Summary below; full article attached
The market impact of weaker office markets moving forward will be quite uneven in our view. Some assets will fall in value significantly, while others will likely hold their current valuations. In determining this, the answer to the following question is critical: In a down cycle, what office attributes matter the most?
Pricing of secondary and prime assets has converged over the last ten years. We believe this will reverse over the next few years. Businesses will be keen to “entice” employees back into the office and landlords will look to help facilitate this. Secondary space will be at a distinct disadvantage. Businesses will view CBDs as still important with suburban assets offering few advantages over working from home. As a consequence we see suburban / secondary office assets underperforming.
In current market conditions as a landlord you want prime, relatively new assets, a long dated average lease to expiry, strong and credible environmental characteristics (NABERS ratings is one measure as is net carbon emissions), be progressive and integrated in your sustainability approach, have access to capital and have had a conservative valuation approach (a conservative and sensible valuation approach of course goes to the broader sustainability approach and long-term-thinking culture of the organisation as well).
Tenants more likely to commit longer term to Mirvac
Mirvac’s weighted average lease to expiry (WALE) is 6.5years compared to Dexus at 4.3 years and the average of the major REITs (excluding Mirvac) of 4.2 years. Mirvac has 8% of its portfolio expiring inFY22 vs 14-16% for Dexus, GPT and Stockland. Mirvac has 7% expiring in FY23 vs12-16% for DXS, GPT and Stockland. This is because of Mirvac’s newer portfolio(much of which is developed by Mirvac).
Sustainability culture
After many meetings with multiple levels of Mirvac executives, it is clear to us that sustainability is central to the culture at the company. This is important because it means the company takes a sustainable approach to everything it does – the decisions it makes regarding its people and its customers, its impact on the communities in which it operates, the attributes of the assets it owns and develops and how it values those assets.
As a consequence, we believe its office assets are conservatively valued in a sustainable way. Its assets are externally valued every two years effectively providing a buffer in down cycles.
Good NABERS Ratings
Mirvac’s weighted average office NABERS Energy Ratings for completed assets is 4.9 stars. This places it in the top quartile in the NABERS Sustainable Portfolio Index 2020. Given this index includes only the better portfolios in the market, it is reasonable to assume Mirvac’s NABERS rating is in the top 10-20% of the market as a whole. It now has three 6 star assets, four 5.5 star assets and eight 5 star assets.
Mirvac is targeting to be net carbon positive by 2030. A new energy agreement reached in late 2019 sees 70% of its office portfolio in NSW,ACT and Victoria (~90% of its total office portfolio) supplied with 100%renewable energy. Its carbon footprint was reduced by 60% as a result and outgoings savings were made for tenants. Green Building Council of Australia has said that Green star-rated commercial buildings use over 50% less electricity and water than the average Australian building.
Businesses will make positive choices when they are able to do so
When office markets are strong, businesses have to take what office space is available so they can continue to operate. However, when markets are weak, there are more choices available enabling businesses to take into consideration the overall quality of amenity, including a building’s environmental credentials in addition to core considerations such as price, incentive and location. In a market with high vacancy, tenants can pick and choose. This is where quality becomes increasingly important. This is the type of market we are likely to be in forCY21 and CY22.
Better sustainability approach = valuation premium
Mirvac’s office portfolio (40% of our pre debt NAV) has the positive characteristics we have discussed in this note and as a result we believe the peak to trough (June 2020 to Dec 2022) valuations will fall by significantly less than the market as a whole. We attribute this expected outperformance equally to Mirvac’s superior approach to sustainability (including having higher NABERS rated buildings with better amenity and a more conservative approach to valuation) with the balance due to its newer assets versus the market and longer WALE. These attributes in addition to its residential exposure and recovering retail portfolio see the company very well placed versus peers.
Ethical Partners Funds Management holds Mirvac securities
