CORE REAL ESTATE 

Continued weakness in core real estate but signs of a bottom 

2024 saw continued weakness in Australian core real estate markets as the prospect of interest rate relief faded and ongoing uncertainty about when the easing cycle would commence persisted. 

Capitalisation rates across all sectors softened further as various completed transactions finally reset market levels and consequently valuation metrics. This was inevitable after the sharp rise in interest rates in the prior year, where cap rate increases had been fairly limited relative to the record level of monetary tightening. 

The office sector was hit particularly hard with most markets across the country continuing to experience high vacancies and suffering from limited progress to this point on the return-to-work front. Office vacancy rates across all capital cities remained high with Melbourne in particular suffering, ending the year at a vacancy rate of 18.0%¹. This softness in demand translated into weakness in office valuations with the MSCI Mercer Core Wholesale Property Fund Office index falling by 13.7% over the year compared to the equivalent retail and industrial indices providing marginally positive total returns and the diversified index falling 5.7% for the year.² 

The retail sector was more resilient having experienced a strong resetting of rental levels immediately post COVID. Despite the interest rate and inflationary environment and consequent cost of living pressures, total annual retail sales grew 2.8% over the year.³ While this supported the trading environment for retail centres, various market participants opportunistically acquired a number of assets at discounted levels due to redemption and other pressures. Total transactions were ~$9 billion for the year – an increase of almost 50% on the prior year⁴. 

The industrial and logistics sector was not immune to the softening in cap rates despite ongoing tailwinds in the sector. Continued rental growth offset some of the impact though there were signs of rental growth slowing over the course of the year. Leasing incentives also trended upwards, indicating an end to the strong momentum the market has experienced over the past few years. 

2025 still to be driven by economic factors 

Most economic commentators are expecting the interest rate cycle to have peaked and an easing cycle to commence imminently in 2025. However, any surprises in economic data such as inflation and employment and further deterioration in the Australian dollar, which would be inflationary, could flip market expectations. 

A confirmation of an easing cycle and ongoing economic data that confirms inflation is relatively under control will be a catalyst for some recovery in core real estate markets. This should see some level of cap rate compression across all real estate sectors as the cost of debt funding reduces. The strength of any such recovery will be dependent on the expected quantum of easing that may be realised during the year. Despite this we believe independent valuations should generally have bottomed for the cycle although specific assets may still experience some weakness based on individual circumstances. 

Over the past year we saw select opportunistic buying as some owners were pressured to divest assets at discounted pricing. We believe these opportunities will continue over the first part of 2025 and we will be monitoring the market for opportunities to acquire high quality assets at historically attractive pricing. We are seeing a significant amount of capital waiting to be deployed into core real estate by both institutional and private investors once the cycle turns and expect this to drive demand in the latter part of the year.  

We continue to expect weakness in office markets as they struggle with high levels of vacancy, although Brisbane is an exception with forecasts for a much quicker recovery due to lack of new supply and better demand dynamics. We continue to believe the fundamentals within the retail sector are very positive, with resilient retail spending and strong tailwinds from a forecast ongoing reduction in total retail space per capita, due to population growth and some supply being taken out of the market. We also continue to see opportunities in the logistics sector particularly for assets in highly convenient well-located districts, although there are pockets of weakness emerging in some locations where supply has now caught up with demand. 

There is no doubt construction costs are a big factor that will impact real estate markets over the medium term, with costs making it uneconomic to build new space which will restrict supply across all sectors. We see clear opportunities to acquire real estate where acquisition prices are at meaningful discounts to replacement cost. 

As noted last year, despite the recent challenges Australian core real estate has historically played a critical role in portfolio allocation providing significant diversification benefits. Strong institutional investor interest in the Asia-Pacific region and the consistent long-term average performance of core real estate is likely to underpin opportunistic buying. Transaction volumes are expected to further increase over 2025 as there is more clarity on the path of interest rates and purchasers return to the market.

ALTERNATIVE REAL ESTATE 

Strong structural tailwinds supporting performance  

Strong structural tailwinds supported performance in most alternative real estate sub-sectors in 2024, and we are seeing solid momentum continuing into 2025.  

Cap rates were relatively flat over the year as the interest rate environment stabilised and investor appetite remained strong as demand continued for opportunities less correlated with traditional asset classes and with better risk-adjusted returns. The higher inflationary environment underpinned strong earnings growth particularly for sectors with good fundamentals. 

This year we will continue to look for long-term thematics and target sub-sectors with strong secular tailwinds where we can bring an institutional-grade approach to asset management and portfolio construction to improve operational outcomes and increase buyer and capital demand on exit – for example in our marinas strategy. 

We are seeing and exploring opportunities in the living thematic at present, including across niche residential and accommodation-related real estate sub-sectors. 

Active management will continue to be key  

Unlike core real estate, the owner of an alternative real estate asset is typically both the tenant and the landlord. The value of any real estate asset is generally a function of its income and growth prospects, including future development potential. By controlling the tenant and landlord relationship there is far greater ability to maximise the value of the land overtime, as well as drive earnings upside and unlock value add-opportunities associated with the operational or going concern interest. 

At MA Financial, we have and will continue to focus on alternative real estate assets where we have greater influence over and exposure to the returns generated by the assets.  

We are active managers and directly operate and manage many of our real estate and hospitality assets, including hotels and marinas. We continue to believe in-house, hands-on management and expertise results in better risk management and stronger long-term performance of the assets we own and manage on behalf of our clients. In 2025 we will continue to work with sector and strategy specific operators and management and invest in the improvement of people, systems and processes to enhance operational efficiency and customer experiences while concurrently investing in the real estate and other strategic growth initiatives.