EP. 1455 HOW IS COMMERCIALS WORST PERFORMING ASSET GOING?

The commercial office market took an unprecedented hit during COVID, with property values on Sydney's Northern Beaches plummeting by a staggering 70-80%. This frank discussion strips away the usual real estate optimism to examine what became Australia's worst-performing asset class.

We explore the fascinating divide between property owner responses during the crisis. Investors with multiple leveraged properties resisted rent reductions to protect valuations, while long-term owners pragmatically accepted 50-70% lower rents just to maintain cash flow. This critical decision point highlights the tension between short-term income and long-term asset value preservation. Smart landlords limited lease terms to 1-2 years, avoiding locking in pandemic-era rates for extended periods.

The remarkable recovery of office properties challenges early pandemic predictions. Despite dire forecasts about remote work permanently destroying office demand, most buildings have rebounded to within 10% of pre-COVID values in just three years. Premium sites like Brookvale's Lifestyle Building have even exceeded previous benchmarks, with office rates surpassing retail and approaching industrial values. This resilience reveals a fundamental truth: after the novelty wore off, both employers and employees recognised the irreplaceable value of face-to-face collaboration.

Looking forward, the market shows clear winners and strugglers. Industrial properties, particularly storage with generous clearance heights, continue their strong performance. Meanwhile, tenanted retail shops face significant headwinds with owners seeking 6% yields while buyers face 8% mortgage rates. For investors ready to act, understanding these divergent trajectories could mean the difference between extraordinary returns and painful losses in Sydney's evolving commercial property landscape.

Episode Transcript

Speaker 1 (00:01):
oh, this is an uncomfortable topic.
Us real estate agents arealways talking it up, talking it
up, talking it up, and this onemakes me uncomfortable because
we're talking about the worstperforming real estate asset
class in sydney, australia.
Stay tuned, I'm the ringleader,so let's go.

(00:32):
Covid, what have you done,covid?
What have you done?
What have you done to thisasset class, covid?

Speaker 2 (00:43):
Good morning everyone .
Welcome to Morning Minutes.
Have you done to this assetclass covert?
Good morning everyone.
Welcome to morning minutes.
Myself, michael berger, marknovak, episode 1554 commercials
worst performing asset class,especially since covert.
The office market, I think atits lowest or biggest
significant drop, especially onthe northern beaches.
I saw about a 70 80 reductionin sale pricing and rental

(01:08):
income.
There are there are a couplebuildings where there was a lot
on the market and we're sellingbefore and after and you could
just dramatically see thatdifference.
It's um, but we're almost backto the full.
The full, but, mark, that's apretty dicey.
What three years for owners.

Speaker 1 (01:29):
Yeah, what do they call it in commercial?
Is that a whale?
What's a whale?

Speaker 2 (01:34):
W-A-L-E.
Yeah, a whale is, when you'rebuying an asset, the average
length of all the leases.

Speaker 1 (01:41):
So it's more on a mixed tendency leases, so it's
more on a mixed tendency.
So the whales just got thrownout completely, um in the last
couple of years, where it usedto be so predictable, um how
long your leases would be, andtenants in and tenants out, and
then the attitude of workers andthe attitude of the government,
um, and the and the environmentchanged completely with COVID,

(02:07):
which changed people's attitudes.
So the whole office thing justgot hammered.

Speaker 2 (02:13):
Yeah, there were two very different attitudes between
owners.
You found that well, there wasthree, but the main one was your
investor, who's borrowing quiteoften to buy multiple
properties.
They almost got hit the hardestbecause they were very
reluctant to drop the rentbecause they knew that would

(02:34):
impact the valuation instantly,where there's a bit of leniency
when it's vacant, compared toyour owner who may have bought
it yesterday or may have ownedit 30 years ago, but wasn't
really regardless if they had amortgage on it.
Most of the time they were morejust like, let's get some rent
coming in, very similar to theresidential model, like, just

(02:57):
get what you can.
I'm not looking.
And I would say to clients ifyou're not looking to refinance
and buy something in the nextcouple years, there's really no
harm in taking a rent 50, 70percent lower.
Um, it's only if you're lookingto buy a new house or anything
like that, because it woulddramatically change the impact.

(03:17):
So those owners who said, no,we're not looking to do anything
, let's just get the income.
You found that they took thelower deals, which were low, and
we're we're still seeingtenants on those wickets now.
We saw one not too long ago inbrookville.
Mark when they're talking aboutsub leasing, um, just the
amount of overall rent they'repaying, and I think some agents

(03:40):
did make I don't want to call itan error, but when I, when we
went through that, I advised notto do anything longer than a
one or two year lease,definitely not five years at
that lower rent, um.
So there were some really gooddeals with tenants and and some
owners who had it empty for twoto three years so are they.

Speaker 1 (04:02):
is that?
Does that mean?
Mean that now that there's thatwhole return to work thing
which which, by the way, we'reseeing a lot, you know a lot of
people saying you know, we'vedone, we've done the home thing
and the home thing just doesn'treally work for us working from
home, so is that now going to bethe best performing asset class

(04:25):
?

Speaker 2 (04:28):
If you bought it with the drop it's definitely the
best because, yeah, nearly allbuildings have recruit to the
rates they were sellingpre-COVID.
One building's exceeded it theLifestyle building in Brookvale
that's.
If you told me when I startedreal estate that would sell
those office rates would behigher than retail rates, I

(04:50):
never would have believed you.
In line with industrial rates.
It's crazy how well thatbuilding's done.
It still took a hit duringCOVID, but not as dramatic.
Building's done, um, it stilltook a hit during covert, but
not as dramatic.
Um, but like, uh, your buildingsin warry ward and your inferior
buildings in dy, they'vevirtually come back to the rates
within 10 percent.
So just in the last what's that?

(05:11):
Three years, that's between a50 to 70 increase and I suppose
where a lot of people can missthat benefit, like anyone who
had owned an office for manyyears and they saw how low it
went would have known that'svery good value.
But when potentially only onesells every six months or a

(05:32):
couple done off market, youdon't necessarily see the trends
.
It's not like residential inDIY where there's 20 apartments
selling a week or a month andyou can just see trends very
instantly.

Speaker 1 (05:43):
Um, with commercial can be a lot harder to spot but
I think the fundamentals of anoffice they ain't changed.
They're not going anywhere.
I understand the work from home, the location, like people were
sweating, the asset from homethey were, their home was an
office as well.
But the whole principle ofhaving an office was available

(06:08):
to people for 50 years and theycould have chosen home.
They chose office and it feltlike it felt like a little bit
of a lolly when everyone said,okay, you can work from home.
It's like yeah, yeah, yeah,yeah.
But really we, you people, werelike I need to be with my team,
I need to be able to train, Ineed to be able to learn, I need
to be face-to-face.

(06:28):
So people have sort ofnaturally gravitated back to the
office.

Speaker 2 (06:33):
It's a huge fall.
I also think what helped thatas well, and residential
interest rates, like, while thiswe had this big downturn in
office market, you could buy,everyone was buying bigger homes
because your interest rates was1.5 to 1.9%.
So to buy the four bedroom homeinstead of the three bedrooms

(06:55):
at the home office.
It seemed like the no-brainer.
It's like why pay 20, 30 grandayear rent in an office when you
could buy a four bedroom homefor an extra couple hundred
grand and pay five grand a yearextra in interest?

Speaker 1 (07:08):
very different calculations.
Now, that's a good point.
It was a.
It was a free hit.
To work from home was a freehit in a couple of different
ways in terms of lifestyle andin terms of you know, you know,
financially it was.
You could upgrade your home, bepaying less than what you were
paying the couple of yearsbefore that and you're like, how

(07:30):
good is this?
I've got an office, I've got towork from home.
After a couple years now peopleare going.

Speaker 2 (07:36):
Yeah, I really want to get in there it's definitely
one of those things where youalways hear it from buyers where
it's like, oh, we'll buy whenthe market slows down a bit.
And I remember, during thisperiod, speaking to buyers like
these rates are 30 years oldrates Like office rates haven't
been below three grand a meterfor so long and no one would buy

(07:57):
it.
Because it's that, that oldsaying when everyone goes left
can you go right.
It's one of those things whereit's all well, if no one wants
the asset, neither do I, ratherthan looking like what's what
has impacted that asset?
Okay, here's the difference.
The fundamentals thefundamentals for the drop in
office market compared to thefundamentals to the drop in the

(08:21):
retail market.
The office market, you couldquite comfortably say, will
bounce back the retail market.
That's a big consumer shift.

Speaker 1 (08:30):
The banks have shifted how they build.

Speaker 2 (08:31):
Yeah, so there's a big difference in how you look
at those assets.

Speaker 1 (08:39):
That's a really good point.
I was talking with a reallyexperienced landlord a couple of
weeks ago and I can't stopthinking about the conversation
because he was saying he wastalking about industrial and he
was saying industrial Brookfield.
I couldn't give him away and hewas just laughing because he
went and bought retail.
He went and bought shops, stripshops, and he's like man, now

(09:00):
that's sort of not performing aswell.
So he's like and now theindustrial is performing really
well.

Speaker 2 (09:08):
Yeah, you've definitely got to really have a
look at it over that 20, 30years to see what it does, but
industrial especially.
Even since I've been doing it,I've sold some properties four
times and the price went from400 grand to 1.2, just in that
sort of 10 in 10 years.
15 year times fit span on innarrowing went from 1 million to

(09:30):
2 million, doubled and the rentwent less both times.
That doesn't make sense.
The income of the property gotworse can.
Can we go out with a bang?

Speaker 1 (09:45):
yep yeah, can we go out with a bang um give, and I
want to want to get your opinionon on the one on the commercial
, I'll do a little bit ofresidential as well.
What's shit hot at the moment?
Resi rents.

Speaker 2 (10:06):
It's anything, industrial Storage I think will
have the best returns withrental yields.
Industrial units are still verypopular but the rental yields
are low.
But if you're an owner-occupierand you want to occupy it, then
that's great and then I thinkthere's going to.
There could be a big shift withthe development of freestanding

(10:31):
properties in Brookvale.
You've got the 18 metre heightlimit now.
That opens up so many moredifferent potential for
development where you can dovery good storage of six metres,
five metres rather than yourthree metre storage.
And we're in French's Forest.
We've nearly sold out of allthe storage with five-metre

(10:53):
clearance which is amazing justin like three months.
So that's very, very popularstock.
So I think anything to do withindustrial.

Speaker 1 (11:02):
And what's not hot.
Now, I know we don't like totalk about this.
As real estate agents, wealways want to talk it up.
But what's not hot?

Speaker 2 (11:10):
Tenanted investments retail shops with tenants
because owners are still tryingto get around a six percent
yield but buyers are gettingmortgages at eight percent, so
it's not looking as hot and thelead time to rent them out is
taking a Michael.

Speaker 1 (11:28):
Berger.
Where are you your opinion?
I'm happy with yours.
I'm happy with yours.

Speaker 2 (11:42):
All right, thank you, everybody.

Speaker 1 (11:44):
Thanks guys, have a good day, have a good week, see
you.
Peace, peace, peace out there,peace, see ya.