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Commercial property and the hunt for yield


Australian commercial real estate is seeing high levels of activity, as investors chase yield in a lower growth, low interest rate world.

 

While sales have been healthy over the past 12 months, capitalisation rates are compressing, led by the industrial sector where some sub-markets have already matched or exceeded their 2007 peaks.

Looking forward, AMP Capital’s view is there is at least another 12 to 18 months left in the chase for yield and capital rate compression, for a number of reasons, outlined below.

  1. The outlook for Australian economic growth is expected to be steady in the short term and not recessionary.
    This will continue to support investor preference for yield as the growth environment will remain “average”. AMP Capital is forecasting gross domestic product (GDP) growth around the 2.9-3.2% range in the short term.

  2. Real estate looks attractively priced against alternative asset classes such as fixed interest
    The spread in yields to bonds is still close to historical wides despite recent cap rate compression.

  3. There is a possibility both long and shorter-term interest rates could fall further in the next six months
    This is especially the case if economic growth deteriorates. Core inflation is running below the RBA’s two per cent to three per cent target range giving it room to decrease interest rates further to protect the economy.

  4. Australia’s higher running yields continue to attract foreign investors
    This is despite worries over the end of the mining boom and an overheated housing market in Sydney and Melbourne. A lower Australian dollar is also making Australian real estate more attractive for foreigners as they gain positively on the currency shift – simply they can now get more ‘bang for their buck’ compared to two to three years ago.

  5. Real estate debt is highly accretive to property income yield at the moment.
    Therefore there is the prospect the leveraged buyer will also return, setting new price benchmarks.

We expect cap rates to fall further in 2016 and popular assets/markets such as trophy buildings, assets in markets with improving rental growth prospects and those with secure high yield where leverage is most accretive are likely to see cap rates fall below their 2007 peaks, as we have seen in many overseas markets.

The largest shifts are expected to occur in those sectors that have lagged in the compression cycle to date with improving fundamentals such as regional shopping centres and Sydney/Melbourne office, both prime and secondary markets. Cap rates will stabilise or start to increase when the outlook for economic growth and inflation starts to improve, thawing “the chase for yield” sentiment. At this stage, this looks likely around 2018.

The movement in cap rates to date has propelled the total return for the Australian commercial real estate market upwards into double digits and we expect this to continue until cap rates bottom. Strongest returns are expected in the markets mentioned previously with greater prospects for cap rate compression and improving rental growth prospects such as the non-resource state office markets and the high growth regional and sub-regional shopping centres.

What could upset the apple cart?

About the author
About the author Michael Kingcott is the Head of Property Investment Strategy and Research at AMP Capital leading commercial property research and investment strategy.
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