THINKTANK COMMERCIAL PROPERTY FINANCE

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1 THINKTANK COMMERCIAL PROPERTY FINANCE Quarterly Market Update October - December, 2017 Up-to-date views on the state of the Australian commercial property market seen in light of recent global economic and financial market developments. We also discuss the implications current monetary policy has for the domestic economic outlook and individual property market sectors across the country. Think Tank Group Pty Ltd Published 31 Level 10, 65 st October 2017 ~ Think Tank Group Pty Ltd 2017 Berry Street, North Sydney, NSW 2060

2 1. The Global and Australian Economies The third quarter of 2017 domestically saw interest rates held unchanged by the Reserve Bank of Australia (RBA) Board while internationally the Federal Reserve Bank s Open Market Committee (FOMC) also left official interest rates on hold in the United States at their September meeting. This was not unexpected but there are now some signs from Fed members that a further increase in this calendar year 2017 remains likely. While President Donald Trump continues to occupy world headlines and newspaper editorials the ability of his administration to implement the economic policies he has espoused is in doubt as the republican Congress has shown a clear reluctance to simply follow the lead of its party s President. International developments such as these have a significant impact on the Australian economy and they have made it difficult to foresee economic outcomes as we continue to wrestle with sub-trend rates of growth, low inflation and until recently pockets of booming house prices. There are now clearer signs that despite these factors various international agencies are firming up their forecasts of global growth for the current year and possible further stimulus from the United States if President Trump s economic policies can indeed be implemented. The Australian national mood has been generally subdued with measures such as consumer confidence having been pessimistic but now beginning to improve. Business confidence still remains more upbeat if not buoyant and globally the steady flow of downgrades to expected economic performance from almost all the major international agencies seems to have come to an end with the latest Economic Outlooks from the Organisation for Economic Cooperation and Development (OECD) and the OECD Interim Economic Outlook - Short-term momentum: Will it be sustained? IMF World Economic Outlook Seeking Sustainable Growth Short- Term Recovery, Long-Term Challenges. International Monetary Fund (IMF) forecasting steady/improved results for 2017 of 3.5%/3.6% respectively and up by 0.1% for 2018 at 3.7%. These latest reports from the OECD and IMF include unchanged prospects for the United States economy and to some extent relies on implementation by the new US Administration of policies that will stimulate growth to 2.1% in 2017 and 2.4% in The steady US outlook is added to by an improved forecast for the Eurozone and China. The OECD lifted its forecast for Eurozone GDP growth to 2.1% in 2017, up 0.3% and to 1.9% in 2018 up 0.1%. The Eurozone GDP growth improvement continues to reflect increasing domestic demand and the OECD is calling for monetary policy to remain supportive until inflation starts to hit targets. Chinese GDP growth is anticipated to increase slightly to 6.8% from 2016 and is up 0.2% from the previous forecast and similarly up 0.2% to 6.6% in The RBA in its August quarterly Statement on Monetary Policy (SoMP) revised slightly higher its forecast growth by Australia s Major Trading Partners (MTP) at just below the long-run average pace of 4% for the next two years reflecting the prospect of more stimulatory fiscal policy in the US. China s current stronger growth for 2017 was noted but with expectations that it would be expected to slow next year, contrary to the OECD and IMF forecast noted above. The report was issued slightly over a month before the release of the second quarter national accounts by the Australian The RBA August SoMP continues to indicate little policy change. Forecasting changes are coming in November. Bureau of Statistics (ABS) on 6 September 2017 with quarterly growth of 0.8% (1.8% annual) compared to 1.1% growth (2.4% annual) in the first quarter. This compares to an expectation by the RBA that growth to Dec 2017 will be 2% to 3% and then rising by 0.50% through to June 2018, a further 0.25% to Dec 2018 and another 0.25% to June Unemployment has fallen in the quarter to 5.5% and remains well below the RBA s earlier forecasts; it is now looking at a range of 5-6% through to The CPI for the third quarter continued to be low at 0.6% for the quarter which produced an underlying annualised rate of inflation (trimmed mean) of 1.8% just below the RBA target band of 2%-3% but as forecast in the SoMP. The RBA s range also remains at 1.5% to 2.5% 2

3 through to December 2018 and then rising slightly by 0.5%. The RBA s Deputy Governor, Guy Debelle recently signalled a change to the broad forecast ranges used in the SoMP which will shift to targets measured to ¼ of 1% instead of the full 1% band currently employed. In this same speech Dr Debelle noted the long period of time taken to report GDP and CPI data by the ABS; while not implying any criticism or suggesting a solution he did highlight the uncertainty this forces on monetary policy decision making. The central bank also continues to remain focussed on the risks presented by the housing sector after having looked at the inner-city apartment property markets in various reports and speeches by senior bank officials. As with the OECD and IMF Outlooks several warnings are given but there is no sense of alarm with the current situation. Three Westpac surveys covering September were recently released; the Westpac MI Consumer Sentiment Survey, the Westpac ACCI Survey of Industrial Trends and the Westpac MI Leading Index. The quarterly Industrial Trends reading was positive again for an eleventh straight quarter and was up by 1.8 points to The monthly Leading Index however fell to -0.21% in September. The Consumer Sentiment Survey was up in September by 2.5 points to 97.9 and then in the October result just released broke into positive territory up another 3.5 points at The three monthly Australian Industry Group (AiG) Performance Indices all remained in positive territory at the end of September although each recorded a fall for the month despite remaining above the 50 mark. The Manufacturing Index fell by 5.6 points to 54.2 and Services fell slightly by 0.9 at Construction fell by only 0.1 points and remained in expansion at We discuss all of the surveys in more detail later in this report. The Dun & Bradstreet Business Expectations Survey was down marginally by 0.3 points to 16.4 in terms of the outlook for the 4 th quarter of 2017 after hitting a two year high earlier in the year. D&B Economic Advisor, Stephen Koukoulas said, "As 2017 draws to a close, business expectations remain broadly steady, which points to ongoing moderate economic growth. Actual business activity ticked higher in the June quarter, but it remains in a range that points to the economy neither being strong nor weak, but rather something in between." 2. Interest Rates The RBA held rates steady again during the third quarter of The key drivers continue to be low CPI, sub-trend growth and low but steady employment while on the other hand rising house prices had been a major concern for policy makers. The August quarterly SoMP did not provide any strong guidance in that regard but public statements did. The AUD/USD exchange rate has again fluctuated through a wide range Westpac and AiG surveys overall still positive Consumer Sentiment improves and turns optimistic; D&B and NAB Business Expectations down slightly Cash Rate still steady as is the US Fed Rate; some correction in AUD/USD after topping 0.80 during the course of last quarter just topping 0.80 at the end of September and then falling back to just under Futures markets fluctuations had been less wide during the past quarter reflecting a lower expectation of movement in the Cash Rate as Governor Phillip Lowe of the Reserve Bank has been quite open in communicating a stable outlook. Opinion continues to be varied on the longer term future direction of domestic rates although both CBA and Westpac continue to expect no change in 2017 and well into NAB and ANZ had been forecasting earlier increases next year. Forward swap rates are now slightly positive up to five years ranging from just about 2.00% at three years and 2.40% for five years. At the longer end, ten year Commonwealth Bonds are near 2.50%. International events and foreign central bank moves have been key to the RBA s monetary policy but this has recently been downplayed by Deputy Governor Debelle. The decision of the US Federal Reserve Bank s FOMC to leave rates unchanged in September was expected but recent statements by various Committee members have firmed a view of a further US rate increase before the end of

4 3. Residential Financial commentators, economists, policy makers and regulators continue to focus their attention on residential housing. Prices for homes and units rose more slowly in most capital cities during the third quarter, especially in Sydney. The monthly housing price statistics through the past three months have shown some renewed levelling off of Sydney and Melbourne markets which was welcome news to many observers particularly at the RBA. Some price stability was to be found in houses which in Sydney were up 5.1% for the year to date and 8.5% in Melbourne. Units in Sydney were about the same, up 5.9% for the same period and in Melbourne up 6.4%. The ABS reported Investor loans were up 0.45% month of August after a similar 0.43% increase in July making the total of housing finance up only 0.52% for the month. For the year that figure is up 6.6% which appears to show that the APRA macro-prudential tightening is having some effect. Dwelling approvals for August seem to tell the same story with figures for all residential dwellings down 5.6% for the month and down 19.7% from a year ago. Multi-unit high rise approvals were down a whopping 45.4% for the year while houses were down 6.8%. The Australian Industry Group / Housing Industry Association Performance of Construction Index for September was down 0.6 points but remained in expansion above 50 at By sector, house building activity continued to expand solidly with the sub-index higher at 56.6 however the Apartment sub-index was in contraction at Capital city dwelling values rose only 0.7% over the September quarter with Sydney up 0.2% and Melbourne up 2.0%. CoreLogic RP Data The RBA, APRA and the Federal Government have been addressing the issue of a potential bubble in the housing market over the past year. The RBA had this to say in its latest SoMP; Household debt is likely to remain elevated for some time: housing credit growth overall has been steady over the past six months, but has continued to outpace income growth. The composition of that debt is changing, however, as lenders respond to regulators recent measures to contain risks in the mortgage market. Investor credit growth has moderated and loan approvals data suggest this will continue in coming months. Also, new interest-only lending has declined recently in response to the higher interest rates now applying to these loans and other actions by the banks to tighten lending standards. Various steps aimed at reducing the availability of funding such as limiting interest only lending and higher Loan to Valuation Ratio (LVR) loans have been implemented through APRA and along with these measures lending institutions have imposed out of cycle interest rate increases on investor loans aimed at reducing demand. This appears to be working although a shift to lending growth amongst non-adi/non-bank lenders has brought about legislation aimed at allowing APRA to exercise the same regulatory constraints on this sector. The CoreLogic RP Data Home Value Index figures at the end of the third quarter are showing weaker quarterly increases across the 8 capital cities nationally of only 0.7% and on a year over year (yoy) basis the gain was 8.5%. The marked difference between the individual capitals continues with Melbourne and Sydney well ahead of the others on an annual basis. The two leaders are discussed above with the other three we cover being well behind with Brisbane at 2.9% for the year, Adelaide at 5.0% and Perth at a negative -2.9%. Encouragingly for Perth, the month of September showed a small increase of 0.1% following a setback last quarter. HTW in their most recent Capital City Property Market research reflect the views in our ratings with Sydney and Melbourne still the clear leaders but approaching the peak of the market for Houses and evidence of oversupply in Units in Melbourne, Brisbane and Perth. Brisbane houses are still seen as starting to recover while Adelaide is in a rising market. Perth is approaching the bottom of its market cycle which is unchanged. As a result our Sydney and Melbourne trends remain Stable for this quarter but with a close watch being kept on monthly Value Index changes with small monthly falls in Sydney perhaps signaling the long awaited levelling out of the nation s priciest housing market. 4

5 4. Office Recent trends continued during the third quarter of 2017 with Sydney and Melbourne staying well ahead of the other capital cities with improving rental markets and falling incentives, particularly so in Sydney. The semiannual PCA Office Report showed a slight downward move in CBD vacancy by Sydney from 6.2% six months ago to 5.9% and Melbourne remained steady at 6.5% with expectations still for a very strong Sydney market for the foreseeable future. By contrast vacancy rates remain high in Adelaide and Brisbane at 16.1% and 15.7% respectively as these cities continue to grapple with weaker demand for office space; despite a slight increase, Brisbane is expected to continue to show steady improvement. Perth on the other hand has improved slightly to 21.1% but with secondary properties still at well over 25%. Knight Frank in a series of Office market research briefs during the third quarter had low vacancies in Melbourne and Sydney continuing to bring down incentives with net effective rents rising and HTW agreed in their most recent update with vacancies tightening and an increasing rental trend. The Sydney Office sector continues to be Strong and is still Improving with withdrawals playing a major role while in Melbourne higher levels of net absorption have kept the market at a Strong rating CBD Office returns Sydney 16.7%, Melbourne 11.6%, Brisbane 8.4%, Adelaide 9.1% & Perth 4.1% PCA MSCI/IPD Property Index and also with an Improving trend overtaking Sydney in growth of net effective rent. As with most other markets some modest tightening of yields continues to be reported with prime yields now below 5.0% and continuing to tighten over the last 3 months. Even in weaker leasing markets such as Adelaide and Brisbane with high vacancy rates and incentives, yields for prime properties have fallen and are reported as low as 5.8% in Brisbane but higher in Adelaide at 6.75%. Perth has also fallen slightly to a range of 6.5% to 7.5 % despite falling rents and sky-high incentives. The strength in the Commercial sectors of Sydney and Melbourne continues and the recent MSCI Property Index showed both delivering double digit returns at 16.7% and 11.6% respectively. Net effective rents in Sydney continue to improve more so than Melbourne but the contrast with the other capitals remains very clear. Brisbane and Adelaide recorded returns of 8.4% and 9.1% respectively while Perth was only 4.1% with a negative capital growth of 2.7%. HTW describes Adelaide as contracting but Perth is now flat while the other capitals exhibit steady growth. Yields are still tightening in most locations, even those with weak fundamentals but most commentators now expect this to level off. Sydney remains Strong as does Melbourne with both enjoying an Improving trend. We continue to see the Perth market as remaining Weak together with Brisbane and Adelaide and there are signs that the worst is over for WA. In this regard we have kept the Trend for all three of these capitals as Stable. 5. Retail Retail sales statistics reported by the ABS for the third quarter of 2017 were disappointing drawing the following comments by CBA s Senior Economist, Gareth Aird; September s flat outcome completed a terrible Q3 for retailers. Alarmingly, September was in fact the best of the quarter s three months with August down 0.6% and July down 0.2%. Overall, it is clear the retail sector is feeling the pinch of weak household income growth, higher electricity prices, elevated household indebtedness, job security fears and competition which is putting downward pressure on prices. In July we wrote that retail sales were on track for a much improved second quarter after the weather impacted first three months of the year and in a CBA research note at that time they asked Could the slump in retail trade be over? In retrospect, clearly not but looking at the annual growth by State all States are above annual 2% growth except Qld and WA beating the national yoy growth of 1.4% by a wide margin. Qld was at 0.2% while WA trailed badly at -1.2%. The break-up by sector showed 5

6 Department Store sales up by 2.1% for the month but their annual growth rate remained in negative territory at The Coles ASX announcement on their current trading performance and write-downs certainly emphasises what a difficult environment the sector is facing. The Westpac-MI Index of Consumer Sentiment has finally just moved into optimistic territory after strong rises in the past two months but the Westpac Redbook analysis of consumer trends which includes various indices continued to point to weak consumer demand in the near term. The AiG Performance of Services Index fell slightly in September but stayed in expansion at 52.1 and only just below the 12 month average of However the retail trade sub-sector fell further in September to 43.8 which marked its sixth consecutive month of contraction. The JLL survey of Shopping Centre Managers conducted in August also showed a level of pessimism with respect to occupancy and rents as pressure on rental income and increased incentives were major themes. Interestingly Take-away and Casual Leasing were the strongest categories of leasing inquiry. Quarterly sales disappoint, up only 1.4% yoy ABS and Myer results point to a very tough market for retailers CBRE s quarterly update shows CBD yields as stable in most capitals and staying at sub 5% levels in Sydney and Melbourne. Outside of the CBD yields are not that much higher with regional centres at just over 5% and subregional and neighbourhood at a range of 6% to 7%. Brisbane has comparable yields of 6.0% to 7.0% for subregional and neighbourhood centres and together with Sydney and Melbourne HTW describes them as approaching the peak of the market. Adelaide and Perth are at the start of recovery and the bottom of the market with steady/increasing vacancies and declining rents. In Adelaide yields are reported at 6.75% to 8.00% and in Perth at 5.25% to 7.00%. Once again there are no changes to our ratings this quarter and all are rated as Fair except Adelaide which is Weak, trends are Improving in Sydney and Melbourne and remain Stable elsewhere. It remains to be seen when the weakness in retail businesses will be reflected in retail property. 6. Industrial The ACCI Westpac Survey of Industrial Trends for the September quarter of 2017 strengthened by 1.1 points from the June result to 66.1, continuing the recovery from the low of 55.0 recorded in June last year, coinciding with the July Federal Election. As noted earlier in our update this is consistent with other surveys we follow with the AiG PMI still in expansion at 54.2 after a decrease of 5.6 points in the September survey. Manufacturing continues to benefit from local apartment and infrastructure projects which are still boosting demand. Exports appear to show signs of recovery in both surveys and expectations are up with 35% of businesses expecting the general business environment to strengthen over the next six months. The ACCI Expectations Market Composite remained at a healthy 65.2, down slightly from the June result of 65.7 and the survey notes that exports posted another solid quarter of expansion. A recent HTW review of the sector retained a positive view on Sydney reporting a tightening of rents in a rising market. The steady economic growth cited was in contrast to all other capitals which were rated as stable and all except Brisbane with an oversupply of available property relative to demand. Adelaide and Perth are viewed as being at the bottom of their property cycle. Colliers in their second half update which highlighted strong domestic investment demand expects that over the next six months yields will remain stable (currently averaging 6.8%) with infrastructure projects supporting growth. Sydney and Melbourne are as low as 5.73% and 6.27% respectively while Brisbane and Adelaide are at 6.55% and 8.16% with all four tightening. Secondary properties, have also seen a contraction of spreads from Prime and are showing yield compression of 50 bps to 75 bps in Sydney and Melbourne but little change in Brisbane and Adelaide. Rents continue to fall in Perth yields for both Prime and Secondary properties have stopped tightening and are 7.3% for the former and as high as 8.15% for the latter. These remain consistent with last quarter s update and as such we have made no changes to our ratings or trends. 6

7 7. Thinktank Market Focus The third quarter of the year saw Australian interest rates unchanged and in the United States the FOMC also held rates steady at their September meeting after having increased them in June following their earlier increase in March. Economically we are still in a period of extended below trend growth both domestically and internationally but by comparison Australian is better off than most especially over the long run with 25 years uninterrupted by a recession. While the likelihood is that international growth and interest rates will remain low for some time to come this looks to be the bottom of the cycle domestically as interest rates rise in the USA and rising housing prices rule out a cut in domestic interest rates even if policy makers were inclined to do so. Internationally, the world s media attention continues to be focussed on the Trump administration almost constant frontpage headlines; this time concerning North Korea. Unexpected political results in European elections also draw plenty of interest. The decision of the Federal Reserve FOMC with respect to no further Fed Funds Rate increase at their September meeting was important if not unexpected. Fed Chairman Janet Yellen and other voting Board members have since further expressed their views that rates should continue their cyclical upturn through 2017 and although this view is tempered with caution many are expecting an increase in December as Mrs Yellen s term draws to a close early next year. The impact this has had on the AUD/USD exchange rates together with a possible misinterpretation of signals from the RBA as to what constitutes a neutral Cash Rate was causing extreme volatility by the end of the quarter and the AUD almost hit 0.80 after having been closer to 0.75 earlier in the quarter and has now fallen but is significantly higher than the RBA would want it to be. We have not made any changes to our property sector trends and ratings since last quarter which is quite unusual. Our individual sector comments continue to generally reflect a slowing in growth of Sydney and Melbourne Residential markets and a return to stability in Perth Commercial reflecting that the worst may be over for WA but not enough for any adjustment to Ratings or Trends. We still have six markets that are Strong or Good and seven that are Weak. Sydney and Melbourne Retail remain Fair and Stable. In contrast, Perth and Adelaide have six ratings Weak but all trends are Stable. Brisbane has one Improving trend which is Industrial while Commercial there remains Weak but Stable. Residential units however remain a concern especially in the East Coast Capital Cities and we continue to remain alert to any sign of change in the RBA s bias on Monetary Policy particularly if employment continues to strengthen. SYDNEY MELBOURNE ADELAIDE BRISBANE (SEQ) PERTH RESIDENTIAL Strong Stable Strong Stable Fair Stable Fair Stable Weak Stable COMMERCIAL Strong Improving Strong Improving Weak Stable Weak Stable Weak Stable RETAIL Fair Stable Fair Stable Weak Stable Fair Stable Fair Stable INDUSTRIAL Good Improving Good Improving Weak Stable Fair Improving Weak Stable Sources and References ACCI Westpac Australian Industry Group ANZ Research Australian Bureau of Statistics Commonwealth Bank CBRE Research Colliers International Research CoreLogic RP Data Cushman & Wakefield Dun & Bradstreet Herron Todd White International Monetary Fund JLL Knight Frank Research OECD PCA / IPD Research, MSCI Reserve Bank of Australia Savills Research Westpac Economics Westpac-Melbourne Institute World Bank 7

8 For additional information, please contact: Publications & Market Update Per Amundsen Executive Director & Company Secretary T: (02) M: Funding & Strategy Jonathan Street Chief Executive Officer T: (02) M: Credit & Operations Peter Kearns General Manager T: (02) M: Sales & Distribution Peter Vala Head of Sales & Distribution T: (02) M: Business Relationships and Loan Inquiries Adam Hutcheson Senior Relationship Manager QLD M: Paul Burns Senior Relationship Manager NSW/ACT T: (02) M: Ranei Alam Senior Relationship Manager NSW T: (02) M: Tony Zaccari Senior Relationship Manager VIC/SA T: (03) M: Joel Harrison Relationship Manager VIC/TAS T: (03) M: Joel James Relationship Manager NSW/WA T : (02) M : jjames@thinktank.net.au Chrissi Sutherland Partnership & Media Officer T : (02) csutherland@thinktank.net.au Thinktank Property Finance is an established independent lender specialising in the commercial property market. We have a wide range of tailored mortgage product options which: Simplify traditional commercial lending products and processes, and Provide a set and forget finance alternative to the major banks without ongoing fees or annual reviews. Important Note This report does not constitute or form a part of, and should not be construed as an offer to sell or solicitation of an offer to buy investments or any fund and does not constitute any form of commitment, recommendation or advice on the part of Think Tank Group Pty Ltd ( Thinktank ). Copyright Think Tank Group Pty Ltd 8