Cautious, subdued, holding pattern, wait and see and moderating are the favoured terms for the year ahead in direct property. But experts are also quietly upbeat about opportunities.
However, even though the key drivers of real estate are strong, much will depend on the performance of the global economy, whether the downturn in equity markets will be sustained long-term, the availability of capital and the potential effect of further interest rates rises.
CBRE Investors global head of research Doug Herzbrun remains positive, declaring Australia's short-term property outlook second only in strength to Singapore.
Speaking at a recent presentation in Sydney entitled Navigating Stormy Seas, Herzbrun says only Singapore had a stronger two-year outlook based on economic and property fundamentals.
While the global credit squeeze had relegated the US and the UK to the bottom of the pack, Herzbrun believed Australia's strong performance, resource-based economy and positive real estate fundamentals had propelled the market ahead of areas such as Hong Kong, Japan and the Eurozone.
"The outlook for the office markets is particularly positive, the supply side here is much more under control and yields are not unattractive by global standards," he says.
The US and the UK had clearly been hard hit by the global credit squeeze which had led to a significant withdrawal of debt financing for real estate, he says. However, there were some indications that investors were beginning to assess future opportunities.
Abacus Property Group funds management director Tom Hardwick says there are several key themes that the markets and its participants are expecting to see, including capitalisation rates softening and property values falling.
"Just how far is too early to say as there has been a dearth of transactions this year," he says. "Factors that will affect this outcome include the future direction of interest rates, the strength of the underlying economy and its impact on demand for commercial property and, hence, rental growth, the extent of distressed asset sales and the availability of capital - both debt and equity.
"The availability of debt will remain tight, although in Australia the major banks are still lending (albeit on a more limited and stricter basis than recent years), whereas property groups in other countries are experiencing great difficulty in sourcing debt."
Macquarie Group head of real estate research Rod Cornish is cautiously upbeat about the office market, saying the current demand-supply equation is good. There are low vacancy rates around Australia with Brisbane and Perth the lowest on record. Melbourne is the lowest since the late 1980s while Sydney is the lowest in five years. Business conditions are also resilient.
However, he says, a sustained decline in equity markets may temper office markets over the next couple of years. "History has shown a sustained equity market downturn does have some impact on leasing demand," Cornish says. "But we still believe there will be rental growth, particularly in Sydney and Melbourne, where rents are cheap relative to Brisbane and Perth, unless equity market conditions worsen or deteriorate for any length of time, say 12-24 months."
In the short term, cap rates may soften because of tighter credit conditions, mainly for secondary properties in secondary locations, he says.
"In Brisbane, there is supply coming on so 2009 will be weaker, particularly as rents are more expensive than Sydney and Melbourne," Cornish says. "Adelaide has just commenced an office cycle with solid interest from overseas. There have been some sales to German investors and there is potential for further growth.
"The listed markets we believe have overshot what will be occurring in direct real estate as they have done a number of times in the past 20 years." Morningstar senior equities analyst David Parker says trophy assets or premium offices, such as Governor Phillip Tower in Sydney and 101 Collins Street in Melbourne, appeal to both national and international investors and may be expected to be less adversely affected than Grade A office buildings, with some commentators suggesting falls of up to 5 per cent in value or around 25 basis points in capitalisation rates.
"Reflecting the impact of the credit crisis and the rising cost of debt, secondary office property such as Grades B and C CBD office buildings and suburban offices may suffer greater price falls, particularly those with a weak tenant profile or ageing building features, with some commentators suggesting falls of up to 10 to 20 per cent in value depending on quality," he says.
Many people may talk of ditching property but it is necessary to have exposure to this asset class in a portfolio, Real Estate Capital Partners executive director Linden Toll says.
He sees office as remaining steady in Adelaide and doing well in Melbourne where "prices should come off slightly but institutional grade offices are commanding decent rents".
The concern for the Sydney office sector will be if the sub-prime fallout causes bigger institutions to scale back their operations in Australia. "Overall, we see it as a reasonably strong office market," Toll says. "There is a lot of bullishness in the market and a fair bit coming on to the market, but that is tempered with where we are on a global perspective. But it is a year of being prudent in my view."
For PIR associate director Dugald Higgins, many investors of property funds are in a holding pattern, lacking the confidence to re-enter the market. While commercial property markets and to a certain extent the US are feeling the heat of unwinding valuations, PIR is not expecting the same rise in mercury in Australia.
"There has been some comment about pending levels of supply coming into the market as we saw in the early 1990s," Higgins says. "The key difference between then and now is that the level of demand is much stronger. We are also at the point where a lot of existing buildings in the marketplace are approaching obsolescence from a technical and environmental point of view so it would be reasonable to assume that there is going to be some level of cross-take in that."
The underlying drivers are still relatively strong: unemployment remains low, vacancy levels are at historic lows for the cycle and the economy is sturdy.
"So while we are unlikely to see lot of further cap growth from yield and cap rate compression, we are looking more at growth in the office sector being generated from rental increases," Higgins says. "The rental market is tight in major CBD markets and the fundamental drivers remain sound.
"In retail, the economy is still performing strongly. We have witnessed a flurry of interest rate rises and though there are some mixed messages about the levels of consumer confidence and consumer spending, it still looks positive. As far as industrial markets, stock is tight. A lot prefer to rent rather than buy."
He says the big caveat will be the global economy. If the US enters a deep recession and the flow-on effects are greater than expected, particularly to China, then the Australian economy will be affected.
On the industrial front, Cornish says with more supply coming on this year after a strong series of pre-commitment deals, it will be those areas close to infrastructure that will witness the highest land value growth. However, some moderation in rents is expected as there will be more choice this year and in 2009.
Parker believes the industrial property sector may be the most vulnerable to downward value pressure, reflecting the big increases in value over recent years, the speed with which new industrial property supply may be created and structural changes in the nature of the industrial property market.
After a more moderate time during the post-housing downturn, retail has experienced a strong period in the past two years, says Cornish. There has been 9% growth in retail grocery sales and total returns across the sector have been 15-20% a year.
However, there is likely to be some moderation in the next few years, partly due to retail's link with the housing market.
"But it's important to note that total returns from retail property have never turned negative" Cornish says. "Even in one of Australia's worst recessions in the early 1990s, total returns from retail property investment still averaged 8-9% a year. We think on a relative basis that investors will still be active.
"Across all of these markets including office there are still investors waiting to invest, including institutional investors. A number are waiting for a price correction. There have been strong sales for office property recently, but we are seeing some hesitancy. But we are also hearing from these investors that they are intending to come back into the market in the second half of this year. They are looking for prime property, particularly office."
The biggest issue confronting the unlisted property market will be the split based on quality, says Higgins. Yields of secondary stock have been compressed over the past five years.
"Our view is there would be potential for some of those prices to be driven above sustainable levels. If that is the case, secondary stock will be the first to unwind. There are exceptions in unlisted retail funds as opposed to wholesale where there is the potential for some of those valuations to take a sharp slide if we get this combination of the economy slowing faster than normal and property valuations unwinding faster than normal."
Higgins is prepared for an "interesting year". Already, many fund mangers with products scheduled to be released have shelved them or opted to take them to the wholesale, rather than retail, market where they feel its longer term view will make it easier to sell.
"There are not a lot of transactions going on at the moment," he says, "which makes it hard to value properties in the market. There probably won't be until bigger trusts issue their full-year reports that we will see the real picture emerging as to the impact of the direct property market."
On the residential front, 2007 proved to be strong on the east coast of Australia with Sydney varied between the inner and outer suburbs, with the latter weak, according to Cornish.
"But this year will be more subdued," he says. "While a number of drivers remain, for example, strong migration and an under-supply of new properties, it is really the rates that will come into the equation this year. Overall, there will be more flat to moderate growth with the outer areas most affected by rate rises."
He believes the rental market across Australia will remain tight. "We have only seen vacancies at this very low level twice before in the past 27 years for residential in Sydney and Melbourne," he adds.
"The construction cycle has been pushed out further which means demand is well in excess of supply on the east coast, particularly in Sydney. We have already seen yields improve and will continue to do so."
Affordability has deteriorated in Melbourne, Adelaide and Brisbane as prices climbed more than 20 per cent in 2007, closing the gap with Sydney, always the least affordable, to its narrowest level on record, says Cornish. Historically, such a decline slows capital city markets.
Real Estate Capital Partners division director of funds management Jason Bennett sees residential as a sit-back-and-wait scenario, particularly for those who are heavily geared.
"Across the market in and around Sydney and Melbourne, there will be some growth. Perth is static. Brisbane and Queensland will offer some growth in the right areas. There is still this lifestyle move going on there and as times get harder people will revisit this lifestyle aspect. Adelaide has seen some good growth but recently tapered off."
The lower end of the residential market will be fuelled by a lack of available stock and a tight rental market while the top end may see a trickle-down effect from the finance sector, he says. But, Bennett says, there is still a lot of money out there.
For Cornish, the next few years may present a good opportunity for residential property. "We have been through three years of downturn from 2004-2006," he says. "We saw a solid jump last year though Sydney was lagging. Sydney would have been stronger this year without the string of rate rises.
"Now we can expect to see 18 months of flat to moderate price growth. We may see rates come down next year, depending on the extent of rate rises this year. We think the next phase of a long upward cycle will occur from 2010-2014. This is normal. First there is a jump, then flat to moderate growth then the next phase of a long, upward cycle.
"With the credit squeeze, the potential impact on cap rates and the financial market downturn, more investors are likely to switch to residential as they have done after every share market downturn."
Bennett also thinks there are good prospects: "There will be great opportunities this year across industrial, commercial and retail. It's just a matter of when is the right time to jump in. As mortgage defaults are on the rise there will be opportunities in that part of the residential market.
"You need to be focusing on property now so you will know what is a good buy and what is not. When is the right time will depend on the asset, the location and the deal."
