Hot residential market drives boom in prices for apartment sites
WHAT should we do about the crazy prices being offered for commercial properties earmarked for residential conversion? Buyers are paying more for potential apartment sites than these properties are worth as office buildings.These are not normal times and it won’t last much longer, particularly in Melbourne.
The boom in apartment sites is a market anomaly driven by the bullish residential property market. It’s all about their suitability for development and the attractiveness as a high-rise residential location. High-rise projects need a large enough land area and appropriate zoning potential. The boom is not just in inner and near city sites, but it’s also affecting suburban office locations.
The strength in residential property markets and prices in new residential developments has underpinned financial feasibilities, allowing a stronger residual value for sites. In particular, overseas developers willing to take on projects at lower margins than the norm in Australia has boosted the amount being paid for sites.
In many cases, offers for office properties capable of conversion to apartments have been fielded at 30-50 per cent above their valuation. I’ve seen double and that’s hard to resist. Real estate agents have been pitching many commercial property sales towards this market.
For commercial property owners, this is a window of opportunity to realise assets at prices well above normal market levels. If these properties remained as offices, even optimistic forecasts would not see the prices currently being achieved this decade.
It doesn’t make sense to refurbish or redevelop secondary office buildings in the current environment. In Sydney and Melbourne, prices are barely at replacement cost, making the financial feasibility for development difficult. Only premium buildings on low costs sites will work.
In fact, it doesn’t make sense to resist the prices being paid as residential sites. But what to do with the money? We may not be able to buy commercial property at sensible prices in the current market.
We shouldn’t confuse this with the strong prices and firming yields for prime property, as both domestic and overseas investors take positions in the Australian markets. And that has flowed on to secondary properties and locations. Super funds, real estate investment trusts and overseas pension funds have been looking for long leases and secure cashflows in quality commercial buildings. The interest seems to be driven by in the greater yield for commercial property relative to bonds, both here and overseas.
I wonder what will happen as bond yields rise significantly over the next few years. My expectation is that demand from this source will dry up and that some of the money will go back to bonds. The lower discount rates and internal rate of returns that institutional investors seem willing to accept now could evaporate. Other things being equal, that would lead to a softening of yields for commercial property.
But other things aren’t equal. While prospects differ city by city, the cities with strong office markets will be relatively sheltered from this effect as the cycle runs its course. So what will we do with the money? Should we invest now looking for higher returns later on? Will increased site values for residential use stick?
I don’t think so. Nothing fundamental has changed about commercial property. We can’t afford to pay over the odds for property without affecting returns. In any case, the only office markets with good medium-term prospects are Sydney and Melbourne. But, given prospective continued weakness of the economy, and hence office demand, even they will be slow to recover.
The real question is how long the residential upswing will last. We can’t compete with the prices being paid for residential sites. But the residential upturn won’t last forever. It’s a window, shorter in Melbourne than Sydney. And site prices will return to more normal levels once it’s over.
Meanwhile, on a positive note we’ll see substantial urban renewal of older commercial buildings as residential uses. The problem is that, while it lasts, the development boom will take away potential commercial sites. Should we protect commercial sites in the cities? But that’s an economic development issue.
Where appropriate, it makes financial sense for investors to take the money and run — perhaps with a view to returning to the market, now if there are appropriate properties, or later when the residential cycles run their course. Meanwhile, be patient. Be aware that demand for residential sites has taken some commercial property prices too high. Make sure we understand the difference between being priced as a commercial property or as a residential site. Stick to your guns and wait until investment makes financial sense.
There will be opportunities for sensible investment. I suspect we won’t have to wait too long.
Frank Gelber is chief economist for BIS Shrapnel. firstname.lastname@example.org
City landmarks face makeover or wrecking ball
Rising demand: An artist's impression of 555 Collins Street, Melbourne. Photo: SuppliedCapital city skylines are set to get more cranes as the wrecking ball demolishes decrepit buildings to make way for new, shiny apartment blocks and futuristic office towers.
In Sydney, one of the latest to be earmarked for change is Gold Fields House at Circular Quay.
Its co-owners Blackstone, the private Valad Core Plus Fund and Dutch fund APG, have appointed CBRE and JLL to market the almost 50-year-old building for about $400 million.
An artist's impression of the landmark Gold Fields House at Sydney's Circular Quay. Photo: SuppliedOnce redeveloped it will bookend Circular Quay with AMP's $1 billion revamp of its 50 Bridge Street office tower and laneway, and the former Coca Cola building opposite in Macquarie Street, which is also being developed into apartments.
Lend Lease has also lodged a draft planning proposal with the City of Sydney for a commercial tower at Circular Quay at 174-176 George Street, 182 George Street and 33-35 Pitt Street.This could include the Jacksons on George bar, which all could be turned into apartments or a hotel.
The revamp has been triggered by the rise in demand for city living and the fact that more than half of city-based office blocks across the country are considered derelict and as they are more than 30 years old.
While a majority still look good and are safe to work in, the demand for high-speed internet connections, hot desking and the new "end of journey" facilities - bike racks, showers and lockers - has put pressure in older buildings.
This has led to the growth in the conversion of the towers into apartments.
According to JLL researchers, the anticipated plans for ageing office stock across Australia's office markets is expected to vary, with Sydney and Melbourne leading a charge for residential development conversions well above commercial book value.
"Melbourne's ageing buildings within the CBD have landlords questioning how best to treat them in order to stay relevant and keep the buildings occupied," said JLL's head of tenant representation for Victoria, Peter Walsh.
"For occupiers, this is a positive as it means landlords recognise the way occupiers work, and what they expect from workplaces, is changing – and they need to keep up with expectations," Mr Walsh said.
"The adoption of new work styles and increased demand for higher-quality amenities, such as end-of-trip facilities, conference facilities and business clubs, certainly hasn't ruled out consideration of ageing stock."
Three examples in Melbourne are 85 Spring Street, which JLL sold to Grocon with planning approval for a residential tower; 35 Spring Street, which is owned by Cbus and recently demolished for a residential tower; and 555 Collins Street, also earmarked for a residential tower.
JLL's head of tenant representation for NSW and ACT, Gavin Martin, said Sydney's strong appetite for residential conversions would continue to maintain a balance of oversupply by absorbing excess older-style stock.
"Over $1 billion of commercial property has been purchased in the last year, with the intent to redevelop or convert the site for residential use," he said.
According to Mr Martin, Sydney is leading the charge across Australia in adopting new workplace styles to achieve more with less. "Unless large corporates have a valid reason to move, they're deciding to stay, with many working more efficiently in less space."
This has been seen along Martin Place, where older properties have been given a facelift.
The biggest are 20 Martin Place, which is currently a skeleton building that the owners Pembroke will redevelop into a futuristic office tower, and the Cbus and DEXUS $450 million redevelopment at 5 Martin Place.
Nearby, GPT is rejuvenating the MLC building and the surrounding retail area along Castlereagh Street.
Similarly, in Canberra's commercial office market, any move needs to be justified by productivity gains. "If an existing fit-out works and the size of the space is appropriate, then the likelihood of a renewal will be higher than that of a move," Mr Martin said.
"Ageing stock in Canberra is likely to undergo a similar cycle to the refurbishment and demolition that other states are currently experiencing; however it may not come to fruition for years due to slower demand."
According to Colliers International, the residential development is the flavour of the month throughout Sydney and this is influencing metropolitan commercial markets.
Its Competitive Rivalry: Office Versus Residential in Metro Markets report, says that some metro markets have seen contraction as a result of residential conversions, while in others development sites that would once have been for commercial use, are now being pushed as residential.