boxes today are as full of such opportunities, reduced rents and deferred auctions explaining a post COVID softening of capitalisation rates in those areas.

Largely as a result of Trend 1, there is and will be an inwards contraction.

Paul Weightman again explains why:

“Distribution networks…change regularly according to distribution methods and logistics chains are constantly being refined by their users…that has an impact on the warehousing requirements and clearly what we’ve seen over the last 20 or 30 years is a move towards the large distribution centres…[I]n a country like Australia…what we need to think about very carefully [are likely] road transport infrastructure impacts and how…that [is] going to impact on logistics generally because we’re seeing a move away from availability…of drivers, diesel costs are going to become more expensive [and] there’s going to be more pressure from a sustainability perspective on transport impact…

…[Y]ou’ll see distribution strategies start to revolve around rail if that infrastructure proceeds…A lot of money has gone into logistics over the course of the last 15 years since the GFC, they were regarded as infallible assets for a long time but at the end of the day they’re pretty much dependent on where and how the transport infrastructure is located…

You can’t stack containers on top of each other the way that you can on rail, you can’t get the number of containers moving in an efficient way by road that you can on rail. [It’s] something government should prioritise…when you look at some of the other efficient rail networks around the world [and] it’s a bit of a tragedy that we’ve had this historic issue with rail gauges across the country and…that we haven’t got the will to…build [such] infrastructure”…

Those thoughts reflect the US experience since 2023 with a 10 August 2023 article inThe Economist reporting…”a sharp reversal taking place in the American logistics industry…Now, as the forces that fuelled its rise [during the pandemic] fizzle out, America’s logistics boom is turning to bust…Consumers are also returning to physical stores, reducing the number of miles their goodies need to travel to reach them. Revenues in the logistics industry have now clocked up three consecutive quarter-on-quarter declines…Amazon, America’s biggest online retailer, doubled its warehouse footprint in the country during the pandemic. In the past year the e-empire has either postponed investments in, scrapped plans for or closed 116 properties”…

Trend 3: Opportunities in the central, southern and western Sydney CBD corridors (the corridors)

Much CRE chatter this year about the Sydney CBD has centred around shrinking vacancy rates in the financial core driven by a peak in WFH, ‘return to office’ mandates and the so called ‘flight to quality’ offered by a concentration of premium grade buildings in that precinct with tenant preferred high environmental, social and governance (ESG) credentials.

The absence of such a concentration in the corridors has led to high vacancy rates and predictions that as happened in San Francisco and Johannesburg, many of the buildings in the corridors are destined to be zombies because they cannot viably or otherwise be re-purposed as residential or achieve higher ESG credentials.

Regardless of the fact that ESG is a more recent and unquestionably important consideration, such predictions are reminiscent of those made about the water filled, mosquito infested black holes in the same precincts during the 1990’s recession which have long since been homes to major developments including World Square.

There are several reasons why those predictions are even more wrong today than they were in the 1990’s including:

• bounded largely by Hyde Park in the east, harbour to the west and comprising just 1.6 square kilometres (approx), the corridors have a natural and locked in scarcity value
• permissive planning controls with plenty of scope for case by case expansion (see below)
• several tired commercial strata buildings amenable to the 75% strata consolidation legislation especially if teamed with adjoining site consolidation to increase building heights and density.
• in addition to the Town Hall and Central Railway Stations which existed during the 1990’s recession, this precinct is now serviced by the game changing Metro via Gadigal and Central. As the SMH reported on 9 November 2024:“[a]bout 27,300 people are also tapping on or off at Gadigal… on Saturdays, the same level as those on Wednesdays – typically the busiest day for travel. The number filing through the new station on Sundays is 81 per cent of that midweek…While the number passing through Town Hall station has fallen since the metro opened, when combined with Gadigal…, more people are using trains to get to the main shopping district in the CBD. About 121,000 people filed in or out of both Town Hall and Gadigal… on Saturdays, which is about 12,000 more than before the opening.”
• State and local government proposals to revive Sydney’s 24 hour economy possibly with 24 hour train and Metro services; an initiative underlying Merivale’s plans to convert five adjoining heritage buildings in King, York, Clarence and Barrack Streets including the CBD Hotel into a substantial hospitality destination known as Kings Green
• There are numerous precedents in the corridors and elsewhere of commercial buildings converted to residential such as:

The above is consistent with findings contained in a September 2023 Report by Hassell, an architecture firm in September 2023 entitled “Radical re-use: from office to home” which identified 86 B-D grade commercial buildings in Melbourne that were capable of being converted to residential. There is no reason to doubt that the same is possible in the corridors especially as commercial yields continue to soften in that precinct relative to the financial core.

• For another vote of confidence in the corridors in addition to Kings Green and despite an often expressed preference for the financial core, property giant Charter Hall recently achieved a Gateway Determination to increase the building height and floor space ratio at 383-395A Kent Street, Sydney; a 1998 building which it purchased in 2022-2023 for $385 million. As an example of ingenuity of one also unlocking opportunity for others, the Urban Developer reported on 13 November 2024 that the …”plan includes a logistics hub with loading dock within the building that could service businesses on both sides of Kent Street”…Many of the surrounding heritage buildings are constrained, attracting limited use due to inadequate facilities,” the Ethos Urban planning report said. Access to a shared loading dock expands what’s possible within these buildings—including the potential to add retail and F&B [food and beverage] elements that are constrained in their use by inefficient loading facilities”… as depicted here with the surrounding heritage buildings shown in orange:

Trend 4: despite our falling birth rate child care centres remain popular

Child care centres might be the last CRE any property buyer or investor would consider after reading this piece in the 11 November 2024 SMH:

“The drop-off in people having babies is so rapid that some economists now believe the states may have to reduce their expected spending on schools through the 2030s because there will be fewer students. Oxford [Economics] warned that if fertility rates fall much further to around 1.45, which would mean 62,000 fewer babies between 2025 and 2030, the number of school-age children would start to decline in the next decade.

The fall in children going to school could reach 8200 a year, a significant enough drop that would affect government planning for schools and the types of homes offered by the private residential construction sector.”

However, in a 30 October 2024 paper,  .id informed decisions, demographers arrived at exactly opposite conclusion for several cogent and well analysed reasons including:

 “By 2044, Australia will have nearly 150,000 fewer primary school-aged children than previously forecast. That’s the impact of an update to our forecasts to account for new, up-to-date information about the birth rate in Australia.

Recent data from the ABS shows Australia’s birth rate has fallen to its lowest point on record. In this blog, we explain how we’ve factored this information into our latest population forecasts, and what this means for anyone planning schools, childcare centres, tutoring services, playgrounds, or other facilities for young people.

Even before the ABS released the latest birth rate data, our demographers had updated our population forecasts to account for this trend. As a result of this change, our forecasts have been revised down by 150,000 primary-school aged children across Australia by 2044.

However, in the shorter term, the revised forecasts show an increase in this age group – an increase of 32,000 by 2029 in New South Wales alone.

How can this be?..

The birth rate is just one of many factors that impact population change. Our National Forecasting Program also accounts for overseas and interstate migration, death rates, the current age structure of local areas, suburb lifecycles and many other factors… While we’ve updated our birth rate assumption in our latest forecasts, we have also reflected the latest information we have about the number of overseas migrants we expect to come to Australia in the years ahead. In fact, we expect the post-pandemic spike in overseas migration will last longer than official government forecasts indicate… While overseas migration drives primary-school aged population up in the first ten years, there is a decline in [NSW] later into the forecast period as a result of the lower birth rate”…

.id informed decisions forecast for [NSW] primary-school aged children:

That currently occupied and operating child care centres are eligible for land tax exemptions in NSW mitigates the risks associated with the forecast decline by 2044 – with 20 years being a long time and in which a lot can change!

Trend 5: Service Stations are here to stay

Similarly as counter intuitive as child care centres, this species of CRE seems destined to retain its long term appeal to property CRE passive investors and some independent owner occupiers.

Often well located and not contaminated with a range of alternative uses and often supplementary revenue sources (eg: convenience shop and car wash) if an exit strategy is needed, any earlier concerns that EVs would render service stations obsolete have abated as sales of EVs stall worldwide for a variety of reasons on which reams like this in Macrobusiness on 13 November 2024 have been written:

“EVs are generally more expensive to insure because the battery pack creates more complexity for repairers, many EV-specific parts need to be imported from overseas, and there are fewer qualified smash repairers for electric cars”, Compare the Market’s economic director, David Koch said.

Meanwhile, several major global automotive manufacturers have pulled back on EV production amid soft consumer demand and stalling global sales.

The reality is that battery EVs are not ready for mass adoption. They remain too expensive, lack fast and convenient charging options, offer poor range (especially on highways where regenerative braking is not utilised), are expensive to insure and repair, and suffer from extreme price depreciation.

By contrast, standard hybrids overcome most of these drawbacks, which is why their sales have risen so strongly.

Toyota has made reliable and competitively priced hybrids since the late-1990s, when they launched the Prius. These hybrid vehicles achieve fantastic fuel economy and range and have strong resale value, unlike battery EVs, whose depreciation resembles disposable junk”.

Fortunately, in addition to hybrids, it appears that the path to carbon neutrality will lie with hydrogen.

As news.com.au reported on 31 October 2024:

“Australia’s favourite car brand is betting big on hydrogen power.

Toyota has signed a memorandum of understanding with Hyundai Australia, Ampol and leading hydrogen technologies specialist Pacific Energy to help develop hydrogen refuelling infrastructure.

Hydrogen fuel cell cars use hydrogen to create electricity that power electric motors. The only tailpipe emission is water, they are quick to refill and can be driven a similar or greater distance on a tank to petrol cars.

The handshake agreement brings together four big industry players that aim to speed up the take-up of hydrogen fuel cell vehicles in Australia by creating the infrastructure so that car makers can in turn bring the vehicles here for sale.”

Toyota recently entered into a similar European partnership with BMW.

Consistent with Ampol being a party to the Australian memorandum of understanding, it would seem easier for existing service stations to morph into hydrogen re-fuelling rather than EV charging stations.

This marketing blurb in relation to a service station – coincidentally, also owned by Ampol – to be auctioned on 10 December 2024 illustrates the appeal of this CRE especially to longer term, passive investors:

“+ Twenty (20) year net lease to 2034 plus options 2054 to multinational fuel conglomerate, Ampol
+ Ampol..: top 100 ASX listed company with 1,800+ sites & market cap of $6.7 billion
+ Gateway position just 4 minutes from the key M1 on-ramp, servicing NSW’s fastest-growing corridor between Sydney and Newcastle
+ Strategic location close to major national and international brands incl. McDonald’s, Bunnings, Woolworths and Aldi
+ Thornleigh: rapid growth suburb with the population forecast to grow 29.4% by 2036, close to double the state average growth
+ Impressive freehold convenience retail building and automated drive-thru car wash
+ Easily managed investment with one market leading ASX conglomerate…
+ Tenant pays all usual outgoings, as per the lease
+ Attractive annual CPI rent reviews capped at 7%
+ Net Income: $678,254 pa* + GST (estimated from 8 March 2025).”

Conclusion

If you would like to see how we can help you find and buy these and other CRE diamonds in the rough, please get in touch.