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Industrial Rental Growth Trends

Author

Ross Turner, General Manager – Commercial

Industrial assets have been the darlings of many institutional portfolios during the pandemic years, largely thanks to the corresponding e-commerce boom and appeal of onshoring. Now, thanks to rising interest rates and bond yields, industrial assets are experiencing expanding capitalisation rates.

In a typical market, a rise in capitalisation rates would put pressure on asset values. However, in the current market, high and growing industrial rentals are offsetting that value pressure and increasingly becoming the metric investors are looking for. ESR Australia CEO, Phil Pearce, was recently quoted by the AFR as saying: “We’re not buying long WALE assets, but properties where we can capture the rental growth and in some cases redevelop at the end of leases.[1]

Opteon collects rental data for all commercial valuations. Since FY19, our data on warehouse rent rates has shown a solid rise in industrial rent levels – particularly in metropolitan areas.

Metropolitan warehouse rental rates

Using a baseline of 2018-19 warehouse rates, as shown in the graph below which focuses on Brisbane, Melbourne and Perth, the trend of rising rental rates for warehouse assets in metropolitan locations is obvious.

Industrial Rent Growth Trends

However, when we examine the year-on-year changes in Brisbane, Melbourne and Perth metropolitan areas there are interesting location and annual variations, which can be seen in the following table.

The strength of growth in Perth rental rates is partly due to the increased demand of new build industrial, while rental rates are also trending higher in Brisbane overall, inconsistent transaction activity in 2020 led to the dip in our data for that year.

Regional warehouse rental rates

Changes in median industrial rent rates in NSW, Vic and WA, compared to our baseline of 2018-19, show rental rates for warehouse assets in regional areas also rose in most locations. However, the regional lift in rates typically lagged a year behind the trend seen in metropolitan areas.

Industrial rental growth trends

The year-on-year changes in regional areas, as shown in the following table, indicate regional NSW has shown more subdued growth in warehouse rentals.

Metro Area Warehouse Rent

Top performing suburbs

When we looked at our recent data based on year-on-year increases between FY21 and FY22, we identified the top 10 performing suburbs for industrial rent rates, as shown in the table below.

Warehouse Rent Rates

It is worth noting that that new/modern warehousing (particularly in regional locations) can skew growth metrics, as seen with Unanderra’s data in our table.

What’s next

This trend is expected to continue, with the AFR reporting in April 2022 that: “Prime industrial rents are expected to rise by an average of 11 per cent this year – more than double the rate of growth in 2021 – and to keep rising at double-digit rates over the next three years”.[2]


Ross Turner

General Manager – Commerical

We’re here to help answer any questions you might have, contact our property specialists below.


DISCLAIMER

This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax, investment or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.

[1] https://www.afr.com/property/commercial/rental-growth-to-compensate-for-lower-industrial-values-esr-boss-20220718-p5b2d4

[2] https://www.afr.com/property/commercial/e-commerce-boom-supercharges-warehouse-rents-20220418-p5ae5c

Rising Construction Costs put Additional Squeeze on Unit Development Feasibilities

By Julian Hawkins, Senior Valuer, Melbourne

Rising construction costs and COVID-19 caused major economic disruption through 2020 and 2021. However, the period of falling property prices was short-lived. National sales volumes rose 37.7% in the 12 months to February 2022. Transaction volumes through the month of February remained elevated at an estimated 57,427, which is 46.1% above the previous five-year February average. National clearance rates averaged 72.4% in the four weeks to February 27th, down from 78.8% in the equivalent period of 2021. Clearance rates are expected to trend lower amid softer housing value growth.

Change in sales volumes

Image Source: CoreLogic – May 2022 Monthly Housing Chart Pack 

Renewed confidence in the market through the second half of 2020 and through 2021 resulted in a surge in demand for land suitable for redevelopment for smaller unit developments (2-20 units) and larger land subdivisions. The success or otherwise of a development project is inherently volatile and a result of:

  • the price paid for the site
  • planning approval for the site
  • construction costs and timeframe for construction
  • consumer demand/price point for the units/apartments
  • off-the-plan sales/rate of sales
  • lending restrictions, regulatory restrictions and government policy
  • interest rates and other holding charges, and
  • broader changes in the economic climate and property market sentiment.

Construction cost risk

Shortages of labour and materials in the building sector continue to add pressure to development projects with the increased cost of labour and materials adding to supply chain issues and extending construction and project delivery timelines.

In a recent article in The Age, The Master Builders Association said 98% of its members are having their profits squeezed or are losing money. As the price of timber, steel, concrete and other construction materials has soared, deliveries are delayed for up to six months.[1]

Victoria’s Supply Chain Review “found that significant delays and shortages in sourcing timber were the result of unprecedented demand for construction in response to rebuilding our society post-bushfires, and the economic stimulus packages provided by governments around the world to boost post-COVID recovery. At the same time, there have been disruptions in global trade and maritime freight due to border closures and port congestion, hampering efforts to import additional building materials.”[2]

Over the past six months, Opteon has seen increases of up to 30% in contract bill prices and significant delays in the supply of materials that are impacting the timing of projects. In one case, the building contract amount increased by $220k over a five-month period for a three-unit development, with no change to the proposed product.

Similarly, timeframes quoted in building contracts are being extended even for smaller unit developments. We are typically seeing townhouse development timeframes move from 270-365 days, out to now 420-450 days.

The price of development land

The original purchase price of development land is a key factor in the feasibility of projects facing rising construction costs and lengthy delays. For example, those who purchased development land through 2020 and early into 2021, may have some buffer against rising construction costs and supply change issues. This is due to a corresponding increase in unit values through this period. However, where the land was purchased through the peak of the market in later 2021 and into 2022, the increased construction costs and material delays, added to the increased land costs, may not be off-set by a corresponding increase in the end unit value. This can result in a feasibility or project-related site assessment being negatively affected, leading to lender hesitance and the requirement for developers to inject more up-front equity.

Off-the-plan sales

Consumer appetite is product and location specific, but there still appears to be a strong demand for larger townhouses in premium locations. Other factors such as sustainability ratings can add appeal for buyers.

Demand for off-the-plan apartments appears to be easing, suggesting apartment developments are a relatively risky proposition at the moment.

As shown in the graph below, Opteon is valuing fewer ‘off-the-plan’ apartments every quarter, which indicates that purchase volumes are dropping. In the two biggest markets, New South Wales and Victoria, valuation volumes have been dropping since Q2 2019 (Apr-Jun 2019) and Q1 2021 respectively.

IMAGE SOURCE: Opteon

Interestingly, the percentage of valuations that did not support the contract purchase price has been on a downward trend in NSW since Q3 2019 and in Victoria since Q1 2021. These downward trends correlate quite closely with those in the volume of valuations.

Looking ahead

While land values remain strong, there is a possibility that rising construction costs and interest rates will create a lag effect on prices as developers become more cautious about feasibility prospects. This was anticipated by the Housing Industry Association(HIA) in 2021, which predicted Australia’s construction starts will drop to 125,030 in FY23.[3]

The alternate view is that many future-looking developers will continue to landbank, recognising the limited supply of land available for development. These developers will also be banking on: a) the likelihood of supply chain and worker demand issues resolving in the 1-2 years it takes to get a planning permit issued; and b) increased demand from foreign investors and a rise in population levels, which will lead to a boost in demand.

Author

Julian Hawkins

Senior Valuer – Residential Development

Contact Us

DISCLAIMER

This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax, investment or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.

[1] https://www.theage.com.au/national/victoria/i-ve-had-enough-why-some-want-out-of-victoria-s-building-industry-20220427-p5agn5.html

[2] https://www.vic.gov.au/supply-chain-review

[3] https://constructiondaily.news/australias-building-growth-will-hit-a-wall-by-2022-report-finds/

On the Pulse - Risk Premium Article image

Shrinking Risk Margins Challenge sub-$50m Commercial Assets

Author

Ross Turner, National Director – Commercial Agri Advisory

A risk margin is the percentage gap between property yields and bond yields. Essentially, the risk margin tracks the size of the financial benefit of a ‘growth’ investment in property compared to a ‘defensive’ or ‘risk-free’ investment in government bonds.

In the last three years, and particularly since the start of 2021, we have seen a decrease in the risk margin of sub-$50m commercial assets contract. This sends a clear signal of risk to the market.

A challenging set of market conditions

There is currently a challenging combination of market factors affecting commercial property in the sub-$50m category of assets.

Commercial property as an investment class carries additional risk to Australian government bonds, with bond returns considered a risk-free investment base due to its sovereign backing.

Commercial property prices have been rising over the last 2 years faster than net income growth, resulting in contracting property yields.  As the growth in value has not been driven by income growth, headwinds are emerging, due to rising interest rates, and trimmed mean inflation at its highest rate since 2013[1]. Added to those factors is the rising value of government bond rates, increasing the attractiveness of this investment class.

While yields on 10-year Commonwealth Government bonds fell to a 2 year low 0.60% in March 2020, they have increased since then to average 3.01% during April 2022[2] and further to a high of 3.57% on 10 May 2022, for a 3.44% 1-17 May average. [3]

These market factors have seen the risk margin between bonds and commercial property drop since 2019, particularly impacting key markets like Sydney. This is resulting in commercial property yield margins struggling to stay above the government bond rate. For example, as shown in the graph below, net yields on properties within the sub $50 million space in Sydney have been falling, which means that the risk margin is expected to drop below 1% in May. The orange dotted line is based on Opteon’s own sales data.

The contraction of the risk margins between bonds and commercial yields of sub-$50m commercial assets raises some key issues for the market:

  • Will investors shift to bonds as the general economic climate faces potential head winds?
  • Are commercial property yields going to soften to reflect an appropriate risk margin between bonds and commercial property and will values fall as a result?
  • Will increases in rents mitigate any softening in values?

Key market exposures

Leases that are structured and oriented to take advantage of rising inflation will perform more strongly at this point of the cycle. Importantly, by virtue of the low inflationary environment over the past ~9 years we have witnessed a shift away from inflation or CPI linked annual reviews toward fixed percentage reviews (say 2.5-3.5%). This may result in annual rental increases not keeping up with inflation during the remainder of these lease terms.

Rises in bond yields

Sub-$50m commercial assets are exposed to rises in government bond yields because of the growing attractiveness of bonds as an investment in comparison to commercial property. Values of commercial property may stall or drop, due to either pressures in net income decreasing (either due to flat growth or increased outgoings in gross lease scenarios), or due to softening of market yields.

Rental Growth

Whilst inflation pressures should be passed through in rental increases, not all markets are created equal, with some lease profiles subject to lease arrangements that may not accommodate immediate increases.

Gross lease structures may not allow for increases in statutory and operational outgoings expenses (leading to a net income squeeze).

Additionally, the ongoing viability of some tenants’ businesses, which may have been propped up by COVID-19 government stimulus measures is still to be proven.

Leases that are structured and oriented to take advantage of rising inflation will perform more strongly at this point of the cycle.

Net Income squeeze

In the context of rising interest rates, flattening rents and increasing outgoings, net income can be squeezed when gross lease arrangements are not being reviewed within a close enough period to accommodate adjustments for inflation of outgoings.

This is often an issue with assets with a high underlying land value. For example, securely leased, underdeveloped retail premises in urban growth areas/ development corridors where there is no ability to break or review the lease within a reasonable period of time may experience significant net income downward pressures, which could lead to a negative cash flow situation.

Outgoings

Outgoings are increasing due to rises in land tax and council rates, due to being linked to rising unimproved/ rateble property values that have risen steadily over the past couple of years. Other outgoings have also been affected by rising inflation and ongoing global supply chain issues. Where outgoings grow at a higher rate than rents in a gross lease arrangement, yields are put under further pressure. This is a common issue for commercial properties in the sub $10m category, which typically include gross lease arrangements rather than the net lease agreements that are more commonly found in corporate lease structures.

Outlook

As the market continues to evolve, holders of sub-$50m commercial assets will be watching the growth potential of their investments through this part of the cycle.

Ross Turner

National Director - Commercial Agri Advisory

Ross is the National Director for Commercial, Agri and Advisory and has over 18 years’ experience in property valuation and advisory across Australia in both metropolitan and regional markets.

Ross has the benefit of having previously reviewed and provided valuation advice from a financier’s perspective in an institutional banking environment. He has considerable experience managing large valuation projects for Government and Corporates across Australia for financial reporting, strategic advisory and mortgage security purposes.

Ross can be contacted on 0435 039 847.

DISCLAIMER

This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax, investment or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.

Hospitality Assets Emerge from their “Worst Days”

Author

Duncan CameronDirector – Specialised & Advisory

A sector hit hard by the pandemic

In the last five years, Opteon has completed 784 hospitality valuations in the sub $50m market. This includes pubs/taverns (30%), hotels/gaming hotels (24%), restaurants (24%), and other hospitality venues (22%) such as small bars, nightclubs, licensed clubs, function centres and casinos. These have involved assets located Australia-wide, in both metropolitan and regional areas, with the highest volumes in NSW, WA, Victoria and Tasmania.

As valuation specialists in the sub $50m hospitality asset class, we saw the COVID-19 pandemic hit the sector extremely hard. The speed at which COVID-19 hit Australia and forced hospitality venue closure was unprecedented, causing significant and widespread financial hardship. During the pandemic period, hospitality venues were forced to contend with significant drops in demand. Unpredictable and wide-ranging lockdown periods, increased and varying trading restrictions and rigid operating protocols caused significant revenue and profitability decline.

The success or failure of businesses during this period was dependent on the size of their pre-pandemic financial resources and cash buffers. During the pandemic, factors such as their scale, impact on revenue, ability to access government funding support (i.e. JobKeeper) and the speed at which they could mitigate operating expenditure all played a role.

While the Omicron variant has also had a negative impact on the sector this year, there are now positive signs of recovery. Profitable trading conditions are starting to return due to high vaccination rates and relaxation of pandemic control measures. Socially, patrons are returning to hospitality venues after lengthy periods of mandatory lockdown and isolation. Most have more disposable income after two years of restricted travel and limited discretionary spending opportunities. For some hospitality businesses, the mandatory closure provided the opportunity to refurbish venues, reassess their service offering and positively restructure their operating model to deliver a more profitable financial outcome.

The impact on the hospitality sector

In a May 2020 story by Hoteliers Australia, Australian Hotels Association (AHA) National President Scott Leach said: “the industry was facing its worst days in over a century”. Leach added: “Our hoteliers and their staff are doing the right thing but they are paying a heavy price. We have to remember too, the industry is not in hibernation… Your typical country pub is losing $25-35,000 a month – again with no money coming in. There really is a limit to how much debt can accumulate before many will be forced to close their doors for good.[1]

In July 2020, an AHA opinion piece published in The West Australian stated: “For nearly every hotel, restaurant, bar, pub and tavern, the Federal Government’s JobKeeper payment scheme is the only reason they have been able to survive.[2] From a property perspective, other support measures included the National Cabinet’s Mandatory Code of Conduct – SME Commercial Leasing Principles During COVID-19 (and subsequent state-based legislation) that was designed to provide a proportionate and measured framework for landlords and tenants to share the financial risk and cash flow impact during the COVID-19 pandemic period. Other wide-ranging relief and support measures assisted hospitality businesses to ride out the initial pandemic impact, including deferred taxation, deferred commercial and residential bank loan reviews and various state-based financial support measures.

In most capital cities, the sector was crippled by lockdowns and the impact of state and national border closures, which curtailed tourism and corporate travel and, in turn, directly impacted venue revenues. Some States and regions fared better due to an increase in intrastate tourism. However, many regional businesses were also impacted by lockdowns, state border closures, vulnerable community isolations (WA) and, in Victoria, Melbourne’s “ring of steel”.

The Australian Bureau of Statistics (ABS) reported the accommodation and food services sector EBITDA fell by $271m in FY20, or 2.7%, following a period of growth [3]. The impact was also felt acutely by hospitality staff. For example, South Australia’s three-day lockdown in November 2020 resulted in 80% of permanent employees and half of casual employees being stood down. Furthermore, between $7m and $10m worth of food and alcohol was wasted[4]

The pain continued in 2022 with isolation requirements and government capacity restrictions in venues – made to curb the spread of the Omicron variant – further restricting profits for hotels and international entry restrictions causing significant staffing issues. Across the board, the cost of doing business in the accommodation and food services sectors increased by 78% from January 2022 to April 2022 according to the ABS[5]. Businesses with between 20-199 staff were hardest hit by: a) an inability to find suitable staff; and b) supply shortages, caused by logistic disruption as COVID-19 community transmissions spread with the relaxation of containment policies.

Hospitality asset valuations

At the best of times, hospitality asset values can be particularly volatile as they are inherently linked to the trading performance and profitability of the going concern business. In turn, this financial viability is influenced by many external and internal factors, including:

  • the economy
  • consumer confidence
  • disposable income levels
  • spending patterns
  • seasonal trends
  • inflation
  • interest rates

These are combined with the skill and quality of management, trading competition and the revenue mix of the business. Fluctuations in revenue and costs can quickly expose businesses to significant trading and financial risks and asset value volatility. The pandemic period intensified trading volatility as it added a rapidly evolving and unprecedented impact on what can typically be a volatile market sector.

Property markets typically stagnate during periods of uncertainty and, consistent with this market behaviour, investors defer investment decisions until they have greater certainty and clearer market direction returns.

Unsurprisingly, hospitality assets became less attractive to business operators and investors during the pandemic period. The pandemic’s impact on the industry saw fewer transactions. Opteon’s quarterly data shows valuation volumes dropped sharply during 2020. This was due partly to the major banks’ loan review moratorium during the 2020 pandemic period, but also  to a decline in market transactional activity.

Currently, recent transactions of prime well-located hospitality venues are lower. They are either owned by:

  1. corporate and owner operators; or
  2. investors who have aggregated good quality venues over the years, and tightly hold such hospitality assets.

The general reluctance to sell profitable or securely leased assets is also impacted by the challenge of securing alternative, similar or superior yielding, replacement assets, which are typically in short supply.

Of those considering selling, many are seeking to recoup capital losses or forgone profit during the pandemic period before putting the asset on the market. Prospective vendors are typically seeking to re-establish a profitable history of trading performance to maximise the future potential realisable sale value. There’s evidence of industry-leading operators, who have successfully navigated the pandemic, making opportunistic, counter-cyclical acquisitions of underperforming businesses to expand their portfolios.

Our data indicates hospitality businesses began recovering at the end of 2020. Unfortunately, the emergence of the Delta and Omicron variants imposed further challenges and delays for the sector returning to pre-pandemic levels of trade. There are now signs of recovery and the industry is expected to rebound to pre-pandemic levels in terms of employment and maintain steady growth over the next three years. [6]

Opteon’s valuation experience indicates that revenue trends dipped in FY20, relative to previous financial years and have shown recovery in FY21 and FY22, as businesses gradually re-open to resume unconstrained trading profiles.

In focus: WA licensed premises market

In WA, the trading environment for hotels, taverns and nightclubs has been adversely affected in recent years by the Western Australian economic slowdown following the mining boom peak in 2012/13. From the moment the Western Australian Government declared a state of emergency on 15 March 2020, the WA hospitality sector was also significantly impacted by the pandemic.

Despite the pandemic challenges, well-located hotels, taverns and nightclubs (that are capably managed) are emerging from the pandemic with more positive trading indicators and recovering financial performance. In contrast, premises in poorer locations, those suffering from high localised trading competition, sub-standard management or marginal profitability, have experienced financial difficulty or failure in the challenging trading conditions.

Economic slowdown
Even before the impact of the pandemic, the Western Australian economy had been slowing for  years due to the end of the mining construction boom (2008 to 2012/13). Despite a low interest rate environment, discretionary spending by consumers also tightened, impacting the trading performance of licenced hospitality venues.

The consequential impact on the local licensed premises market is that patrons have been more discerning in their spending patterns, especially with high price consumer items, such as food and alcohol in licensed premises. Operators have needed to work harder to deliver revenue growth, so have focussed on expense mitigation to maintain prior profit levels and deliver real profit growth.

Wage costs
The market, in line with the wider economy, is expected to experience inflationary wage pressures. This is likely to impact hospitality venue operations until international and interstate migration returns to pre-pandemic levels. This adds to the current challenges of finding suitably skilled hospitality staff. Staffing shortages are widely reported, especially as businesses navigate resourcing pressures with isolation requirements for COVID-19 infections as community transmissions become more commonplace under the relaxation of containment protocols.

Increased operating expenses
Hotels, taverns and nightclubs have experienced higher than inflationary increases in many operating expenses such as utilities, rates, taxes and insurance costs. COVID-19 and current international constraints on supply chains, products and essential tradable goods are also constraining hospitality businesses during the post pandemic recovery period.

Changing community behaviours
Very public and active policing of drink driving laws, tighter general economic conditions and the convenience and accessibility of packaged liquor has resulted in increased alcohol consumption in the home (including ‘pre-loading’) compared to on-venue consumption, which has impacted revenue in licensed hospitality venues. This has been offset by people’s desire to socialise publicly post-lockdowns.

Responsible service of alcohol laws
The introduction and active policing of Responsible Service of Alcohol laws has made operating hotels, taverns and nightclubs more challenging. It has added additional training requirements, staffing and rostering logistics, compliance and potential trading impacts on venues.

Increasing competition
Reforms to the Liquor Licensing Act in late 2006 gave rise to a change in focus in liquor licensing to cater for modern consumer needs. The legislative changes introduced public interest considerations in determining the merits of new licence approvals. The reforms also saw the introduction of a small bar licence category, which has proven extremely popular.

Consequently, the growth in small bar venues has provided increasing competition to the traditional hotel and tavern licensed premises. Further, the evolution and increasing incidence of ‘big barn’ liquor outlets (i.e. Dan Murphy’s and First Choice) has provided increased packaged liquor sales competition to the detriment of some traditional drive through bottle shops and takeaway liquor outlets. More recently, the increased incidence of ‘pop-up’ bars and temporary entertainment venues has added to the competition burden for traditional hospitality venues.

Trading environment and competition

The combination of soft economic conditions pre-COVID-19, tightened discretionary spending habits and growth in small bar licenses have presented challenging trading conditions to smaller venue or marginal licensed premises operators. Anecdotal evidence indicated that such venues were feeling the financial pressure, with many marginal businesses closing or being offered for sale. Such conditions led to a natural, economic rationalisation to the benefit of larger, established, well-run sustainable businesses. Larger venues with sound clientele bases and strong market positions appeared less impacted, although they still experienced challenges in maintaining revenue, cost reduction and delivering profitability.

After the initial COVID-19 lockdown, hospitality venues generally witnessed stronger trading conditions as clientele elected to spend more heavily on discretionary food and beverage entertainment in the wake of interstate and international travel restrictions and socially constraining lockdown periods. However, volatility has been evident, and moderation of this trading performance is expected now that interstate and international border restrictions have been removed.

Property impact

During the pre-pandemic environment the constraining trading environment and softening profitability trends caused downward pressure on rental and capital values. To some degree, this pressure was offset by the softening interest rate environment and downward pressure on yields (capitalisation rates). The pandemic period government initiatives also caused deferral of rent reviews leading to a period of rental value and capital value hiatus.

As venues return to profitable trade there remains the potential for a rental value growth.  However, any potential for future uplift in capital values will be tempered by the future upward trajectory of interest rates and consequential upward pressure on property yields.

Feedback from both brokers and agents active within this sector suggests purchaser demand is currently very strong for profitable, well-performing venues given the weight of capital seeks strongly-yielding investments that deliver sustained returns. However, like most asset classes, supply of prime assets is particularly tight.

Meet our Hospitality specialists

WA


Duncan Cameron
Director – Specialised & Advisory

VIC


Ryan Danaher
Director – Specialised & Advisory

WA


Doug Shorten
Associate Director – Specialised & Advisory

QLD


Alex Dickinson
Commercial and Agribusiness

Alex Dickinson - Opteon

NSW


Ian Britton
Senior Valuer – Specialised & Advisory

WA


Ray Codalonga
Director – Specialised & Advisory

SA


Daniel Sander
Associate Director – Specialised & Advisory

TAS


William Reynolds
Director
Technical Services

DISCLAIMER

This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax, investment or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.

Opteon - On the Pulse Article Image

Opteon Expands Prop-tech Partnership with Forbury to Streamline Specialist Commercial Reports

In 2021, Opteon revolutionised the market by meeting demand for accurate, fast and easy to understand valuations across the sub $5m commercial property asset classes. The solution was the Core Commercial Report, a tech-enabled report that provides banks with a succinct summary of the key risks and metrics up-front. The report has reduced turnaround times to five days in metro areas, reduced post-valuation enquiries by 4%, and increased report preparation efficiency by 20% – 30%.

Building on this success, Opteon has just expanded its long-term partnership with valuation software company, Forbury, to increase efficiencies and effectiveness in preparing commercial reports for complex specialist valuations.

The expanded partnership now provides a secure, cloud-based connection between Forbury’s commercial and retail products, which use a cloud-based SaaS calculation engine to offer deeper insights into the values of assets, and Opteon’s Valuation Management System (VMS).

Opteon’s valuers use the VMS to manage the end-to-end valuation process seamlessly in one place. Now, with linked access to data generated by Forbury’s SaaS engine, they can also readily produce complex reports for $10m+ commercial assets, such as shopping centres, office buildings and high value industrial assets. These can involve single or multiple tenancies.

Opteon has been providing cutting-edge systems and valuation data solutions to the property industry for more than 10 years. This latest investment into prop tech in the commercial space is going to transform our specialist valuers’ ability to produce insightful, complex reports quickly,” said Dan Hill, Opteon’s Senior Director- Specialist Real Estate.

This expanded partnership is good news for our clients, as well as our team. With the press of a button valuation outputs from Forbury are directly transferred into our complex commercial reports, so our highly skilled specialist valuers can now spend more of their time providing advice and commercial solutions to our clients, rather than manually inputting data. We want our valuers valuing, not word processing!” Dan added.

Opteon are at the frontier of what is possible for commercial valuers, both in terms of workflow design and generative reporting. We are excited to be extending our partnership by supporting Opteon with the technology to turbocharge their team of specialist valuers.” said Scott Willson, CEO of Forbury.

About the tech

Opteon’s Valuation Management System

The Valuation Management System (VMS) is Opteon’s proprietary tech platform, which supercharges Opteon’s business by delivering speed, efficiency and quality outcomes to the 500+ Opteon people who use it.

Opteon’s VMS also provides customer connectivity, creating system-to-system integrated channels with lenders by plumbing straight into third party and bank systems using industry standard protocols.

Forbury Commercial

Forbury Commercial provides an integrated assessment of value using capitalisation of net income, discounted cashflow and direct comparison methods of valuation. It can be used to:
• assess acquisition and divestment opportunities
• undertake property valuations for mortgage and other reporting purposes
• provide project valuation forecasts
• provide leasing scenario analysis
• prepare cashflow budgeting / forecasting (up to 20-year cashflows by month, 10-year rolling discounted cashflow)

Forbury Retail

Forbury Retail draws on detailed information on each space within a shopping centre. Using inputs from a variety of critical elements, the software provides industry-leading modelling to inform property valuations, project valuation forecasts, acquisition and divestment opportunities, cashflow budgeting and forecasting, and leasing scenario analyses. It also assesses tenancy performance by major tenant and individual trade categories.

Dan Hill

Senior Director

Dan started his valuation career valuing residential property, before moving to the Commercial Division of Opteon (Western Australia) in 2009. In 2014, Dan became a Director and Equity Partner of Opteon (Western Australia), the firm’s youngest-ever equity partner. In conjunction with six other partners, he was responsible for managing 65 staff, ensuring business plan and budget targets were met in areas including staff management, business development and financial analysis.

In 2017, following Opteon’s national integration, Dan was appointed Regional Director – Commercial and Agriculture, leading a team of 25 valuers across Western Australia.

He prepares valuation reports for key clients for finance purposes, acquisition and disposal, negotiation and strategic advice, as well as managing the day-to-day activities of his team, and their ongoing training and development.

Daniel is committed to his own professional excellence and that of his team.

Dan can be contacted on 0418 487 373.

Contact Us

DISCLAIMER

This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax, investment or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.

Managing Leasing Risks in Commercial Markets

By Ross Turner, National Director – Commercial Agri Advisory

Following sustained growth and value uplift, yields on residential flats and multi-residential property reached all-time lows during the pandemic. This led to a noticeable pivot by investors to commercial property. This shift in focus, along with low interest rates, has driven a healthy sales recovery in select national commercial markets – particularly the sub-$10 million owner occupied and investment space.

The second wave of lockdowns across Australia led to many sub-$10 million investors contemplating the fundamentals of the commercial property sector. In the post-pandemic onset, one of the most important factors quickly became the underlying ability of commercial tenants to sustain rental payments.


Addressing the risks of commercial leases

One of the largest points of difference between residential and commercial investment property is that commercial leases are negotiated for longer terms (usually 2-10 years). These leases typically have structured provisions that allow for the rent to increase annually over the term of the lease.

The COVID-19 lockdowns and restrictions highlighted the need for investors to confirm that the tenant can sustain rental payments and rental increases over the term of their lease. For investors, there are two risk factors to consider when assessing the sustainability of income for an asset:

  1. the strength of the tenant covenant (i.e. the ability and financial strength of the tenant/lessee to pay rent), and
  2. the rental growth provisions in the lease and how these co-relate with market growth within the tenant’s asset class.

Strength of tenant covenant

The strength of a leasing covenant is determined by the financial strength, credit profile and balance sheet capacity of the tenant to sustain rental payments. For example, government tenants are very attractive because the risk of rental payment default is all but eliminated due to the very low level of sovereign risk in Australia. Similarly, if corporate tenants are backed by a strong balance sheet, the tenant covenant is likely to be one that features income security that in turn will ensure the property keeps generating income.

As tenants, smaller businesses – especially those in industries that have been negatively affected by the pandemic – are often riskier. As sustainability of rental payments could be compromised, any balance sheet volatility warrants further due diligence and risk assessment if an impacted business comprises part of the tenancy mix of a property.

Rental growth provisions in the lease

One of the most important, but potentially least discussed, items in the sustainability of income in commercial property is the growth profile of the rent outlined by the provisions of the lease, and how this may differentiate from market leasing transactions at any point in time in the property cycle.

It is also important to note that leases negotiated before the onset of COVID-19 pandemic may not reflect the future growth projections in the new COVID normal economy.

Before the pandemic, some commercial leases were structured with 3%-4% fixed rental increases over the term of the lease. In contrast, leases featuring growth rates based on CPI are not faring as well. Data from Deloitte Access Economics shows an average CPI growth forecast of 1.9% per annum for the next five years. Whilst inflation is currently a key topic of discussion, not all markets are created equal, and it should be noted that any potential inflationary pressures to rents would need to be balanced by demand levels changing from new work and consumer buying patterns post-pandemic.

Figure 1 shows the growing cumulative differential to a lease with a 4% contracted growth provision compared to one with projected CPI growth provisions. Using this example, this creates a significant gap of 10.5% between projected passing and market rent in 2025/26.

Figure 1: A significant income gap is created when moving from a 4% contracted growth provision to a CPI growth provision.

 

While rental growth has been impacted by COVID-19, particularly in industries such as retail and hospitality, it has not necessarily been priced into current market transactions. This is because rental growth is a lag metric that takes time to impact underlying property values. It can also be potentially hidden by other measures, such as tenant incentive side agreements.

Tenants will also be aware of this difference. Leases negotiated before the pandemic with fixed increases will need to be monitored closely to gauge their long-term sustainability. Using the graphed example, and assuming the growth of parts of the economy does not strengthen, there is the possibility that market rents will not align with passing rents at the end of a fixed lease term. That outcome will increase several risks, as outlined below.

Weighing the risks

When monitoring commercial portfolios or performing due diligence on a commercial property acquisition, it is important to understand, manage and mitigate the various risks to income. Three factors to consider are:

  • the diminishing probability that the tenant will renew the lease for a further term
  • the ability of the tenant to sustain rental payments during the period of the lease if they do not have the right financial capacity, and
  • the sustainability of the property’s value, as adjustments will need to be made if there is a noted differential between passing and market rent, with the added value of any profit rent diminishing towards the end of the lease term.

By doing so effectively, investors can help protect the sustainability of income and the value of their asset.

Tenant renewal

There are measures in a lease that can protect landlords from a sitting tenant’s rent falling below a previous years rent in the event of a lease renewal, including cap and collar provisions, and rachet clauses. However, it is worth considering whether there is a higher level of risk that the sitting tenant may not renew the lease on expiry. If that is the case, it may be worth provisioning for higher incentives, leasing costs and downtime.

Sustainability of rental payments

Similarly, landlords can be protected against non-payment of rent by provisions such as personal guarantees, security deposits and bank guarantees. However, if the passing/contract rent is above the level of rent indicated by market transactions that may flag a warning that the level of contract rental may not be sustainable for the tenant.

Depending on the strength of their business, this could increase the risk of tenant default. That scenario would be reflected in the risk profile of the asset and would impact the property’s valuation.

Sustainability of property value

Finally, as market net income is a fundamental value driver of commercial property, it is important to note that risks to the sustainability of income ultimately may impact the value of a property. This could be caused by the introduction of incentive provisions, downtime, leasing agents’ allowances, or the adopted net yield/capitalisation rate/discount rate softening to allow for the risks in the income profile.

Author

Ross Turner
National Director – Commercial Agri Advisory
M: +61 435 039 847

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DISCLAIMER

This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax, investment or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.

On the Pulse - Water Risks

Rising Water Risks for Agricultural Properties

By David McKenzie, Director

The value of agricultural land is increasingly being affected by issues relating to reliable access to water. This is particularly true in the Murray-Darling Basin, which produces 40% of Australia’s agricultural produce worth $24 billion (food and fibre) annually [1], where the rivers are under pressure and rainfall can be unpredictable.

Environment

Environmental factors are contributing to water criticality in the Murray-Darling Basin. Over the last century, there has been a stepped reduction in annual inflow for both the Goulburn (39% reduction from 1891 – 1995/96 average compared to the 1996/97-2019/20 average) and Murray Rivers (36% reduction from 1891 – 1995/96 average compared to the 1996/97-2019/20 average).

Over a similar period (1910-2018), the annual mean temperature anomaly across the Murray Darling Basin also rose considerably, as shown in Figure 1.

Annual mean temperature anomaly Murray Darling Basin

Figure 1: Annual mean temperature anomaly Murray Darling Basin (1910-2018) [2]

Allocations and pricing

The productive capacity of much agricultural land is underpinned by the reliability of allocation against water shares and entitlements (which in turn are driven by rainfall). This includes broader scarcity for irrigation water affected by increasing competition from other user groups, including the environment, urban and recreational users, and cultural groups. All these issues combine to set the price of both permanent entitlement, and annual allocation. These prices can fluctuate significantly, often at very short notice.

Yearly allocation volumes of high reliability and general security entitlements in the Southern Murray-Darling Basin, mapped against the price per megalitre as seen in figure 2, demonstrate the volatility of the market.

Figure 2: Yearly allocation volumes in the Southern Murray-Darling Basin and the price impact

Figure 2: Yearly allocation volumes in the Southern Murray-Darling Basin and the price impact [3]

Policy framework

For decades, there has been a focus on finding a balance for water use between production and the environment. The issue remains highly political.

The Murray Darling Basin Plan (the Plan) puts sustainable diversion limits on water use, which have applied since 2019. Under the Plan, the long-term average environmentally sustainable level of take for surface water is set at 10,873 GL/year and for groundwater the sustainable level of take is 3,324 GL/year. In 2019, there was already significantly more water being taken from the system than these thresholds. The Plan is designed to reduce the actual take, back to the sustainable levels set out above.

Since the Plan came into effect, water has been recovered with a $13 billion budget through direct purchase of water entitlement by the Australian Government, or the exchange of water entitlement for investment in modern infrastructure (on farm and system efficiency projects).

The recovery target was 2,750 GL by 2019, which may be reduced by 650 GL via supply measures or offsets. The water recovery strategy also allows for a further 450 GL reduction by 2024, subject to neutral or improved socio-economic outcomes.

The current state

The Federal Department of Agriculture and Water Resources (DAWR)’s offset project analysis has shown 26% of water recovery projects are unable to be delivered without major intervention and there is likely to be a 158 GL shortfall against targets. Further, a number of significant projects are considered at risk, including the Menindee Lakes Project and several contentious constraints projects.

Victorian Farmers Federation (VFF) analysis shows a likely shortfall of 230 GL in 2024 as well as a 45 GL gap overall. The only mechanism available under current legislation to recover the balance will be via buybacks. Extensive socio-economic analysis has proven that buybacks are the most damaging form of water recovery for regional communities and economies. Consequently, this looming recovery gap presents as a significant risk for irrigation dependant regions of the Murray Darling Basin.

Growing deliverability risk for downstream irrigators

The Barmah Choke is a natural narrowing of the Murray River channel, near Echuca. The gradual movement of sediment and sand down the Murray has caused significant loss of channel capacity in the natural waterway – it is silting up. Consequently, there is a growing deliverability risk past the Choke, which has seen capacity reduce from 11,500 ML/day in the 1980s to 9,200 ML/day in 2019[4], and less again in 2021. Additionally, the Darling River has been in drought for many years which has limited transfers from the Menindee Lakes to the Murray system and affects South Australia’s entitlement flow. These factors have combined to put great pressure on the Goulburn River to make up the difference on downstream commitments.

Delivery shortfalls occur when the levels of actual water used are higher than the forecasts because of the time it takes water to travel through the system. These are commonly caused by unexpected spikes in irrigation demands or river evaporation during heatwaves.

System shortfalls occur when the combined capacity of the system is unable to supply all downstream requirements over the full season. One of the key issues is the loss of capacity at the Barmah Choke due to bank erosion and sand levels. When there is a system shortfall, water use below the Barmah Choke (with a capacity now understood to be closer to 7GL/day may need to be rationed to deliver South Australia’s entitlement flow (a minimum of 1,850 GL/year or 5.3GL/day).

What can be done?

There are a range of options to manage the Barmah Choke, including doing nothing to manage the sand, improving banks to control new sediment inputs, physically removing the sand and moving water around via new infrastructure. Each option has its pros and cons.

There have already been some rule changes to protect the Goulburn River, including limiting Goulburn inter-valley trade (capped at 40 GL/month) and removing tagged water provisions. However, while these changes remove the opportunity for tagged water to sneak past the choke, they also exacerbate delivery shortfall risk in heatwaves.

What it means for the agriculture sector

Agricultural landowners, developers and investors need to consider water access issues in the context of the Murray Daring Basin Plan and the likely recovery shortfall and buyback demand.

Agricultural land value will continue to be affected by deliverability risks that cannot be fully mitigated, and that these are likely to increase going forward.

The new rules will partly insulate districts above the Barmah Choke, however there will continue to be significant pressure on low value irrigation below the Choke and increasing pressure for user groups between the Choke and the SA border.

Between climate change, elevated competition for water, uncertainty about fulfilment of recovery targets in the Basin Plan, and growing deliverability risks in the lower Murray region, there is little doubt that the classes of water that can be traded along the length of the Murray River (with all attendant access rights), will be increasingly sought, and likely to experience significant upward price pressure in the medium to long term.


[1] Murray–Darling Basin Authority (MDBA)

[2] Bureau of Meteorology

[3] Claire Miller Consulting

[4] Managing Delivery Risks in the River Murray System (MDBA)

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DISCLAIMER

This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax, investment or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.

On the Pulse - Carbon Farming

Hot Topic: Carbon Farming

By Julian Nichols, Director – Specialised and Advisory

With personal experience in agriculture and an understanding of land management practices, our agribusiness team is at the forefront of the rural property market.

Carbon Farming has recently established itself as a new sector. It is the financial incentive to change agricultural practices and management of land, to increase the amount of carbon stored in the soil and vegetation (known as sequestration) in order to reduce greenhouse gas emissions.

Farm

The system allows farmers (and others) to sell Australian carbon credit units (ACCUs) to governments and companies to offset their emissions (1 ACCU = 1 tonne CO2). Currently, ACCUs can only be traded within Australia (noting carbon credits can attract higher prices internationally). Depending on the property type and land use, potential future carbon credits are calculated on the existing biomass of vegetation. In areas such as the pastoral rangelands, they can be measured by satellite.

Farmers can earn carbon credits through activities such as protecting or planting vegetation, building soil carbon, and achieving energy efficiencies. However, the future challenges, particularly on large pastoral properties is having the traditional grazing land use co-exist with carbon farming.

Presenting agricultural enterprises with opportunities to diversify their business whilst mitigating the effects of climate change, carbon farming provides a potentially favourable outlook for both enterprises and financiers.

Given the industry is in its infancy, there is currently limited availability of sales within Western Australia and broader Australia to determine the premiums paid for such carbon agreements. There is however significant investment in the industry as a whole. A carbon scheme can take up to 6 months to register and a further 18 months before a first payment is received, so it is likely to be some time yet before clear market trends are established.

As the environmental and valuation impact of carbon farming continues to evolve in Australian agriculture, the Opteon Agribusiness team bring decades of valuation expertise into this developing sector.

Meet one of our Western Australian Agribusiness Leaders:

Julian Nichols

Julian Nichols

Julian Nichols

Julian has over 29 years of experience as an Agribusiness, Commercial and Residential valuer throughout primarily Regional Western Australia. As an Agribusiness leader, he has strong expertise in undertaking valuation and consulting advice for a number of the corporate farming interests both Australian and International that own land within the Western Australia agricultural region.

Julian works with the Opteon team that have demonstrated experience in the completion of valuations with approved Carbon Farming Projects and has presented on this topic at the Elders WA Rural conference in December 2021.

Contact Julian on 0407 443 635 / julian.nichols@opteonsolutions.com

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DISCLAIMER

This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax, investment or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.

The Rise of Alternative Real Estate

By Chris Mitrothanasis, Regional Director – Commercial & Agribusiness

The Australian Financial Review’s Property Editor, Nick Lenaghan, recently wrote that the alternative real estate market is “heavily under-represented in Australia’s listed property sector, a shortfall drawing increasing interest from major investors”.

Opteon data suggests that it is not just the institutional investors showing interest.

Buoyed by low interest rates and attracted by a range of factors, including compressing yields, individual and private investors are increasingly turning their attention to alternative real estate assets – particularly in the petroleum and childcare asset categories.

Why the interest?

In the past year, <$10m commercial, industrial and retail assets have remained fairly stable in a positive market across metro and regional locations. While these asset classes remain attractive to investors, many are also being drawn to alternative real estate assets as they can offer:

  • better short-term returns – yields for this asset class are typically stronger in the short-term than for the more traditional property asset classes, particularly residential (which has historically attracted many individual and private investors)
  • firming yields – boosted by increasing rents, particularly in NSW, and increases in capital value
  • good income while awaiting redevelopment opportunities – sustained demand for large land sites, particularly in metro areas in Sydney and Melbourne, mean these assets can present good redevelopment opportunities
  • strong capital growth – transaction prices across the vertical asset class have risen, particularly in Sydney and Melbourne
  • robust, landlord-friendly lease terms – typically these include blanket recovery of landlord expenses, and
  • weighted average lease expiries regularly exceeding 10-15 years – indicating very stable tenant bases and the use of lease covenants.

Beyond the attraction of investor benefits, we have seen demand for valuation of these assets also boosted by low interest rates, changed lending policies, refinancing requirements and strong marketing activities.

Vertical asset class performance

Two asset categories are performing particularly well in the <$10m alternative real estate asset class – petroleum and childcare. These categories are providing investors with secure long leases, good returns, capital growth and redevelopment opportunities. Other areas of strong valuation activity are being seen in motels, hotels, storage facilities and caravan parks.

One of the reasons petroleum and childcare assets are being embraced by individual and private investors is the active marketing they have received over the past five years. Stock levels are also being boosted by corporate owners, such as g8education, Caltex, Ampol and 7 Eleven, which are diversifying their portfolios. Many of these alternative real estate assets are sold with leaseback arrangements, making them more attractive to investors.

Overall, yields have compressed across regional and metro areas because of the low interest rate environment, an increase in investor demand and capital growth.

Petroleum assets

Over the past five years, Opteon has valued more than 600 petrol station sites in metro and regional areas (noting some properties were valued more than once). These have been in capital cities, key regional hubs and along main routes between cities. By volume, these properties were evenly split between being more traditional service stations (fuel and garage) and multi-purpose fuel outlets (fuel and convenience store).

Demand for these valuations has been increasing over the past four years, as shown in the graph below.

Graph showing increase in demand for Petrol Station valuations - alternative real estate

Graph showing increase in demand for Petrol Station valuations

Larger petrol station sites have attracted many developers as they offer good holding income for potential redevelopment down the track. However, in most cases, petrol stations are being bought as lessor interests, many with current lease covenants and high WALE.

These lease covenants also inform due diligence on remediation risks, together with environmental assessments and site history investigations. This is particularly important for petrol station sites, as well as other sites, such as workshops, that have been used for petroleum storage.

Petrol stations have also seen an increase in retail sales as they evolved their convenience offerings. As these businesses continue to evolve, for example in the way Caltex has with Foodary, their attractiveness to lessors and lessees is likely to increase.

Over the past four years, market net yields on petrol stations have compressed in both metro and regional areas nationally, as shown in the graph below. In the 2021 financial year, 50% of yields were between 4.3% and 6.1% in metro areas and 50% of yields in regional areas were between 6.3% and 9.2%.

Graph showing compression in market net yields on Petrol Stations - alternative real estate

Graph showing compression in market net yields on Petrol Stations. The red line shows regional petrol stations; the blue line shows metro petrol stations

This reflects increased demand from the investor market, increasing rent rates, increasing transaction prices and the low interest rate environment.

Childcare assets

Childcare assets are appealing to many individual and private investors. Most investments are made for the lessor interest and holding potential, however approximately 20% are sold for the freehold and going concern.

Leases for childcare centres are typically standardised, with long initial lease terms of up to 30 years (source) . Rents have increased over last five years, aided by an increase in childcare daily rates.

Opteon has conducted approximately 380 childcare property valuations over the past four years, with strong valuation activity in NSW (131 valuations), Victoria (76 valuations) and WA (74 valuations). These childcare centres have been located across the country and spread between metro (238 valuations) and regional (143 valuations) areas. By volume, these properties were evenly split between being day care centres and early childhood development centres (kindergarten and childcare).

Demand for these valuations has been increasing over the past four years, as shown in the graph below.

Graph showing increase in demand for Childcare valuations - alternative real estate

Graph showing increase in demand for Childcare valuations

We have seen a notable increase in demand in regional areas during the past 18 months reflecting the pandemic-driven treechange trend embraced by many young families. This reflects increased demand from the investor market, increased government funding, increasing rent rates, increasing transaction prices and the low interest rate environment.

Market net yields on childcare centres have dropped in the last four financial years in regional areas across Australia and have dropped in the last three years in metro areas, as shown in the graph below. However, it is worth noting that, after strong compression (6.8% in FY 2018 to 5.4% in FY 2020) in recent years, there was a slight softening in the Sydney metro market for childcare centres, with median yields ranging from 5.4% – 5.7%.

Graph showing decrease in market net yields in Childcare Centres - alternative real estate

Graph showing decrease in market net yields in Childcare Centres. The red line shows regional childcare properties; the blue line shows metro childcare properties

In the 2021 financial year, 50% of yields were between 5.6% and 6.7% in metro areas and 50% of yields in regional areas were between 6.3% and 7.1%.

The COVID-19 impact

In very different ways, petrol stations and childcare centres are key to the country’s productivity. As such, the businesses associated with these alternative real estate assets have attracted both financial and essential worker status support from governments during the pandemic.

The childcare sector has attracted significant government funding and support during the pandemic, helping ensure the sector remains financially stable and open for business. This has allowed many essential workers to go to work and other employees to remain productive when working-from-home.

The pandemic has “pumped up” the service station asset class, with one market commentator noting: “With long leases to national tenants and greater exposure to domestic travel due to the pandemic, service stations remain well-placed to outperform all other asset classes (source).” Anecdotally, we have also seen rises in convenience sales during lockdowns.


DISCLAIMER
This material is produced by Opteon Property Group Pty Ltd. It is intended to provide general information in summary form on valuation related topics, current at the time of first publication. The contents do not constitute advice and should not be relied upon as such. Formal advice should be sought in particular matters. Opteon’s valuers are qualified, experienced and certified to provide market value valuations of your property. Opteon does not provide accounting, specialist tax or financial advice.
Liability limited by a scheme approved under Professional Standards Legislation.