ESR Australia boss Phil Pearce says he expects rental growth to “more than compensate” for any expansion in capitalisation rates across the industrial property sector, after the real estate fund manager snapped up five properties in Melbourne for $106.5 million.
An expansion in capitalisation rates – being driven by rising interest rates and bond yields – is expected to hit industrial property values, which have surged in the last few years as institutional investors have competed for prime assets amid record low vacancy rates fuelled by e-commerce and onshoring booms. Capitalisation rates are akin to investment yields, with any expansion typically putting pressure on values.
“We’re not buying long WALE [weighted average lease expiry] assets, but properties where we can capture the rental growth and in some cases redevelop at the end of leases,” Mr Pearce told The Australian Financial Review.
“We have not seen real rental growth for years and years, but in the last 18 months there has been very strong rental growth because of very high occupancy rates.”
Mr Pearce, who orchestrated ESR’s record-breaking $3.8 billion acquisition of the Milestone logistics portfolio last year, tipped strong rental growth over the next two to three years, but said the one caveat to this forecast was the Reserve Bank “not over correcting in terms of lifting interest rates”.
He said capital values could ease back to what they were 12 months ago, depending on when properties were last valued, but that rental growth would be stronger.
“We continue to be active buyers for the primary reason that we believe in the rental growth story. We have seen rental growth across our portfolio and our new developments are all outperforming,” he said.
The five properties, which are spread across Melbourne’s major industrial precincts, were acquired for the institutionally backed $1 billion ESR Australia Logistics Platform II on a weighted average capitalisation rate of 4.46 per cent and a WALE of 5.7 years.
They comprise adjoining sites at 102-130 Turner Street in Port Melbourne acquired for $28.1 million; a 1.54 hectare property at 9-13 Annick Crescent in Truganina purchased for $16.2 million; a 2.29ha property at 147-153 Canterbury Road in Kilsyth ($22.2m); a 1.95ha property at 321-327 Greens Road in Keysborough ($25m); and a 1.1ha property at 4 Healey Road in Dandenong South ($15m).
The Port Melbourne properties cover almost a hectare of land in Fishermans Bend and are the closest assets ESR owns to the CBD. The properties hold three warehouses leased to multiple tenants.
“Port Melbourne is going to see a major transformation over the next 10 years, and when a rare opportunity presented itself to acquire assets within the Fishermen’s Bend Employment Precinct we seized the opportunity,” Mr Pearce said.
The Dandenong South property has two years of holding income, providing the option for ESR to either re-lease or re-develop when the tenant vacates, while the tenant of the Kilsyth property is B&D Australia, a subsidiary of the Dulux Group.
Mr Pearce said these two properties plus the one in Keysborough was part of EALP II’s strategy to acquire sites in Melbourne’s land-constrained south-east.
Along with the shorter leases, Mr Pearce said rent reviews were structured to capture annual inflationary rental increases, forecast by CBRE and JLL to be in the double-digits over the next three years.
“In the current interest rate environment, you can’t sit on a 10-year lease in Sydney that’s worth a 3.5 per cent cap rate,” Mr Pearce said.
But he stressed that unlike other asset classes, industrial or logistics property was getting rental growth, which meant it was “well positioned to weather the storm”.
“Historically, landlords have been happy with 3 per cent annual rental growth, but in places like western Sydney, there’s been 20 per cent growth in the last six months.”
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