The commercial property opportunity for investors
Commercial property markets are likely to outperform residential following the introduction of tighter lending conditions for residential property investors.
Banks have tightened lending conditions for residential property investors in response to increasing pressure from the Australian Prudential Regulation Authority (APRA) for the banking industry to adhere to the 10% cap on property investor lending growth. This move is set to weaken capital growth in the residential market, allowing commercial markets to outperform residential in the next couple of years.
What’s driving the demand for Australian housing?
Australian property prices are high in a global context, due to factors which include low interest rates since the early 1990s, deregulation of the banking system and the rise in two income households.
Additionally, housing construction has not matched the rise in demand. Vacancy rates remain low and there has been a cumulative supply shortfall since 2001 of more than 200,000 dwellings. Construction of apartments is rising which is likely to slowly close this gap.
Will tightened conditions soften the housing market?
APRA is adamant for property investment lending to slow as we head into the second half of the year – if lenders don’t toe the line, tougher action is likely. As such, we should expect to see a slowing in the availability of credit for property investors and some slowing in price growth in Sydney and Melbourne over the next year.
Commercial property currently represents better value than residential housing
Historically, residential property has been a high performer due to the consistency of capital growth over the long term, rather than the income yield from rental income. The gross rental yield on housing is around 2.9% (after costs this is around 1%), compared to yields of 6% on commercial property and 5.7% for Australian shares (with franking credits). With the prospect of weaker capital growth in residential, the commercial markets are likely to outperform in the next couple of years supported by higher income yields and increasing demand for higher yielding investments.
Housing price vulnerability has been around since the house price boom that ran into 2003. As such, APRA and the RBA are right to be concerned about further inflating the property market. The renewed strength in auction clearance rates this year to record levels, particularly in Sydney and Melbourne, is a concern.
We expect commercial property to benefit from this environment. Our research suggests that the greatest opportunities lie in population growth areas/cities, dominant assets and core locations with ‘destination’ and experiential assets to attract customers and staff.
About the author
Michael Kingcott is the Head of Property Investment Strategy and Research at AMP Capital leading commercial property research and investment strategy.