The next property crisis is coming. And it’s not just about housing

Yes, rate cuts are vital to driving investor interest and stabilising vacancy rates and valuations. But Vanessa Orth, managing director of investment management at property giant Lendlease, neatly summed up the other big reason the industry is so bullish: we simply aren’t getting enough new buildings out of the ground.

“We don’t have enough supply, so it’s all about simple fundamentals,” Orth said. “Low supply and strong demand will start to push up pricing. And when I say pricing, it’s rents.”

The great Australian housing supply shortage has been endlessly discussed, of course, and although the first day of the property summit was ostensibly about commercial property, we couldn’t escape the topic.

There were questions over whether wealthy Sydney suburbs had taken not-in-my-backyard opposition to development so far that they could soon be all but empty of children, and debate over whether the federal government’s goal of building 1.2 million homes over the next five years is really achievable.

Capital is now moving to this opportunity; as Cushman & Wakefield’s local chief executive, Noral Wild, and Morgan Stanley’s Tim Church noted, it’s the living sector (including built-to-rent, aged care, student accommodation and retirement living) that’s been at the centre of capital flows this year.

But if we accept that the housing supply crisis was a decade in the making, then Monday’s speakers at the property summit left Chanticleer with the clear impression we are sleepwalking into another property crisis, as demand from resilient population growth (via immigration) collides with a lack of supply in key commercial property sectors, including retail, office and industrial property.

Peter Huddle, the chief executive of shopping mall giant Vicinity Centres, said there hadn’t been a major new retail project in Australia in more than a decade, and neither Vicinity, Westfield owner Scentre Group nor GPT had plans to add any large amounts of new space in the foreseeable future.

Carmel Hourigan, head of office property at Charter Hall and president of the Property Council of Australia, said it’s unthinkable that the iconic Chifley Tower in Sydney’s CBD could be built today.

“It’s getting increasingly harder to actually build new stock, particularly of prime quality. For us to build a Chifley now, it’s near impossible, the type of economic rent that we would need to charge to get Chifley up and running.”

Again, this is great for landlords, who will see rents and valuations go up. And there’s no doubt the commercial property supply shortage is a global problem; Blackstone’s local boss, Chris Tynan, said the New York-based capital giant was seeing the supply and demand balance tilt in the favour of landlords right around the world.

But cast forward five or 10 years. The higher rents that landlords will earn as sticky demand meets limited supply growth will ultimately be passed on to households and flow through the broader economy, keeping inflation and interest rates elevated, and pushing up commercial property valuations in a way that increases the gap between the haves and have-nots.

Similar questions being asked

David Harrison, the chief executive of Charter Hall, said the same questions we’re now asking about residential property will soon become part of the conversation around commercial property.

“If you don’t create the supply you’re going to have an undersupplied market, and rents and capital values continue to grow,” Harrison told the Summit. “I think as a population, we need to decide, do we want more supply for our kids and grandkids and great grandkids or not.”

So why isn’t supply rising to match demand? The simple answer, as numerous speakers said on Monday, is that the cost of building a new commercial property is just too far above the replacement cost of existing buildings to get an appropriate return.

“That is the biggest risk to the supply. The problem is, people just don’t invest because it’s too bloody hard,” Harrison said.

Elevated interest rates have been part of that in recent years, but are now starting to come down. Construction material costs have also stabilised and are drifting lower, according to Dexus chief executive Ross Du Vernet.

But pushing against that are two big problems. The first is construction productivity, which remains depressed. Du Vernet gave a stark example in Queensland, where he said union-controlled building sites are sometimes getting just 2.5 days of productivity per week.

“You’re working effectively a nine-day fortnight and you’re paying premium wages for part-time productivity. We’re not going to be able to deal with the challenges in front of us unless we’re addressing that.”

Du Vernet said the problem would likely get worse before it gets better. “All the good work the government’s doing is actually unlocking the planning pathways [and] means we have more approvals and more sites ready to build,” he said, but there was a lack of construction resources to build them.

Constrained resources

Morgan Stanley’s Tim Church doubted there was “a tier-one builder today that will enter into a watertight, fixed-price construction contract … [because] it’s been too risky for them over the last five years in particular, and that is going to constrain supply in a way that is good for value increase for existing assets”.

Further, Church said the construction demand for major infrastructure projects in NSW and Victoria and in Brisbane for the 2032 Olympics would mean resources for industrial, retail and office projects remained constrained for the foreseeable future.

The second issue is government intervention. While planning and approvals remain a sore point, it’s taxes, particularly the movable feast of tax changes in Victoria, that are clearly weighing on the property sector.

“It’s the uncertainty that people feel about Victoria in particular,” Cushman & Wakefield’s Wild said. “There’s a lack of trust about, well, if I go and do this, what tax am I going to get added to after I’ve made my investment?“

GPT chief executive Russell Proutt, who has about 40 per cent of his portfolio in Victoria, said the Victorian government is “correcting a horrendous balance sheet with congestion levies, a temporary COVID tax, emergency service levies transferred to property taxes then doubled, vacant land tax, windfall gains tax, the changes in stamp duty… All those things are not generating confidence in the investment market for Victoria”.

Clearly, there’s been no shortage of Victoria bashing in the past four weeks, whether that’s around rising crime levels, work-from-home rights or the general state of the economy. But investors like Tynan remind us that capital is a coward, and it goes wherever it’s most welcome.

“When you’re in my seat trying to put up the best opportunities out of Melbourne, and they’re being compared with Madrid and Mumbai, which are trying to actively attract investment, and Melbourne’s putting more and more roadblocks in the way, it just means that the capital is more likely to flow to those investments, as opposed to the one in Australia,” he said.

Clearly, resolving the housing supply crisis is Australia’s first priority – get that sorted, and the above issues will be more manageable, not least because there will be more construction resources available.