The PROPERTY DOCTORS, Sydney Australia Novak Properties

EP. 1455 HOW IS COMMERCIALS WORST PERFORMING ASSET GOING?

• Mark Novak, Michael Burgio • Season 51 • Episode 1455

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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.

Speaker 1:

oh, this is an uncomfortable topic. Us real estate agents are always talking it up, talking it up, talking it up, and this one makes me uncomfortable because we're talking about the worst performing real estate asset class in sydney, australia. Stay tuned, I'm the ringleader, so let's go. Covid, what have you done, covid? What have you done? What have you done to this asset class, covid?

Speaker 2:

Good morning everyone. Welcome to Morning Minutes. Have you done to this asset class covert? Good morning everyone. Welcome to morning minutes. Myself, michael berger, mark novak, episode 1554 commercials worst performing asset class, especially since covert. The office market, I think at its lowest or biggest significant drop, especially on the northern beaches. I saw about a 70 80 reduction in sale pricing and rental income. There are there are a couple buildings where there was a lot on the market and we're selling before and after and you could just dramatically see that difference. It's um, but we're almost back to the full. The full, but, mark, that's a pretty dicey. What three years for owners.

Speaker 1:

Yeah, what do they call it in commercial? Is that a whale? What's a whale?

Speaker 2:

W-A-L-E. Yeah, a whale is, when you're buying an asset, the average length of all the leases.

Speaker 1:

So it's more on a mixed tendency leases, so it's more on a mixed tendency. So the whales just got thrown out completely, um in the last couple of years, where it used to be so predictable, um how long your leases would be, and tenants in and tenants out, and then the attitude of workers and the attitude of the government, um, and the and the environment changed completely with COVID, which changed people's attitudes. So the whole office thing just got hammered.

Speaker 2:

Yeah, there were two very different attitudes between owners. You found that well, there was three, but the main one was your investor, who's borrowing quite often to buy multiple properties. They almost got hit the hardest because they were very reluctant to drop the rent because they knew that would impact the valuation instantly, where there's a bit of leniency when it's vacant, compared to your owner who may have bought it yesterday or may have owned it 30 years ago, but wasn't really regardless if they had a mortgage on it. Most of the time they were more just like, let's get some rent coming in, very similar to the residential model, like, just get what you can. I'm not looking. And I would say to clients if you're not looking to refinance and buy something in the next couple years, there's really no harm in taking a rent 50, 70 percent lower. Um, it's only if you're looking to buy a new house or anything like that, because it would dramatically change the impact.

Speaker 2:

So those owners who said, no, we're not looking to do anything, let's just get the income. You found that they took the lower deals, which were low, and we're we're still seeing tenants on those wickets now. We saw one not too long ago in brookville. Mark when they're talking about sub leasing, um, just the amount of overall rent they're paying, and I think some agents did make I don't want to call it an error, but when I, when we went through that, I advised not to do anything longer than a one or two year lease, definitely not five years at that lower rent, um. So there were some really good deals with tenants and and some owners who had it empty for two to three years so are they.

Speaker 1:

is that? Does that mean? Mean that now that there's that whole return to work thing which which, by the way, we're seeing a lot, you know a lot of people saying you know, we've done, we've done the home thing and the home thing just doesn't really work for us working from home, so is that now going to be the best performing asset class?

Speaker 2:

If you bought it with the drop it's definitely the best because, yeah, nearly all buildings have recruit to the rates they were selling pre-COVID. One building's exceeded it the Lifestyle building in Brookvale that's. If you told me when I started real estate that would sell those office rates would be higher than retail rates, I never would have believed you. In line with industrial rates. It's crazy how well that building's done. It still took a hit during COVID, but not as dramatic. Building's done, um, it still took a hit during covert, but not as dramatic.

Speaker 2:

Um, but like, uh, your buildings in warry ward and your inferior buildings in dy, they've virtually come back to the rates within 10 percent. So just in the last what's that? Three years, that's between a 50 to 70 increase and I suppose where a lot of people can miss that benefit, like anyone who had owned an office for many years and they saw how low it went would have known that's very good value. But when potentially only one sells every six months or a couple done off market, you don't necessarily see the trends. It's not like residential in DIY where there's 20 apartments selling a week or a month and you can just see trends very instantly.

Speaker 1:

Um, with commercial can be a lot harder to spot but I think the fundamentals of an office they ain't changed. They're not going anywhere. I understand the work from home, the location, like people were sweating, the asset from home they were, their home was an office as well. But the whole principle of having an office was available to people for 50 years and they could have chosen home. They chose office and it felt like 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, were like I need to be with my team, I need to be able to train, I need to be able to learn, I need to be face-to-face. So people have sort of naturally gravitated back to the office.

Speaker 2:

It's a huge fall. I also think what helped that as well, and residential interest rates, like, while this we had this big downturn in office market, you could buy, everyone was buying bigger homes because your interest rates was 1.5 to 1.9%. So to buy the four bedroom home instead of the three bedrooms at the home office. It seemed like the no-brainer. It's like why pay 20, 30 granda year rent in an office when you could buy a four bedroom home for an extra couple hundred grand and pay five grand a year extra in interest?

Speaker 1:

very different calculations. Now, that's a good point. It was a. It was a free hit. To work from home was a free hit in a couple of different ways in terms of lifestyle and in terms of you know, you know, financially it was. You could upgrade your home, be paying less than what you were paying the couple of years before that and you're like, how good is this? I've got an office, I've got to work from home. After a couple years now people are going.

Speaker 2:

Yeah, I really want to get in there it's definitely one of those things where you always hear it from buyers where it's like, oh, we'll buy when the market slows down a bit. And I remember, during this period, speaking to buyers like these rates are 30 years old rates Like office rates haven't been below three grand a meter for so long and no one would buy it. Because it's that, that old saying when everyone goes left can you go right. It's one of those things where it's all well, if no one wants the asset, neither do I, rather than looking like what's what has impacted that asset? Okay, here's the difference.

Speaker 2:

The fundamentals the fundamentals for the drop in office market compared to the fundamentals to the drop in the retail market. The office market, you could quite comfortably say, will bounce back the retail market. That's a big consumer shift.

Speaker 1:

The banks have shifted how they build.

Speaker 2:

Yeah, so there's a big difference in how you look at those assets.

Speaker 1:

That's a really good point. I was talking with a really experienced landlord a couple of weeks ago and I can't stop thinking about the conversation because he was saying he was talking about industrial and he was saying industrial Brookfield. I couldn't give him away and he was just laughing because he went and bought retail. He went and bought shops, strip shops, and he's like man, now that's sort of not performing as well. So he's like and now the industrial is performing really well.

Speaker 2:

Yeah, you've definitely got to really have a look at it over that 20, 30 years 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 from 400 grand to 1.2, just in that sort of 10 in 10 years. 15 year times fit span on in narrowing went from 1 million to 2 million, doubled and the rent went less both times. That doesn't make sense. The income of the property got worse can. Can we go out with a bang?

Speaker 1:

yep yeah, can we go out with a bang um give, and I want to want to get your opinion on on the one on the commercial, I'll do a little bit of residential as well. What's shit hot at the moment? Resi rents.

Speaker 2:

It's anything, industrial Storage I think will have the best returns with rental yields. Industrial units are still very popular but the rental yields are low. But if you're an owner-occupier and you want to occupy it, then that's great and then I think there's going to. There could be a big shift with the development of freestanding properties in Brookvale. You've got the 18 metre height limit now. That opens up so many more different potential for development where you can do very good storage of six metres, five metres rather than your three metre storage. And we're in French's Forest. We've nearly sold out of all the storage with five-metre clearance which is amazing just in like three months. So that's very, very popular stock.

Speaker 2:

So I think anything to do with industrial.

Speaker 1:

And what's not hot. Now, I know we don't like to talk about this. As real estate agents, we always want to talk it up. But what's not hot?

Speaker 2:

Tenanted investments retail shops with tenants because owners are still trying to get around a six percent yield but buyers are getting mortgages at eight percent, so it's not looking as hot and the lead time to rent them out is taking a Michael.

Speaker 1:

Berger. Where are you your opinion? I'm happy with yours. I'm happy with yours.

Speaker 2:

All right, thank you, everybody.

Speaker 1:

Thanks guys, have a good day, have a good week, see you. Peace, peace, peace out there, peace, see ya.