Steve Bennett on the growth phase of Australian commercial property

Hello and welcome to the Investment Markets Podcast, where we aim to discuss investment matters that impact self-directed investors. I'm your host, Darren Connolly, CEO of Investment Markets, and today I'm delighted to be joined by Steve Bennett, Direct CEO at Charter Hall. Today we're going to discuss commercial property. However, before we get into it, I need to remind you that this is general advice and general information only. Nothing in this podcast should be construed as an investment recommendation. you will need to decide what is right for you. Welcome, Steve.

Thanks, Darren. Great to be here.

Now, Steve, let's start with an overview of the commercial property market. You're in it every day. You're talking to investors, talking to all the participants. Can you give us an overview of where it's at right now across sectors and geographies?

Yeah, look, that's a good question to sort of set the scene, I guess. Where we're at now, we saw it December 2025 across the 1600 assets that Charter Hall owns property values up across all the sectors or flat. That's the first time in a number of years. And in fact, properties had its biggest valuation reset in more than 45 years.

45 years.

The good news is we've now turned that corner and we're seeing risk adjusted returns that are as good as I've seen in my 25 year career in real estate from core, high quality, institutional grade property. And when I like to look at the overall scene, I did an economics major at university, look at the supply and demand. Supply is very challenged in all the core real estate sectors. Everyone's familiar with residential and how hard it is to get projects up.

There are no houses.

Yes.

No houses being built.

And people are shocked when I say, if you want to build a CBD office tower here in Sydney, where we're filming today, it'll cost you 50% to 60% more than an equivalent building that you can buy with lower risk, no planning risk, no building risk. You don't have to lease it up. You don't need to finance it for development finance. So the rational thing is people aren't building the stock that you would normally expect.

So it is that much harder just to get an asset out of the ground?

It is, it really is. We're developing Chifley South, premium grade office building up there top of town in that core precinct here in Sydney CBD. There's only one other asset being developed in Sydney CBD in this core market before 2030. After that, there's no new stock. So you've got big tenants that want to be in high quality office towers. located close to their client's infrastructure. They're getting declining, declining options. Same's happening up in Brisbane, CBD. And then what happens? Well, the rents start going up as that supply comes off for the stock that they want. Should look at industrial logistics as well. We've had massive run in rental growth over the last few years.

Industrial's been on a bit of a tear over the last few years.

It has. And you saw rental growth 12%, 15% per annum. We've said for a long time that's not sustainable, and we expect a normalization to occur. That's happening. So you've still got one of the lowest vacancy rates globally in Australian industrial logistics. So when people say to me, oh, the industrial story's dead, I said, no, the industrial story's still there, still very strong fundamentals. It's just got to a level where it's sustainable again. So 3.2% national vacancy rate, exceptionally low by any measure.

So what's happening to flatten things out in that sector? What does normalisation actually look like?

Yeah, look, there was a major step up in supply and demand for industrial logistics.

Post-COVID?

Yeah, absolutely. And for all the obvious reasons which your audience would be familiar with, e-commerce, a lot more people ordering from home. But that's just one part of it, right? It is still challenging to get new supply out of the ground in industrial as well. You need roads, you need to get the power, you need all that... Planning approval? Yeah, planning approval. All this just adds costs, delays, and it's quite common for a new property, even in industrial logistics, to cost you 20% to 30%. more than established stock.

Even if it's just a shed?

Yeah, but it's not just a shed now. So people have that misconception from the start of my career, industrial was seen as these dirty manufacturing sheds. I challenge anyone to go into a brand new institutional quality industrial property now. There's robots whizzing around, the height's 14, 15 meters, they're well located on major intersections of freeways near ports, airports, it is high quality real estate. They're measuring the slabs with lasers to make sure they're that level that the robots can work in. The automation cost alone is sometimes worth more than the building envelope. So that whole image of dirty, industrial, low tech sheds is changing. And that is where the market's moving to. And at Charter Hall, we're focused on developing stock into that part of the market. because that's where you get the highest quality tenants, you get long term leases and the like.

Well, that's a lot of investment that's got to be put into a shed if it's got that complexity built into it.

Oh, it does. We've got an industrial property down in Woolworths Dandenong. they put more than $300 million of automation in when they built that years ago. And it's fantastic. It runs 24-7, improves their economics. It's a great property, but very large dollar value. So it's not necessarily available to syndicators, direct investors themselves, but that's what we do at Charter Hall. We provide that same quality institutional grade, but make it available to our high net wealth and our wealth clients.

And if we look at maybe, we touched on, mentioned the pandemic, the office sector was unloved, I guess you could say for a while. Everybody was working from home. It's probably seen some green shoots. Is that probably a fair comment? What's happening with office?

Yeah, I'll give a 30 second recap of how we've got to where we are and then I'll give you my view of what to expect going forward. So pandemic happened, everyone was forced to work at home. commentators throughout, they say, and the office market's dead, no one's ever gonna go back into an office.

Ever.

Ever again. And where we're at now, all the institutional tenants, and that's who we're targeting at Charter Hall, your ASX top 100, your government, your state, your federal, your large entities, your great balance sheets, cash flows, they recognize that if they wanna get the most out of their business, if they wanna innovate, if they wanna make sure that junior people are trained up, They want to be close to clients. They want to do things like this. This is much more impactful, you and I, Darren, doing this together than on two separate screens, for example, that they need to have high quality office property. So the first thing I'd say is office is not dead. The second thing I would say, not all offices equal. So if you get high quality, we're in Barangaroo Tower 1 right now, brilliant, great location, we're walking around, there's a Woolworths right underneath it, great amenity. These are the type of buildings that will attract tenants. If you have an outer suburban old office tower that's 50, 60 years old, that's had no money spent, poor natural light, these aren't the kind of assets that are going to continue to attract tenants. So you need to make sure you've got the right stock. Then the third thing I'd say is look at the right locations. Not all parts of Australia are growing and strengthening at the same rate.

So different cities are in different stages?

Different cities. Let's take Brisbane, for example. They've got the Olympics coming up in 2032. They've got a huge infrastructure built out. They've got interstate and international migration, growing population in that southeast Queensland. It is very expensive and very difficult to get new office stock out of the ground. We are seeing that Prime, and Prime is just that highest quality office stock, really dwindle in terms of volume available to those larger users. And then demand and supply tells you as that comes off, the rents start to go up. And there will be a point when supply makes more sense, but you've got to have the rents continue to go up. And if you're an existing owner of stock, that's great. No supply coming in, rents going up.

Maybe less if you're the tenant.

Less so if you're the tenant. But look, I guess I'm here representing the investors. We at Charter do do the right thing by our tenants and that's simply good business. You want to spend the money on the buildings, you want happy tenants because they will renew and stay in your buildings.

Yeah, which ultimately is a much better result for the investors.

Absolutely, and no one should ever lose sight. The quarterly or monthly distributions that all our funds pay, somewhere between 5 and 8% per annum, is paid for by the tenants. So the stability and the ongoing nature of those is only as good as the tenants that are paying that monthly rent roll.

And how happy they are to be in that asset.

Yeah, because you don't want them moving away. Probably I should touch on, I feel like retail has been a little bit unloved in that story as well. So if you remember, a little bit similar to office, but it happened sort of five years before COVID where everyone was saying online is going to kill retail. what people didn't necessarily, well firstly that didn't play out.

But it did help the industrial side of things.

It did. And people didn't necessarily differentiate between the types of retail. So they were just looking at your big malls, Bondi, your Chadstones, with lots of discretionary retailers in them. and saying, oh, it's toast. Well, what people didn't necessarily focus on up until now was that convenience end. So think of your neighborhood shopping center, your Coles, your Woolies, Darren, you might pop in on the way home, sort of five or six smaller retailers hanging off that. They've proved extremely resilient.

Well, everybody's got to eat.

They do. And people don't necessarily for 30 bucks or 50 bucks of food want to go online, wait till tomorrow. They want to prepare their meal for the kids or they've got some friends coming over, they need it now. Where do people want these neighbourhood shopping centres? They want them in great population catchments, so where the people are. And we have been growing population in this country very strongly. Let's not get political, good thing, bad thing. All I would say from a real estate point of view and a commercial real estate owner, more people has been strongly underpinned demand. And buyers of these stock, so these investment quality neighborhood centers, your Bunnings, they want them in the best catchments, the metro areas, because you think of your local neighborhood if you live somewhere near a major city, you simply cannot build these things. There's no land. Even if there was land, you're not gonna get it through council. You're not gonna get it through the residents. You're not gonna get the access times you need and the foot traffic. So we believe that this supply is limited. And in fact, in the retail space, that convenience retail, per our numbers and our research, we think the supply is the lowest it's been in more than three decades.

Maybe just a little bit of a side, but how does that change? You know, if that supply issue is replicating itself across multiple sectors, and we see it in residential as well, right? From the commercial, as a sort of a play in the commercial space, how does that change? How do you get things out of the ground?

Well, you need to lower costs to get these things out of the ground. Very tough. Building costs don't very often go backwards. They tend to reset. You can reduce, another cost is time. So getting developments through the approval process, shortening that, shortening what an owner needs to do before they can start getting a project like shovels in the ground is valuable. The second thing that can really do or really will happen, rents will go up and rents will rise to a point where once again, it becomes more economical. It makes sense. Developers, regardless of the asset class, people need to get a return on their investment for the risk that they take. And so once you get those rental levels increasing, it will once again at some point come back in and go, it will make sense to build these. But irrespective of that, we think if you own those really defensive convenience retails in those metropolitan areas, It doesn't matter how far rents go up. Your competition's capped because you cannot put new supply in. Sure, there'll be new sites coming on greenfield locations, new estates, further out, but what you will see is the operators get more efficiency and be able to deliver more sales out of each of the site. And again, we like that because once again, they're gonna continue to be there and it will help them make sure that they can continue to be paying increasing rents.

And with that sort of property development lifecycle, are there any other sort of levers that you're sort of carefully monitoring and looking at before you, for example, would assess a new opportunity to get something out of the ground?

Look, the government settings are important without having a crack at any state in particular. It's fair to say the settings in Victoria are very different to what can be seen in New South Wales or Queensland.

So I was just going to say some states are easier than others. But that's okay, you've said Victoria, Steve, so that's fine.

I apologise for anyone watching this. But that is a reality and you only need to look at Property Council of Australia submissions, the level of taxes that have been put on the property sector, particularly in that state. It's scared off foreign buyers. So you do want, and irrespective of the government, stable settings that encourage growth and encourage development. And equally, some governments are much more forward in getting their staff back into the office. So again, if you're looking at office, for example, Sydney's performing very strong, it's vibrant. There's certain days in Melbourne where certain parts of Melbourne, so the East End, Paris End's performing very well. We've seen good rental growth there. But other parts of that market, we think, will come back, may just take a little bit longer.

Yep, and we probably haven't, maybe a little segue, but some of the other secondary markets. So we've touched on Brisbane, it's got the Olympics, Sydney, Melbourne. Any focus on some of the smaller city markets around the rest of Australia?

Yeah, look, absolutely. So if I look at our office fund, like we've got a large one and a half billion dollar office fund off. We have weighted it around 60% to Sydney and Brisbane. If you look at industrial, for example, we are seeing some really strong rental growth come out of the Perth and Adelaide markets. South Australia has a real benefit over other states in that there's no stamp duty. That means the friction costs are lower, it's easy to get in and out, and we've seen that become a lot more attractive in terms of the economics. Perth's an interesting one. It is a more volatile market. Everyone knows the story around the impact mining and resources has. But again, there are periods where you see some really strong rental growth. We're seeing some great growth come through on our Perth industrial portfolios. So it is about picking the right assets in the right sectors in the right locations. But generally as a concept, most of the portfolios in Charter Hall are very diversified and will have exposure to most states. Probably Northern Territory is the one that is quite lacking and is just not the scale. And we are always focused at Charter Hall on the exit as well. So are they going to be a deeper, large enough pool of buyers when you want to sell to be able to take you out.

And if I was to, I know you talk to a lot of investors day in, day out across retail, wholesale, sophisticated, institutional capital, international buyers. What are they, where are they? What are they, when they're thinking of investing into commercial property, where are those different types of investors? What's going through their heads?

Yeah, look, I'll even move it from what's in their heads to what we can physically observe that they're doing, because I think that's always, sometimes what people say and what they do aren't aligned. The retail team at Charter Hall has raised more than $3 billion of equity from institutional investors in the last, I think, eight or nine months into convenience retail. So the big end of town, and these are some of Australia's largest super funds, global pension funds, sovereign wealth funds, are moving some of that money that used to go into the discretionary, the big malls, and they're saying, you know what? We understand all the things and the benefits, the stability of the convenience retail, and they voted with their feet. So $3 billion in that shorter period is pretty unheard of for a new fund being launched. We've launched a sleeve for that for our high net wealth clients. So we've said, you know what?

So they can get the same assets.

Same assets, same everything, slightly different fees because obviously we're dealing with not someone that's written a $200 million check, but it might be $100,000. But still, they're very set low in our view and they compare very favorably to syndicates and other offerings. But being able to offer our high net wealth investors that exact same opportunity as a big end of town. That's what we like to do at Charter Hall. That's where we're seeing our high net worth investors come back into. But the other thing they've come back into is around that syndications. So they don't necessarily... Because that market stopped for a while. It did. And it stopped because people don't like uncertainty. They wanted to see valuation stabilised. They wanted to have certainty that Interest rates wouldn't keep going from 4.35 and keep going up in orders of magnitude. And they've seen that. So we've had a lot of success with the number of office syndicates recently, but we've been very targeted. So the markets that we've gone into with Brisbane, some great stuff down in ACT, at least to the government. Also in Adelaide, great asset down there, great tenant mix. But we've been very selective in what we're doing. So they are coming in early. They recognize that property does move in cycles. One of the things that does make property reasonably predictable.

You've seen a few now.

Yes, exactly. And those that come in at the inflection point or bottom of the cycle, history shows they'll get outsized returns for the same level of risk. And that's what we're seeing the big end doing, and the high net wealth clients are rapidly following.

Yep. And if I was a high net worth client, what role do you think that the property slice should be playing in a portfolio? Not a recommendation.

No, I was going to say that.

But, you know, I will have a portfolio of a certain size across multiple asset classes. Where, theoretically, does commercial property play? Where is it strongest?

Yeah, look, it should be in that satellite piece of your portfolio. I always tell people, put it in your illiquid piece. I don't care if a manager's got frequent liquidity. You should think of it as an illiquid part of your bucket. It provides great income levels, paid regularly, that grow over time. It provides low correlation to other asset classes, such as U.S. equities, Aussie equities, and the like. So a portion of-

Nobody's tweeting about commercial property overnight.

No, I think they got tired of that though.

And impacting the market.

No, exactly. And so all that is just noise, what we're witnessing over there at the moment with software as a service, what AI is going to do. It provides strong levels of income. It's paid regularly to our investors, quarterly or monthly. It provides uncorrelated returns. At the moment, from core real estate, we think you can get 11, 12, even more percent equity IRRs from core property without taking on asset repositioning risk or development risk, which you normally have to do to get those returns. That's simply where we're at in the cycle.

That's not an IRR that you would normally get in the normal part of the cycle for core property. You would have to go up the risk spectrum.

Or drop the quality of the assets you're looking at. We don't like to do that at Charter Hall. We think there's a period in time and I can't tell people how long that will last, where you can get in and valuations haven't moved in any materials respect yet. We saw convenience retail tighten the most at December. We saw a little bit in industrial logistics, offers pretty much flat. We thought cap rates would tighten a bit quicker than they probably will, and that's simply because of the recent interest rate increases. So for those investors that come in now, I think they'll look back in five years and go, you know what, it was the right decision to make at that point in time.

What do you think is going to be the impact of potential future changes in rates?

Look, that's a great question, Darren. It's one I've been fielding for the last couple of weeks, actually. Let's look at what happened. You saw interest rates go from 0.1% to a peak of 4.35%.

A very large, large jump.

In a very short period of time. What we saw was cap rates in this country stabilize when interest rates were 50 basis points higher than they are right now. So we saw three cuts, cap rates stabilized after the first cut, and they didn't come down. So the fact that we've had 25 basis points as we sit here now, if we have another 25 basis points sometime before 30 June, we're not concerned what that's going to do to the valuation equation of commercial real estate. It's immaterial. It's the noise around that people need to look through.

Over the cycle.

Over the cycle and whether it's 25 bps, 50 bps, that's a rounding compared to that 425 bps we saw and the valuation changes that have already washed through the market. So we think what will separate the best assets though is the ones that can generate real rental growth because ultimately that is what drives value and that's whether you're talking about an Aussie equities or a company pricing, same applies to real estate. Ultimately people are willing to pay more for assets that have higher levels of income.

And that's going to be driven by some of those supply and demand dynamics that you outlined earlier.

Absolutely, absolutely.

If there's no assets or other options available for those tenants, they've got nowhere to go, so to speak.

That's right. And it's just like picking stocks, though. Real estate is even more nuanced. You can't just say Sydney's going to outperform and apply in all asset classes. You do need to be specific. At Charter Hall we're the largest owner of real estate in the country. We've got great research teams, treasury teams. We see every transaction that comes in the market. Our data is second to none. We think that allows us to spot the trends that are going to drive value over that medium to long term. Because I'm not trying to outperform in six months, 12 months. Our investors, remember I said it should be in that illiquid part, should form part of that long term income generating with capital growth.

So you're looking at a five to seven plus time frame?

Absolutely. And the managers that focus on those right assets, we think they're going to really outperform for investors.

Excellent insight into the market. Steve, thank you very much for your insights today. It was great to have Steve with us. If you liked what you saw or what you heard, please subscribe, share, or leave a comment on the channel of your choice. And for more insights like this and to search, find, and compare hundreds of investment products like all of Charter Halls products, please go to investmentmarkets.com.au. Thank you.