COMMERCIAL property values across Australia have dropped in the past 18 months in line with the global economy. Although the timing has varied, the decline has been observed across all capital cities and commercial asset types.
Melbourne and Sydney have fallen less than Brisbane and Perth, with the dichotomy in economic performance over the past three years amplifying the performance of commercial property.
As commercial property yields are affected by current rents and future rental growth, tenant demand and the volume of vacant supply are the major considerations when determining value. The availability and cost of debt and its relationship to the safe return of a 10-year government bond, provide the investment market an indication of the expected returns for a long-term commercial property investment.
Office markets have been among the hardest hit with values falling by 15 per cent to 25 per cent nationally. This has resulted in yields (rent/value) for prime quality assets increasing by around 100 basis points in most capitals from about 6 per cent to more than 7.5 per cent.
Melbourne and Sydney enjoyed relatively solid economic performance in the years leading up to the global financial crisis, which limited speculative activity and kept a lid on office floor space in the development pipeline. As a result, yields compressed to 5.5-6.5 per cent for prime assets as debt became increasingly accessible.
Sydney has been the traditional centre for Australian business and been the home of the majority of offshore head offices, which are likely to re-commence business activity when the global economy improves. Melbourne has fewer international head offices and accordingly has a higher proportion of local companies occupying the office market.
Brisbane and Perth have seen massive increases in demand for office space in recent years as a result of the resource boom. This has resulted in huge rental growth, and when compounded by easy access to credit, has also seen construction activity booming.
Many of these projects were constructed on a speculative basis and are now nearing completion, aggressively competing for the few tenants available. Unfortunately, the global crisis has stifled demand resulting in plummeting rents and soaring vacancy rates.
Investment activity in both the retail and industrial sectors has declined over the past 12 months with the tightened access to debt and decreased demand for facilities.
Retail investor activity has continued albeit at reduced levels, with access to debt being the limiting factor. Values for retail assets have declined even with solid retail sales supporting limited rental growth. The impact of the government's stimulus package, A$52 billion (S$64 billion) in total, has enabled households to continue spending, which has supported sales, employment and many parts of the economy.
While many retail assets are currently for sale around the country, the ability of investors to pick up a bargain in this sector is in most cases (apart from distressed sales) minimal.
Industrial yields have in many cases increased by 25 per cent to 30 per cent as demand for facilities declines and an oversupply is reflected in sliding capital values.
The majority of prime industrial assets are held by Reits or institutions, with few private individuals or companies able to access credit at the levels required to purchase such assets. Yields for secondary properties have increased to more than 10 per cent in most instances. However, few transactions have taken place with most owners not prepared to sell property at prices well below purchase levels several years earlier.
Are prices attractive?
The fall in values has naturally affected the willingness or urgency with which owners have put property on the market. Vendors with high gearing have in some cases had to sell at any price in order to reduce debt. This has resulted in several sales with yields above 10 per cent. However, in some cases, assets have been sold with poor tenancy profiles, very short leases and significant building works required.
Furthermore, several of the major Reits have undergone large capital raisings which they have used to pay down debt, hence reducing the requirement for the sale of prime assets.
So the question of whether prices are attractive is fundamentally a function of the risk a purchaser is prepared to take on a property. In Melbourne and Sydney, limited future office supply along with ongoing demand is likely to result in considerable value in long-term investments.
The high costs and long time frames involved in developing office buildings may see rents increasing and in turn, yields improving as demand returns from both investors and occupiers.
Conversely, Brisbane and Perth are likely to experience an oversupply of office space for several years. Reduced occupier demand will see rents fall further, and values decrease or remain at low levels for several years to come. However, several significant mining and oil related deals are likely to result in improving demand being pulled forward, potentially reducing the length of the yield drought.
Deals that are occurring
Across the board, while yields are above long-term levels, there are, as always, risks associated with purchases in the current environment.
Sydney has had very few large office transactions this year, with only four sales over A$50 million. Many properties have been put on the market then later withdrawn with buyer interest well below expectations. Melbourne has had a greater number of sales with several over A$100 million, a sign of the overall confidence in the local economy and its potential to come out of the economic storm earlier.
Perth and Brisbane have had very few large transactions in 2009 with the huge drop in demand for office space and the massive new supply under construction resulting in little upside in the current environment. With few transactions taking place in either city, there is limited ability to derive a real indication of current yields.
Australia's capital, Canberra, has had a disproportionate number of large transactions with buyers keen to acquire assets with the certainty of long-term leases to government bodies.
Longer term, asset value growth may be less than in other regions with high levels of supply and changing government requirements with respect to energy efficient buildings, making ongoing use without significant refurbishment, unattractive. Several of these purchases have been made by German institutions seeking consistent long-term returns.
Outlook
The future for commercial property values across Australia remains as varied as at any point in recent history.
From an office market perspective, the limited pipeline of new supply in Melbourne and Sydney is likely to result in both cities returning to positive rental growth in 2011, which at a time of increasing economic prosperity and demand for assets, may well result in yields compressing and growth in asset values.
However, Melbourne's significantly lower rents, compared with most capital cities (60 per cent of both Sydney and Perth) combined with its larger population and limited development pipeline, makes it well-placed to realise strong rental growth post- 2011.
Perth and Brisbane have seen both demand and rents spike in recent years due to massive demand and minimal new floorspace. But going forward, even with new demand created from the Gorgon gas project, Perth will be over-supplied for many years. This may provide investors with the opportunity to purchase at high yields (9-plus per cent). However, it may be many years before capital growth returns.
Industrial markets nationally are likely to see yields remain high while GDP remains low and occupier demand is reduced. Little improvement is seen in the short or medium term. The high availability of potential industrial supply (land) nationally places considerable pressure on all non- prime assets, and considerably affects their ability to see capital growth.
Yields for retail centres are expected to come under pressure in 2010 as retail spending declines in the aftermath of the crisis and effects from the government's stimulus package wear off. Rising unemployment, which is forecast to peak in mid-2010, is likely to see discretionary sales decline and values for retail assets decrease further.
While the idea of securing a bargain in the current market is appealing, realistically they are few and far between with buyers' appetite for risk being the deciding factor.
The writer is associate director, research, DTZ Australia
Source: Business Times, 24 Sep 2009
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