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Jason Huljich
Commercial Property Expert
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2018 commercial property outlook

Monday, January 29, 2018

Sydney and Melbourne have been the pick for office property returns over the past few years. Despite some significant yield compression in both markets, they continue to present strong fundamentals and good opportunities for investors this year. At the same time, the second half of last year evidenced some promising green shoots to our north in Brisbane, and even to our west in mining-dependant Perth, setting the tone for what’s to come. Jason Huljich, CEO of Unlisted Property Funds for Centuria, looks at where the returns came in for his investors in 2017 and where he’ll be seeking them this year.

Overall, 2017 presented no real surprises for commercial property investors, and we are likely see more of the same in early 2018. With the national office vacancy rate falling in 2017 by 1.5% to 10.4% and rents increasing, the value of commercial property has lifted across the board with strong demand from both local and global investors. This is strongest in Sydney and Melbourne, where this demand – particularly from overseas buyers – has seen significant yield compression. 

Yield compression in Sydney sign of rising prices 

The sale of Sydney’s Australian Securities Exchange building to a Hong Kong investor for $330 million last year, for example, was struck at cap rate of 4.6% – setting a new return benchmark for investors and serving as a reminder of the recent uplift in values. In a number of other sub 5% yield deals, boutique B-grade office 28 O’Connell Street was bought by Coombes Property for $91 million, and 210 and 220 George Street were sold to Chinese state-owned Poly Group for $165 million; almost 60% more than what they were purchased for at around the same time the year prior. 

In what has been described as the “Deal of the year”, Centuria also settled contracts with Lendlease to sell 10 Spring Street, Sydney for $270.05 million in October last year, reflecting a 3.9% passing yield and a capital value rate of $19,447 psm. The listing resulted in significant interest from both local and global investors who were looking for 100% ownership of a property with development potential in the heart of the CBD, and ultimately led to the record sale price. This exceptional result tripled the original purchase price of $91.6 million in 2013 and is just one example of the significant investor appetite for Sydney CBD assets that we expect to continue steadily into the new year.

Concerns of a bubble overstated

Despite the concerns expressed by the Reserve Bank about the sustainability of recent pricing levels, we believe the likelihood that commercial property is in a bubble on the verge of bursting is potentially overstated. The spread between government bond rates and property yields remains substantial enough to keep investors happy, and we anticipate that further strong rental growth in both Sydney and Melbourne will keep the lure of quality commercial property alive.

This is backed up by a global survey of investors undertaken by CBRE last year, which identified this yield spread (between property and the risk-free bond rate) as the dominant factor influencing foreign investors – ahead of capital appreciation, income levels and geographic diversification. This spread puts markets like Melbourne, Sydney, and to a lesser extent Brisbane, in a strong position going forward, as compared with a number of Asia-Pacific markets. 

Sydney CBD vacancy rates driving demand in metro markets

Sydney is set to benefit from the $12.1 billion investment in public transport infrastructure currently underway. This is driving demand for office space, not just in the CBD, but also in metro markets, where new transport links are likely to improve commuting times and connectivity. 

Furthermore, improving economic conditions have buoyed corporate Australia’s confidence in the medium-term revenue outlook, translating into strong employment growth throughout 2017. As a result, we have seen a corresponding decline in office vacancies across the nation – but especially in Sydney. As recently reported by commercial agents JLL, Sydney’s CBD office vacancy rate fell to 5.4% in the December quarter, down from 7.7% 12 months prior and prime rents have increased more than 20%.

As a result, quality stock remains scarce in the Sydney CBD market, prompting strong demand and upward pressure on prices. The withdrawal of office space for conversion to residential – and for the construction of the Metro Rail project – continues to play a role in reducing supply, although we believe that the majority of these withdrawals have now been completed. 

To our north, Brisbane is picking up

There is good news in Brisbane, where the office market is showing signs of reinvigoration. Vacancy rates have stabilised, and with no significant supply coming online anytime soon, we expect to see some recovery in rents. 

In fact, as shown in the graph below, our expectation is that vacancy rates have peaked and will begin to fall over the next few years. According to JLL, the Brisbane CBD office leasing market ended 2017 in a stronger position than it started, with the overall vacancy rate falling to 15% from 16.8% a year ago and a positive net absorbtion of 33,200 sqm recorded over the year. This has been confirmed with several transactions in Brisabane CBD, the fringe and suburban markets in the first half of 2017, suggesting increased investor appetite and compressing yields.  


Brisbane office market supply expected to continue contracting. Source: Centuria

To the south, a bright spot in Geelong

We see the regional city of Geelong, the second largest in Victoria, undergoing a significant reinvigoration – thanks in large part to the relocation of several Government agencies, including WorkSafe and the National Disability Insurance Agency. The city is currently an hour from Melbourne by train, but this should drop by 20 minutes with the completion of Transurban’s West Gate Tunnel Project. On track for 36.5% population growth over the next 18 years, the city offers an attractive prospect for investment.

To this end, Centuria has acquired an A-Grade building at 60 Brougham Street for $115.25 million. The office building has ten years remaining on a lease to the AAA-rated State Government owned entity, the Traffic Accident Commission. The Centuria Geelong Office fund, a single asset unlisted fund, will launch February 2018. 

To our west, the first green shoots are appearing in Perth

In what has been the weakest of the CBD markets in recent years, yields are now holding up in Perth, with some indications of improving fundamentals. According to JLL, Perth’s vacancy rate remained high at 21.8%, but fell from 24.1% a year ago with a net absorbtion of 41,800 sqm in 2017. 

The general feeling about mining is more optimistic than it has been, and some of the larger corporations, like Chevron for example, which has been shedding large numbers of staff over the past few years, are now starting to employ again – all good news for office space. 

As evidenced in the graph below, we believe that vacancy rates, while still very high, have peaked, and moving forward we expect to see them start to fall as the economy in Western Australian continues to pick up.


Perth office markets showing showing signs of recovery. Source: Centuria

Canberra stable

Canberra remains stable and its fundamentals sound. Vacancies are low in A grade stock, and we believe that downward pressure will continue. Effective rents are beginning to rise and there is some buyer-side demand that is helping keep prices solid. We continue to focus on B and C grade space where there is potential for refurbishment and upgrades. 


We continue to actively seek quality property in markets across the country. As asset-specific buyers, we consider all properties that we believe we can actively manage for the potential to produce an attractive return for investors – even in markets with weaker fundamentals. As we anticipated, with the sale of 10 Spring Street in Sydney’s CBD, we received outstanding results our investors that will allow us to re-direct that capital to other markets where we see value. 

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Commercial property with liquidity: the best of both worlds

Monday, November 27, 2017

By Jason Huljich

Unlisted property funds have long been recognised for their ability to pool investors’ funds and thereby provide direct access to quality commercial property that would otherwise be out of reach. While the returns of such funds are undoubtedly appealing, the sticking point for some investors has traditionally been the fact that investments are locked up for five or even seven years. Jason Huljich, CEO of Unlisted Property for Centuria, reveals how investors can now achieve the best of both worlds.
Quality commercial property – when purchased well and actively managed – has long been recognised for its investment potential. The potential for attractive, tax-advantaged income along with the potential for capital gain when the property is sold is an appealing combination. The challenge for investors, however, is the cost of entry to quality property – something which puts it out of reach of many.
This is where unlisted property funds, which pool investors’ funds to purchase commercial property, have the potential for attractive returns for investors, typically in the form of tax-advantaged income and capital gains at the end of the trust.  
Unlisted trusts have a closed structure in which property assets are valued annually, so unit price movements are not as volatile. In contrast, A-REITs are traded on an exchange, making them strongly correlated with equity markets (and therefore more volatile), and less likely to move in line with the value of the underlying properties, meaning they don’t necessarily achieve the same level of portfolio diversification.
While both listed and unlisted trusts have their advantages – and a sound investment portfolio should incorporate both – the challenge comes in accessing unlisted funds. With cash locked up for a minimum of five years, sometimes seven, and minimum investments as high $50,000 or more, unlisted trusts are naturally more appealing (and accessible) to self-directed high net worth investors, SMSF trustees and the clients of boutique financial planning firms. Furthermore, by not offering daily unit pricing and redemptions, most unlisted funds are not suitable for larger investment platforms, which typically are the starting point for investors that come via most major financial advice firms and aligned planners. This means that a large proportion of investors have lacked easy access to unlisted property trusts and the benefits they bring – a clear market shortcoming.
Meeting market needs

In order to level the playing field, Centuria made the decision last year to create a fund which would offer investors unlisted property exposure, with liquidity. The resultant Centuria Diversified Property Fund (CDPF) invests in a range of unlisted funds as well as some A-REITs and cash in order to provide the daily unit pricing and a limited monthly redemption facility that is required by some investors. In essence, what we have created is an open-ended, diversified commercial property portfolio with target liquidity levels and which aims to provide tax-effective monthly income, coupled with the potential for capital growth.
Initially funded with internal group money in order to thoroughly test the concept, the CDPF became open to direct investors earlier this year. Today, 92% of the portfolio is comprised of units in a number of Centuria’s unlisted property funds, with the remaining 8% in the form of cash and A-REITs, to provide a strong level of liquidity. Already this year we have secured five million units in the unlisted Centuria Sandgate Road Fund as well as an additional 2.6 million units in the Centuria Havelock House Fund, which will be purchased as investment continue to flow into the fund.
Such additional investment will serve to further diversify the fund, reduce its gearing, increase the overall weighted average lease expiry (WALE) and improve distributions, at which point the weighting to cash and A-REITs will also be increased in order to provide enhanced liquidity. 
Understanding the changing environment 

As investment increases in CDPF, our intention is to purchase property directly – leveraging the investment process and research that has proved successful in the past for purchasing and managing properties for both our unlisted and listed vehicles.
As an asset-specific buyer, we don’t reject markets out of hand, even those with comparatively weak fundamentals (although naturally we take such fundamentals into account). For example, one of the striking features of the market cycle at the moment is the divergent nature of Australia’s different CBD markets. In particular, markets which are heavily reliant on the resources sector (Brisbane and Perth in particular) are much weaker than the east-coast markets of Sydney and Melbourne. This comes as no surprise, as the fading resources boom has impacted demand for office space in these related markets, leading to an excess level of supply. This in turn has been compounded by a strong construction cycle, meaning that supply has continued to grow even as demand dwindles.
If you look at the bigger picture, however, the RBA estimates that non-rural commodity prices have significantly recovered – good news for Perth and Brisbane – while net absorption in non-resource led CBD centres has started to ease, diminishing the gap between CBD markets. There are also green shoots appearing in both Perth and Brisbane as demand starts to pick up. Given that supply is likely to remain limited, we anticipate favourable investment conditions to come, and potentially some strategic buying opportunities in these markets.
Of course, even as market conditions continue to ebb and flow, one thing remains constant and that’s our commitment to actively manage the commercial properties we own in order to unlock greater value. Our ability to maximise returns from our properties, rather than taking a ‘buy and hold’ approach or holding properties as passive assets, remains central to our strategy and competitive advantage. Through a hands-on approach that includes refurbishments, facility upgrades and the development of spec fitouts to appeal to tenants – all conducted by our own in-house leasing and property management team – we are able to proactively add value to properties wherever possible.
Consider and understand the risks to investing

As with all investments, each property trust will have varying degrees of risk that should be considered by prospective investors. Investors should read the Product Disclosure Statement for a Fund carefully to better understand the risks of investing in commercial property and/or unlisted property funds.  
The best of both worlds

While we’re still in the relatively early days of what we hope will be a prosperous future for the CDPF, we’re certainly very pleased with its performance so far. Indeed, it’s proved to be a ‘win-win-win’ situation: providing investors with an opportunity for attractive returns; building a much-needed bridge in the market to provide all investors with access to unlisted funds (and direct exposure to commercial property and its potential capital gain); and creating tangible improvements to properties, to the benefit of tenants and users alike. Commercial property with some liquidity is achievable, making this investment class accessible to more.
This is a sponsored article from Centuria.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Deferring tax can make a big difference to total returns

Monday, November 13, 2017

By Jason Huljich

No one likes giving the tax man more of their money than they need to. And when personal tax rates range from a third to a half of your income, finding ways of reducing the burden is definitely time well spent. Negatively gearing residential property, or investing in companies which pay a franked dividend, for example, are two well-used solutions to the problem of reducing and/or deferring tax liabilities over time.
What some investors may not realise is that the income, and potentially the capital gains, on commercial property can also be significantly tax-advantaged. The reason is that the ATO allows for certain deductions and allowances on commercial property, which can serve to reduce assessable income and defer tax liabilities for the period the property is owned.
Furthermore, these tax benefits are available to investors regardless of the structure in which their property asset is held, e.g. as a direct investment, or through a pooled investment, such as an unlisted property trust or even a listed property trust.
Why does depreciation make income tax-advantaged?

Property funds make distributions to investors which come primarily from the rental income received from tenants. Tax-deferred distributions arise because the tax deductions that property owners can claim mean there is a difference between the trust’s cash or distributable income and its taxable income.
These benefits flow through to investors, because investors can effectively claim the deductions (in proportion to the size of their ownership in the property) against their personal income. This means that their taxable income (not their actual income) is reduced, thereby reducing their tax liability. This difference between distributed income and taxable income, referred to as a tax deferred distribution from a property trust, is only recouped when the investment is sold. This is because the cost base of the investment is reduced by these deferred tax amounts and CGT will be paid on the difference between the cost base and the sale price.
The good news is that if the property is held in a trust structure, such as an unlisted trust, then you will be eligible for 50% CGT discount if the investment has been held for over 12 months. This is almost always the case in an unlisted property trust, which typically has a fixed term of five or seven years during which time investors cannot exit and the property will not be sold. This means you are paying only about 50% of your marginal tax rate for this portion of the income.
What is a Depreciation Schedule and how does it work?

Commercial properties are subject to a ‘depreciation schedule’ – which sets out capital allowances and tax depreciation. There are two main elements: deductions for capital works, and deductions for plant and equipment.
High quality commercial properties tend to have higher depreciation allowances, and larger, higher buildings, which have more services (lifts, fire services, air-conditioning etc.) typically have higher depreciation allowances as well.
Capital works deductions

Sometimes referred to a ‘building write-off’, capital works deductions are allowed for various structural elements of a building, including fixed parts of the property such as the foundations, walls, roof, doors and windows. How much you can ‘depreciate’ depends on when the property was built, and ranges from 2.5% to a maximum of 4% per annum.  
These kinds of structural elements of a property are typically depreciated over a long time period, potentially up to 40 years.
Plant and equipment deductions

Plant and equipment refers to assets which can be easily removed or are mechanical in nature – in essence, assets which are deemed to have a limited effective life so could reasonably be expected to depreciate over time. The effective life of an asset is set by the tax commissioner and changes over time.
Plant and equipment such as air conditioners and even lifts usually don’t last more than 10 years or so, so are depreciated more quickly and at a higher rate.
Deciding how to claim depreciation entitlement is also important.

Once depreciation has been calculated, the property owner (in an unlisted trust this will be the manager of the trust), can choose one of two methods to claim: the ‘prime cost’ method and the ‘diminishing value’ method. Prime cost means the deduction for each year is calculated as a percentage of the cost. The diminishing value method calculates the deduction as a percentage of the balance you have left to deduct.
Neither method is intrinsically better than the other – the one which will work best depends on the time horizon of the property investment. Under the diminishing value method, more of the depreciation allowances will be claimed in the earlier years, whereas with the prime cost method, deductions are spread evenly over time, which will tend to suit long-term investors better.
Transparency. At the beginning and over the life of the trust.

One of the nice things about tax benefits from property investment in an unlisted trust structure is that they are transparent – from the beginning of the trust to the end. The Product Disclosure Statement (PDS) will outline the first two years of returns and forecast tax benefits clearly.
Unlisted trusts do not pay tax within the trust structure; rather, all benefits and deductions flow through to the investor. At the end of the financial year, Centuria will issue you with a tax certificate which shows all tax deferrals and depreciation which can be included in your personal tax returns. And chances are, you may end up paying less tax than you think.

This is a sponsored article from Centuria.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Can property investments provide a yield to live on anymore?

Friday, August 04, 2017

By Jason Huljich

Real estate investment has performed very well across the board for investors over the past few years. But depending on what investors are looking for, not all property investment is the same. If you’re looking for a yield to live on, commercial property may just be the answer. 

For many investors, and particularly those in or heading towards retirement, yield can be everything. Capital growth is important, but it’s the yield that makes the difference between living on the returns from your investments and drawing down on capital too soon. But with interest rates at record lows, returns from low-risk assets like cash and fixed interest are pretty grim, and investors are facing up to the reality that they need to look at other asset classes to achieve the returns they need.

Residential property can provide stellar total returns – but for how long?

According to a 2016 Long-term Investing Report produced by the ASX and Russell Investments, Australian residential property has been the top performing asset class over the past 20 years. Yet at the same time, in our low-growth, low-return world, Australia’s commercial property sector – including office towers, industrial facilities and shopping malls – has also delivered standout returns.

In fact, data produced by the Property Council of Australia shows that as at March last year, the average annual return on commercial property was 14%, excluding leverage. Add in leverage, and the returns look even better. These are figures which compare very favourably to the 9.2% from listed property and the depressing 1.6% from fixed interest.

Unlike residential property, in commercial property, rental returns drive the results. Average income yields on the $160 billion of commercial property in the Property Council’s index was 6.6%, whereas in residential property, the picture is very different. Residential rental yields in Sydney and Melbourne are at all-time lows: just 2.8% in Sydney and 2.7% in Melbourne as at January this year.

The seemingly endless upward trajectory of residential property prices (in other words, capital growth), has been the major factor driving its great performance. But continuing to bank on massive capital gains to make up for very low yields is starting to look like a risky strategy. Tax-driven investment strategies, like negative gearing, have played a role in propping up the market, but plenty of analysts are now predicting that the tide is about to turn, or at the very least stall.

So where investors should be looking for their property exposure?

Commercial property can offer a better yield/capital growth ratio.

Investors looking for a yield they can live on, without foregoing the prospect of capital growth, could do a lot worse than commercial property. Most investors are not in a position to purchase a commercial building outright – but there are other, pooled investment options which might appeal. Unlisted property trusts are one.

Unlisted property trusts pool investors’ funds to purchase one or more properties. Investors buy units in the trust, which is managed by a professional property manager, with investors’ money remaining in the trust for a specified time period. At Centuria, the period is usually five years, with an option for a further two years if unit holders agree. Investors receive monthly income distributions (yield) from rent throughout the life of the trust, and any capital gain achieved on the sale of the property is distributed when the trust is wound up.

The good news is that the yield/capital growth profile of commercial property can be very attractive – but it does depend on a number of factors.  Chief among them is quality of the property itself, but the quality and track record of the manager is equally crucial.

Factors which impact returns from a property asset

The quality of the property and whether it is fit for purpose, i.e. will the property perform well in its market/compared with comparable products?

- Location, Location, Location.

Weighted average lease expiry (WALE). This is a measure of the amount of time that leases are locked in across the property. Depending on the property and the manager’s intention, a long or short WALE can be equally attractive. Where a property does not need a great deal of refurbishment and is tenanted by quality businesses or government departments, then a long WALE is preferable. However, some properties offer scope to be upgraded and refurbished and rents raised as a result. In this case, a shorter WALE may be better, because it means that when existing tenants leave new tenants can be brought in at higher rents.

Tenant profile. In most cases, quality corporations and businesses with a track record are more attractive than start-up companies, for example, because investors have more comfort that rents will be paid.

Factors to consider when assessing an unlisted property trust manager

The manager’s track record. A track record of success is a positive sign, and while not a guarantee, it's a good indication that future success is likely. Experience in property markets and in managing unlisted trusts is important.

Whether or not the manager is an active property manager. At Centuria, we are active managers. This means we actively seek to add value to the property assets and back ourselves to generate attractive total returns as a result. We do not use external property managers, but rather an in-house team which is close to our tenants, and knows our properties inside out. We see this as our competitive advantage – our ability to buy well and then really work our assets to get the best out of them.

-The trust structure itself. Look carefully at how the trust is structured. Is it clear when the trust can, or will be, wound up? Is it clear when distributions will be made? What is the gearing level of the trust? How well, and how often, does the manager communicate with investors?

Unlisted property trusts – some examples

We have a long track record in unlisted property trusts. To date, we have completed 33 unlisted funds – with an average return to investors of 13.2% per annum.

At the same time, not all our unlisted property trusts are the same, and our strategy with respect to different properties is reflected in different structures and outlooks for the trusts themselves. 

Sandgate Road – a bond-like structure, with better yields than bonds

Sandgate Road Fund is a ‘passive’ unlisted trust and, in this regard, is somewhat bond-like in its structure. The property does not require refurbishment as it is only four years old, offers a long WALE (9.4 years), is 100% occupied, with 81% of the space leased to State Government-owned entities.

This means that income distributions are locked and fixed, in the same way that bond yields are.

The term of the trust is six years and forecast distributions are 6.5% initially, increasing to 7% in the 2019 financial year – with additional rental growth forecast to increase distributions to 8% by the 2023 financial year.

Zenith Fund – active management in a strengthening market

The Zenith Fund – which co-owns the Zenith, an institutional grade office tower in Chatswood on Sydney’s lower north shore is arguably higher risk, but we believe has more potential upside than Sandgate.

The property required refurbishment when it was purchased, and we are about to undertake $27.8 million of capital expenditure to improve amenities. Zenith was 94.8% occupied at purchase, but with a WALE of only 2.7 years.

Given our view that metro market of Chatswood is set to benefit from falling vacancies and strong rental growth, partly due to State Government investment in infrastructure in the area, the lower WALE was very attractive.

We have already been able to raise rents for incoming tenants, and anticipate further rental growth going forward. The current yield is 7.6% and we anticipate that this will rise over the next year.

The bottom line

The nature of property investment means that it has always been appealing to investors looking for on-going yield, but with some potential upside in terms of capital growth at the end. The issue in the current economic environment is that yields from some property investments are simply not high enough, particularly for investors relying on it to live. In this case, commercial property in general, and unlisted property trusts in particular, are certainly worth considering.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Mixed outlook for Australian office property

Thursday, April 06, 2017

By Jason Huljich

Australian office property will continue to be a mixed bag in 2017. Despite the weight of offshore money flowing into Sydney and Melbourne in search of a safe-haven from global volatility, a measure of overall weakness in the Australian economy and the on-going effect of the demise of the mining boom are contributing to some very different fundamentals.

Nonetheless, according to Jason Huljich, CEO of Unlisted Property for Centuria, it’s not all doom and gloom – there remains opportunities for attractive yields and solid returns from office property for the well-researched investor.

According to the Property Council of Australia’s (PCA) most recent office property report, the Australian CBD office vacancy rate remained steady over the six months to January 2017, declining only slightly, from 11% to 10.9%. However, this steadiness belies significant differences in the markets which make up the index.

While Sydney and Melbourne remain robust, the residual effects of the end of the mining boom continue to negatively affect exposed markets. Perth has been particularly exposed to the fallout of the mining boom, and Brisbane is also feeling its impact. In South Australia, the overall economy remains weak with flow-on effects to the Adelaide CBD office market.

So, what does 2017 hold for the major office markets? The bottom line is that we are seeing little change from 2016.

Sydney and Melbourne the pick

Sydney and Melbourne are the pick of the major markets. According to the PCA, at the end of January vacancy rates were 6.2% and 6.4% respectively. Both markets benefit from strong underlying fundamentals.

In Sydney, over the past two years, we saw B-grade office rents double, which is clearly unsustainable. With some tenants now paying excess of $1,000 per sqm, flattening is to be expected this year.

The trigger for rapid rental growth was the ongoing withdrawal of B-grade office stock for the Sydney Metro and residential conversions. We don’t foresee major additional withdrawals in the near future, which should keep rental growth capped. At the same time, demand remains strong for A and B-grade stock, and we continue to see suites of sub 1,000 sqm leased before the previous tenant vacates. Vacancy rates will fall particularly in the B grade market however, in our view, both demand and the resulting rental levels are now stabilising.

On the sales side, we are starting to see an injection of new stock into the market. Over the past few years, most owners believed that the office market still had some way to run, and as a result, were unwilling to sell. However, now there is growing divergence in views with some believing that the market may be close to its peak. We therefore expect more stock to come up for sale. This is good news for buyers, who at the very least will be presented with more opportunity and more activity than they have seen in past few years.

Sydney metro markets benefit from stock withdrawals and infrastructure

Sydney metro markets continue to go from strength-to-strength. Withdrawal of office stock for residential conversion in metro and CBD markets has been dominant driver of demand for office space in these markets, and as A and B grade office space has become more scarce and more expensive in the Sydney CBD, businesses have looked to move further afield. North Sydney was the first recipient of overflow demand from the CBD, followed by St Leonards, and now Chatswood on Sydney’s north shore.

Centuria recently purchased a property in Chatswood. This created The Centuria Zenith Fund, which is already proving to be strong performer for investors. Leasing deals are coming in at rents up to 10% higher than we forecast, and the recent re-valuation of our stake in the property saw it rise from our purchase price of $279 million to $301 million – all of which is good news for investors.

The fact that the NSW Government is investing heavily in infrastructure has been a contributing factor to rising demand in metro markets. Parramatta is worth mentioning. Situated in the heart of Sydney’s rapidly growing western suburbs, and with new transport links, Sydney's "second CBD" is now one of the strongest office markets in the country. Quality assets are in hot demand, and this has resulted in upward pressure on prices.

Melbourne is solid, but remains tightly held

Demand for office space in Melbourne is strong. Over the past six months, it grew at 3.5 times the historical average – yet Melbourne continues to be tightly held, and supply is constrained. As a result, we expect vacancy rates will continue to fall throughout 2017.

However, despite the lack of new supply, we expect demand for office property to continue to be strong throughout 2017, as investors seek safe property havens in markets with strong underlying leasing market fundamentals. Offshore money continues to pour in – and we expect offshore groups to dominate the investment landscape looking forward. In 2016, 10 out of the 14 office purchases were made by offshore groups, and this kind of ratio is unlikely to change.

Rental levels have held up well on the back of strong tenant demand, particularly at the Premium end of the market, where landlords have gained some face rental growth. In the A and B sector, however, rental growth has been more subdued, and landlords are finding they need to offer a competitive product to appeal. This means taking an active property management approach – speculative fitouts and upgrading and refurbishing of common areas such as lifts and lobbies have been key to success.

Other markets are struggling, but there are opportunities

Outside of Sydney and Melbourne, capital city markets are weaker. Brisbane, Perth and Adelaide remain weak early in the year. Both Perth and Adelaide saw a sharp contraction in rental levels during 2016 as demand for space fell and vacancy rates rose.

The Perth market is struggling and landlords are offering very significant incentives, in some cases up to 50% incentives to secure quality tenants. Incentives like this are a feature of weak markets, because when there is plenty of available space to lease, landlords compete to attract tenants in one of two ways – by contributing to the tenant’s fitout, or by offering rent-free periods.

On the upside, the Perth Landlords has been saved from complete disaster by on-going low interest rates, which are allowing owners to continue servicing debt despite the poor returns.

The most recent figures from the PCA saw Brisbane picking up. Over the six months to end January 2017, demand for office space grew at over five times the historical average. Nonetheless, conditions remain tough. Money is continuing to flow into the market looking for yield, helping to keep conditions more positive. The fundamentals are weak but should improve during 2017, all of which means we may have seen the bottom and come out the other side!

Little significant change overall

Office CBD markets have not changed significantly since the end of 2016, and our view is that in most cases the fundamental drivers of return have not changed. While Brisbane may have seen the worst and should improve from low levels, Sydney and Melbourne remain our top picks. Given that there is no major new supply in either city (albeit expectation of some new stock in Sydney), we expect to see both markets perform well through 2017. 

 Source: Property Council of Australia

 Colliers International, Research and Forecast Report, CBD Office, First Half 2017

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Will commercial property perform strongly in 2017?

Tuesday, January 10, 2017

By Jason Huljich

Investors haven’t had it easy since the global financial crisis – and real estate has been no different.

A number of both listed and unlisted property trusts undertook highly dilutive equity raisings, collapsed or were frozen as a result of the crisis, leaving investors scarred and wary. Financial markets generally have taken their time to normalise, as volatility became the norm. And to top it off, investment managers have struggled to achieve real diversification in their portfolios as previously uncorrelated asset classes have moved in lockstep, and correlated assets moved apart.

Aggressive quantitative easing (QE) by central banks injected liquidity into global economies as governments attempted to prevent a downward spiral of economic contraction and to stimulate investment and employment. Originally conceived as an ‘emergency measure’, QE has continued for much longer than initially thought, and while it may have succeeded in halting downward momentum after the GFC, whether it has succeeded in reviving real growth is less certain. What it has done is keep interest rates at historic lows - increasing prices for financial assets generally, and punishing savers as bond yields stayed suppressed and investors faced lower real returns and higher volatility than ever before.

The good news for property investors is that against the backdrop of low rates, global volatility and sluggish growth, commercial real estate has been one of the big winners. Falling bond rates and volatile equity markets have driven investors into the stable yields and possibility of upside capital growth of commercial real estate, and in the case of the Sydney office market, offshore money looking for a safe haven has played its part in keeping demand buoyant and prices robust.

So what does the future hold?

Interest rates in the US have now been lifted, and there’s more to come

On 14th December this year, the US Federal Reserve announced a 0.25% interest rate increase, taking official rates from 0.5%-0.75% and calling the move a ‘vote of confidence in the US economy’. In addition, three further rate hikes were predicted for 2017, up from previous expectations of a maximum of two. There was no explicit comment on the US Presidential election, but there is widespread expectation that if Mr Trump follows through on his promise of massive tax cuts and huge infrastructure investment, this could well be catalyst for a more sustained economic recovery in the US, putting further upward pressure on rates.

If rates go up here, will commercial property markets in Australia suffer?

The short answer is probably not. If we look back at what happened in 2013 when the US Federal Reserve Chairman, Ben Bernanke, made the first direct suggestion that the Fed might pull back on its bond-buying program, what resulted was the so-called ‘taper tantrum’. US Treasury yields rose by over 100 basis points in four months which would normally have a negative effect on commercial property markets, but in fact, the effect was negligible. The same was true here.

There is certainly strong long-term relationships between long-term interest rates and real estate capitalisation rates, but there are other, more specific market-based factors at play, not the least of which is supply and demand. High institutional demand, for example, in the face of limited supply plays a very significant role, even in a rising interest rate environment, and this is what we have seen to some extent supporting commercial real estate in the major markets of Australia as well.

Commercial property faces some global headwinds – but they may be to our advantage

Global economic and political uncertainty does present challenges for commercial property managers – because it can mean lower growth generally. And, in fact, the IMF downgraded global growth twice last year, never a positive sign. On the other hand, the impact of global uncertainty can be positive for markets such as Australia, as foreign flows move into markets which are largely viewed as safe haven options.

And as returns from other investment assets struggle, funds which have not been in real estate before are starting to invest. For example, at the end of 2015, after posting huge losses, Japan’s Government Pension Investment Fund announced a move into real estate for the first time – to the tune of US$65 billion. There’s no question that this massive wall of money will provide a boost to some of the larger, or ‘gateway’ real estate cities globally, as it seeks a home in quality commercial real estate. Markets in the US will no doubt be the big winners, but Australia may profit as well.

Sydney and Melbourne could be on the receiving end of significant flows

Our expectation, not surprisingly, is that the most significant flows (both from onshore and offshore) will move into the strongest markets – Sydney and Melbourne.

In Sydney, demand across the board for commercial property has been strong, and as supply has been constrained due to withdrawal of stock for residential conversion, fundamentals have improved. Centuria’s property at 10 Spring Street in the Sydney CBD is a case in point. The property was purchased for $91.6 million three years ago, rented at that time for an average of $620 per sqm. The space is now attracting rents in the order of $1050 per sqm, due to the withdrawal of similar stock and was recently valued at $164 million.

Looking forward, if rates do rise more quickly than anticipated, cap rates could become squeezed, but in our view they are starting to stabilise after a number of years of decreasing significantly.

Commercial property ticks plenty of investment boxes

The bottom line is that the right commercial property investment can tick plenty of boxes. Residential properties are lucky to be making a return of between 2.5-3%, so without some serious capital gains, returns are looking pretty low. This is partly because residential property owners are responsible for outgoings, including council rates, water rates, repairs and maintenance.

By comparison, in commercial property, tenants are responsible for the majority of all outgoings. As a result, yields from quality commercial property can be in the order of 6-8% and when combined with capital growth, total returns are much higher, often 12-13%, or more. For example, Centuria unlisted property trusts over the past 18 years have offered investors, on average, total returns of 13.2%.

Needless to say, a higher return doesn’t come without some risk, and in commercial property, one of the biggest risks is vacancy. But that’s where it’s important to look at the track record of the property manager you are investing with – how well they have managed vacancy across their portfolio in the past, and how competent they are at maximising both rents, and capital gain.

But if these factors are covered, and despite some global economic malaise and the prospect of rising rates, the right commercial property will continue to perform strongly in 2017.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Finding yield with unlisted property trusts

Tuesday, July 12, 2016

By Jason Huljich

It’s the old conundrum; if it sounds too good to be true, it probably is. Higher risk can mean higher returns, but it also means higher risk! At the same time, low risk means lower returns. In an economic environment of near-zero interest rates, many low-risk assets just can’t give investors the income stream they need - let alone the possibility of growth in the future. Let’s take a look at unlisted property trusts and see whether they fit the bill in challenging times. 

Global growth is improving, but the views of the world’s leading economists remain cautious in the extreme. The US Federal Reserve Chair, Janet Yellen, acknowledged this month that she could not rule out the possibility that slow productivity growth will continue into the future. This is despite the fact that she has argued for years that the headwinds to economic growth would fade, allowing growth to pick up and interest rates to rise.

For advisers and their investors seeking a yield they can live on, this kind of rhetoric is unlikely to raise their spirits. But it does signal a need to carefully assess investment and asset allocation decisions. Traditional glide paths which saw investors (in particular those approaching retirement) shift out of so-called growth assets like property and shares, into fixed interest and cash, must now be approached with caution.

So where should advisers and investors be looking?

Unlisted property trusts are one option

The right unlisted property trusts can provide investors with a yield they can live on and the possibility of capital growth in the future. Many invest in high-quality commercial office property, which individual investors would not otherwise be able to access, and active asset management can increase both income yield and potential sale price in the future. On the other side of the coin, most unlisted trusts last for between five to seven years, during which time it can be difficult to exit. But for investors looking for yield, rates of between seven and eight per cent are very appealing.

But not all unlisted property trusts are created equal. Investors can be faced with a difficult conundrum when assessing their options. In property, as in any investment, the more you move up the risk curve (or down the quality curve) in the expectation of a higher return, the more danger. And we only have to look back at the experience of unlisted property trusts in the global financial crisis (GFC) to see where that can lead. In that instance, a heady mix of high gearing, poor asset quality, inadequate disclosure and a lack of transparency from management saw many investors get burnt.  

The trick is to get the balance right – too little risk can leave investors unable to live, but too much can be even more catastrophic.

Look carefully at the manager

One way of mitigating potential risk is to choose an unlisted property manager carefully. If there was one good thing to come out of the GFC, it’s that some of the less scrupulous managers were weeded out. However, despite the fact that the industry has made significant improvements in relation to disclosure, fund structures and fees, it is still of utmost importance to look at a manager’s track record. How long they have been managing unlisted trusts, how have their funds performed over time, and what level of transparency and communication an investor can expect.

Unlisted property trusts closely mimic the performance of their underlying assets, much more than their listed counterparts, A-REITs, which tend to move in line with equity markets. Because an unlisted trust is not priced daily by the market, it is very important that the manager is transparent about how properties are valued, and how the fund’s net tangible assets (NTA) are calculated. There are strict rules governing how assets are priced, the disclosure of borrowings, as well as fees and charges, and a good manager should automatically disclose this information.

Active versus passive asset management

Because returns from an unlisted property trust are so closely based on the performance of the underlying properties, understanding the quality (or otherwise) of the property and its tenants is crucial. A good manager should explain his or her reasoning in this regard.

There are also a number of key figures and ratios which an investor should consider carefully. Some of these relate to the likely income from the property, and others to the potential for capital value. In both cases, the ongoing actions of the manager can make a significant difference to overall returns.

For example, on the income side, the weighted average lease expiry (WALE) of a property is very important. The WALE measures the average time period in which all leases in a property will expire. Given the leases in a commercial building provide the income streams which make up the yield, the length of the leases clearly underpin income returns. Generally speaking, the longer the WALE, the more secure the income stream, and potentially the higher the price of the property when it comes to sale.

Also important is the quality of the tenants in the building, and whether or not there are opportunities to improve the property and increase rental levels. This is where an active manager can play an important role. We have a dedicated in-house asset management team whose job it is to identify ways of managing our portfolio of properties and identifying possible improvement. Upgrading foyers and lifts, improving air-conditioning and even undertaking ‘spec’ fitouts in order to attract smaller tenants, can all improve a property’s profile. 

Never has the ability to identify an appropriate risk/return relationship been more important. Too much risk can lead to disastrous results, but in a world where term deposits can’t put food on the table, investment options which provide a liveable yield are in demand.  While every investor’s situation is different and asset allocation decisions must take into account individual risk profiles and investment horizons, there are many reasons why advisers and investors might consider adding unlisted property trusts to the mix.

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How the Budget will impact property prices

Tuesday, June 07, 2016

by Jason Huljich

The bad news

It’s fair to say that the Federal Budget’s changes to superannuation went further than many analysts were expecting. For some wealthier investors, in particular those with high super balances, or who have been used to contributing large sums to super at preferential tax rates, the changes may prompt a fundamental re-assessment of their options.

The good news

The good news is that negative gearing and capital gains tax were left unchanged – and the Reserve Bank of Australia (RBA) cut the cash rate to its lowest level ever, which on the face of it is good news for property.

At the same time, a recent squeeze on local and overseas lending conditions and some economic malaise has seen some of the heat come out of the property market, in particular the residential market in Sydney, and to a lesser extent, Melbourne.

So will the Budget re-ignite the fire, and if so, is residential property an investor’s best bet?

Residential property – can the boom in capital growth continue?

According to data from the Australian Bureau of Statistics (ABS), residential property in Sydney and Melbourne has risen 52% and 20% respectively since the RBA began cutting rates in 2011.

Other markets have also risen, but by much less, with none above 15%. Over the past year, Perth and Darwin have both recorded negative growth.

With the RBA cutting the cash rate on the back of weak economic growth and low inflation, can house prices really continue to rise as they have been, even in Sydney and Melbourne, which account for 65% of housing stock?

It’s hard to believe. Affordability is the big issue - particularly when you consider that the average increase in weekly income is not rising at anywhere near the rate of house prices.

At the same time, for yield-hungry investors who can see rates on term deposits and other cash-like investments plummeting, the stable, consistent yields from property can look attractive.

But again, it depends on the type of property in question.

And that’s where residential property struggles to compete. Typically, in Sydney, gross yields are in the order of 3-4%, and net as little as 2% once expenses are taken out. That means after tax and inflation is taken into account, unless a large capital gain is assured, the total return isn’t great.

The only hope is that capital gains growth will mirror what has been seen over the past 25 years, again, not a sure thing.

What about commercial property?

In comparison with the residential sector, commercial property had much to thank the Treasurer for. The Budget was business friendly, with a variety of measures designed to encourage employment growth, all of which is good news for commercial property.

Tax incentives for start-ups as part of the $1.1 billion National Innovation and Science Agenda, tax cuts for small business, as well as government employment growth, are all measures which should stimulate tenant demand. This will be particularly positive for Sydney and Melbourne, where new businesses, particularly those focused on innovation, are most likely to benefit.

In addition, announcements about investment in defence ($195 billion over 10 years for defence infrastructure including submarine, frigate and patrol boat building) is all good news for the depressed markets of Adelaide and Perth, where much of the action will take place.

New spending on infrastructure – almost $3 billion across Australia – is good for property everywhere. $115 million for a second Sydney airport at Badgerys Creek, $594 million for inland rail between Melbourne and Brisbane, $1.7 billion from asset recycling for Sydney Metro rail and $857 million from asset recycling for Melbourne Metro rail should all provide a boost to commercial property in these areas.

Commercial property - a favourable tax structure and stable yield

In comparison with residential property, yields from quality commercial property are typically higher (7% – 8%) and more stable than those on offer from residential property. Tenants are corporates rather than individuals, and leases are usually longer, are often indexed to inflation, and income is usually tax-advantaged.

At the same time, for most investors, due to the cost, direct investment in a commercial property is not possible, so in order to access the sector they will need to consider a syndicated structure. The two most common are listed property trusts or AREITs, which are traded on the Australian Stock Exchange (ASX), and unlisted property trusts.

AREITs are closely correlated with equity markets, whereas unlisted property trusts are more closely tied to the performance of the underlying property assets. They are not as subject to market movements (properties are typically valued annually rather than daily) and distribute regular income. On the downside they are not liquid, and investors are usually required to maintain their investment for a period of around five years.

Yields from unlisted trusts can compare very favourably with those from residential property. For example, the Centuria Zenith Fund, which owns a 50% stake in two office towers in Chatswood, will have a forecast distribution yield of 7.6% in the 2017 financial year, growing to 7.7% in the 2018 financial year.

The bottom line?

The changes to superannuation and other economic stimulus measures announced in the Budget mean that many investors are taking the opportunity of re-assessing their investment portfolio in line with their expectation of what the changes will mean for them.

Investors looking for tax-advantaged income which can keep pace with the cost of living, would do well to assess what’s on offer in commercial property.

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Volatile markets? Time to look for steadier performers

Wednesday, February 17, 2016

By Jason Hulijch

Market commentators are united in their conviction that equity market investors are in for bumpy ride this year – irrespective of how they see the ultimate outcome. The reasons for this are much the same as for the latter half of last year: concerns about whether the US Federal Reserve will prove trigger happy when it comes to rate hikes, falling commodity prices and disappointing Chinese growth are all likely to keep markets flighty. On the home front, the outlook for business investment is still weak and the Aussie dollar too high. 

Equities aside, historically low interest rates mean that cash, term deposits and fixed interest are barely feeding the family. 

Against that backdrop, there is a real appetite for investments which can provide a stable, yet reasonable yield, without foregoing the possibility of capital growth over time. 

That’s where property comes in.

The property outlook

Looking at residential property, yields are very low, in the order of 3%, so it’s clear that investors are foregoing income now in the hope of major capital gains later. 

On the other hand, commercial property (including office, industrial and retail), looks like a better option. Yields are more stable and higher, around 7-8% p.a. And indeed, over time, yields from Australian property have proven to be extremely consistent, regardless of the rise and fall of capital values. 

For investors interested in taking a position in commercial property, the most common options are either a listed trust or AREIT, or an unlisted trust. Given current volatile equity markets, an unlisted property trust might be the better option right now. 

AREITs and unlisted property trusts: similar but different

While both AREITs and unlisted trusts often invest in the same kinds of property, the precise mix of assets differs depending on the trust. And, even though the underlying assets may be similar, the structures are quite different. 

AREITs are listed on the ASX and are therefore priced daily by the market. They are closely correlated with equity markets and, like equity markets, the price is influenced by market sentiment and other macroeconomic factors not necessarily closely related to the underlying assets.  

The bottom line is that listed and unlisted property trusts can differ markedly, with valuations and investment returns that do not necessarily move in tandem – even with similar underlying assets.

This means that regardless of the changing fortunes of the properties in the trust, if share markets are volatile, listed property may be volatile, too. For this reason, an AREIT does not necessarily provide full diversification benefits in relation to equities. 

At the same time, AREITs deliver the benefit of liquidity, which means investors can buy and sell units at short notice. 

Depending on the trust, unlisted property trusts are usually priced six-monthly or annually. This means that valuations are more stable and more closely tied to underlying property values. They are inherently illiquid however, with most trusts lasting for between 5-7 years, during which time it can be difficult to exit. 

Unlisted property trusts have the benefit of stable returns and certainty of cash flow, due to the locked in nature of commercial leases.  Returns also tend to be a good hedge against inflation because lease payment increases are usually inflation-linked. And the low correlation with other asset classes means that unlisted property offers real diversification benefits throughout the investment cycle.

Both types of investment have the potential to provide tax effective income, due to the ATO’s favourable treatment of the depreciation of property assets. 

In both cases, returns are very much influenced by a number of eminently more controllable factors; the quality of the underlying core assets and the quality of the management. And these go hand in hand. The ability of a manager to choose quality properties, pay the right price and extract maximum performance over the life of the asset will naturally contribute to better returns from both types of investment.

Volatile markets suggest a tilt to unlisted property trusts

What it comes down to is that property plays an important role in a diversified investment portfolio, and both listed and unlisted property should be considered. 

The big question at the moment is exactly what that allocation should look, like given prevailing market conditions. High market volatility, lower liquidity as quantitative easing ends and economic uncertainty in all its forms are all likely to translate into ongoing market swings, causing associated volatility in the listed space. 

That’s why it’s time to look seriously at unlisted property.


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Property - looking outside the residential square

Monday, September 28, 2015

By Jason Huljich

Does asset allocation matter?

During the 1982 to 2007 bull market, many fund managers became less focused on asset allocation at the portfolio level because returns were strong across the board. The GFC changed all that. Now, with low interest rates and low growth, the consensus is that asset allocation is a major contributor to portfolio performance.

What role should property play in the asset allocation mix?

The general view, be it for an SMSF or otherwise, is that a balanced portfolio calls for some property exposure. The question for many SMSF trustees and investors who want to balance their portfolios appropriately is exactly what that allocation should be.

As always, the answer depends on the individual circumstances of the investor and his or her desired outcomes. Here are just some factors that you might consider - which can form the basis of further research.
First, understand that there are different forms of property investment – so the allocation decision is just the beginning. You can choose a direct investment in residential or commercial property, purchase units in an unlisted trust, which invests in different property sectors, or buy a stake in a listed property trust (A-REIT).

These different forms of property investment also perform differently. Many consider A-REITS to be very similar to equity investments, because returns are more likely to mimic those of the share market and may, as a consequence, be less closely tied to the underlying returns from the property itself.

Something else to factor in is that many Australian equity funds already have an exposure to property stocks. This means you may be more heavily allocated to property than you realise, particularly given the very high weighting to domestic equities typical of many Australian investors’ portfolios.

Equally, it’s important to consider the exposure you already have when deciding whether to increase your allocation to residential property.

Many investors feel more comfortable with this sector than others because they own their own home and have some knowledge of the market. That’s why it’s important to understand what the real returns from residential property are. At the moment, for example, residential rental yields are very low, particularly when compared with commercial properties.

For sophisticated investors, an unlisted property fund run by a quality manager is another way to gain direct exposure to property. Because unlisted commercial property trusts are not closely correlated to equity markets, values can be more stable and rental income streams more locked in including, in many cases, with inflation-linked growth built in.

While there are no hard and fast rules about property allocation within a balanced portfolio there are some options to consider once you’ve done your research as to what type and quantum of exposure will suit your needs. Some investment managers would suggest a split between unlisted and listed property, often half and half. And always factor in the likely structure of returns from different property sectors, taking into account both expected yield and the potential for capital growth.

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The fundamental things still apply for property

Property investment and the relentless hunt for yield

Commercial property to outperform

Property and SMSFs – a match made in investment heaven?

Three keys to property investment success

End of financial year. Time to change everything. Or is it?

When is property right for an SMSF?

Once bitten, twice shy?

To syndicate or invest directly, SMSFs push into property

A tale of two cities

Quality tenants mean quality returns

Industrial or commercial – where should investors be looking in a low yield world?

Looking for unlisted property?

Extracting value from your property investment

Commercial v. residential: what stacks up?

Commercial property continues to provide good upside

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