The global office property crisis has finally hit Australia

July 17, 2023
Posted in News
July 17, 2023 veps

The decision to limit redemptions from an unlisted Charter Hall office property fund shows investors are spooked, and the market is in a difficult spot.

More than eight months after a property fund managed by Blackstone shocked the investment world by limiting investor redemptions, the global office property crisis has finally washed up Down Under.

Charter Hall’s unlisted Direct PFA fund, which owns a $2.45 billion portfolio of office properties, most of which are located in Australia’s major CBDs, has told investors that it too has limited redemptions, citing “challenging economic and property market conditions”.

The fund, which holds a liquidity event every five years, paid out a quarter of redemption requests made by investors in February.

It has since marked a number of properties for sale to meet the remaining 75 per cent of requests, but has now declared it “will only sell assets for prices that reflect fair value and given the lower sales volumes in the office investment markets, sales have proved challenging”.

“Acting in the best interest of all investors, we will continue to apply financial discipline to deliver stability and long-term returns as well as liquidity,” the fund says.

Charter Hall chief executive David Harrison has told The Australian Financial Review that investors awaiting redemptions will receive another instalment “shortly” and the balance of their redemption requests by the end of this calendar year. The specific fund, rather than the Charter Hall headstock, is responsible for meeting redemptions.

“We have sold some assets in the fund. We’re in the process of selling others, more or less in line with where the June 30 valuations have got to,” Harrison told the Financial Review’s Michael Bleby.

But the limit on redemptions suggests local investors have become spooked by the global downturn in commercial property values broadly, and office values specifically, even despite the Australian market holding up much better than those overseas.

Strong economic fundamentals
While US office property values have plunged about 35 per cent from their pre-pandemic peak as the market adjusts to much higher interest rates and the new world of remote work, the experience in Australia has been more benign. Charter Hall marked its office property valuations down by just 3.7 per cent in the six months ended June 30, while Dexus cut its office values by 7.7 per cent.

In its March quarter report for Direct PFA investors, Charter Hall argued Australia’s commercial property sector could hold up better than those overseas.

While it conceded this did “not mean that Australia’s office market will be immune to headwinds particularly in the secondary or lower quality assets where there is less tenant and investor demand”, the company said, “the Asia-Pacific region, including Australia, has led the return to work” and declared Australia’s comparatively strong economic fundamentals would be an advantage.

But that argument hasn’t resonated with investors. This has long been evident in the deep discount at which the share prices of Charter Hall and Dexus trade relative to the book value of their assets. But the rush of redemptions in the Direct PFA fund makes the hit to investor confidence even clearer.

Like the Blackstone property trusts that limited redemptions in December last year, the Direct PFA fund has been a good performer, delivering a 9.7 per cent return since inception, versus a 6.6 per cent return from its benchmark, the MSCI/Mercer Australia Core Wholesale Monthly Property Fund Index. But the past 12 months have been tougher, with a return of just 2.6 per cent versus a 4.2 per cent benchmark return.

No time to take on more debt
Is its decision to limit redemptions reasonable? As any investor knows, there is always a difference between price and value, and at times of market dislocation those gaps can get very wide.

With transaction values in the Australian commercial property sector very low, and buyers and sellers obviously a long way apart, it could be argued that waiting for the market to become more orderly is a reasonable approach. This certainly isn’t the time for the fund to take on more debt to meet redemptions.

And as Charter Hall specifically makes clear, this fund is not a liquid vehicle, so investors know what they are getting into.

Nevertheless, the decision to limit redemptions will probably have repercussions across the property and funds management sector. It makes it crystal clear that office property valuations in Australia are really under pressure, and that pressure is unlikely to abate quickly.

There has been a school of thought that office values would take time to shift, given valuers and landlords tend to try to smooth valuations over an extended period. Landlords may have also been hoping to hold values as high as they can for as long as they can in the hope that interest rates will eventually fall, taking pressure off capitalisation rates and valuations.

The recent good news on US inflation may provide property giants with some succour. But rates may still have a touch further to rise, and may not start falling for a while.

Add in that the work-from-home debate continues to rage, and it may be a while before we know exactly what “fair value” for office property looks like.

source: financialreview