Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 113

Demand for non-residential property drives returns

Fuelled by strong investor demand, the latest PCA/IPD Australian All Property Index reveals that non-residential property has performed strongly in recent years.

Direct non-residential property has been a key beneficiary of the hunt for yield, and for good reason. The lure of high and relatively stable income is driving investors to bid up property prices. Non-residential property generated an income return of 6.9% in the past year, underpinning the total return of 10.7%, as shown in Figure 1. This is now the sixth consecutive year of positive total returns since the GFC.

Figure 1: Non-residential Property Annual Returns to 31 March 2015

Source: PCA/IPD Australian All Property Index. The PCA/IPD Australian All Property Index tracks the performance of 1,293 non-residential property assets with a combined value of $137 billion. Participants represent A-REITs, unlisted wholesale and retail property funds, syndicates and private investors.

Property returns by sector

Industrial property was the standout performer over one and three years with a total return of 12.4% for the year and 11.2% p.a. for the 3 years to 31 March 2015 (Figure 2). The relative high yield (+8.2% in the past year) and the repositioning of the sector from manufacturing to high quality distribution centres leased to ‘blue-chip’ tenants driven by the growth in logistics (transport and storage) is attracting significant investment into industrial property. The industrial sector is also benefiting from rising land values as the rezoning of inner city industrial land to residential gathers momentum, particularly in Sydney and Melbourne.

Figure 2: Non-residential Sector Returns, One and Three Year to March 2015

Source: PCA/IPD Australian All Property Index

The next best-performing sectors were retail centres and other property (carparks, self-storage, medical centres, etc.), both with a total return of 10.9% for the year to March 2015. The robust retail sector performance was driven by solid capital growth - the 4.1% capital return was the highest of the major property sectors.

The recent cut in interest rates to their lowest level on record, lower fuel costs and a pick-up in housing activity have contributed to an improvement in retail sales however the rate of growth remains below the historical average. As evidenced by the recent sales updates from the listed retailers, parts of the retail environment still remain challenging due to both cyclical and structural factors (on-line retailing, changing retail formats etc.). Despite this, investors continue to chase retail centres, particularly sub-regional and neighbourhood centres; the major regional centres rarely change hands given they are tightly held by Westfield, AMP, Lend Lease and QIC.

Despite the office sector returning a healthy 10.2% for the year and 9.5% p.a. over three years, there is growing divergence in the performance of the major office markets. Melbourne CBD was the best-performing office market with a total return of 13.5%, 6.6% of which came from capital growth. Next best was the Sydney CBD office market with a total return of 11.5%. Both markets are benefiting from the strong competition from investors for office assets and signs that tenant demand is improving.

At the other end of the scale, the Perth CBD and Brisbane CBD markets are being impacted by the slowdown in the mining sector. Both markets recorded declines in value over the year of 1.9% and 0.3% respectively. We expect values in both these markets to fall further in the year ahead. Weak demand and further new supply will push the vacancy rate in both markets higher – above 15.0% in Brisbane and more than 20% in Perth – putting further downward pressure on rents and values.

Property versus other asset classes

Whilst non-residential property was not immune from the GFC fallout (capital values fell 12.5% in 2009), its performance over the longer-term has been stellar, generating a total return of 10.4% p.a. over the past 15 years outperforming A-REITs (+5.9% p.a.), Australian equities (+9.1% p.a.), and bonds (+7.7% p.a.) (Figure 3). As a rule of thumb we expect non-residential property to generate a total return of 10% over a cycle with circa 7% coming from income and 3% from capital growth.

Figure 3: Non-residential Property versus Other Asset Classes, Annualised Total Return 15 Years to 31 March 2015

Source: PCA/IPD Australian All Property Index, MSCI Indices

As we approach the half way mark of 2015, we expect continued strong investor demand for non-residential property to support total returns above 10%. According to IPD, the spread between bond rates and non-residential yields is now 432 basis points, well above the long-term average 232 basis points. With 10 year bond yields not far off their historic lows, on this measure, non-residential property looks attractive.

For global investors, Australian non-residential property looks cheap relative to the 3-5% yields on offer in the gateway cities of London, New York, Tokyo and Hong Kong. A significant amount of equity has been raised to invest in property globally. One example that typifies this global phenomenon is the private equity juggernaut, Blackstone, who recently raised $US15 billion ($19.5 billion) from pension funds and endowment foundations, to invest in global real estate – some of which is earmarked for Australia. Add leverage to this, and they have a $30 billion ‘war chest’ to deploy.

We also have a huge wave of Asian capital, particularly from the Chinese and Singaporeans, looking for a home in Australian property. Debt market conditions are favourable, both availability and cost, and as one global investor told me on a recent trip to Hong Kong, “Australian property may look expensive to you but to us it is not – our cost of capital is lower than your domestic capital and this is not going to change anytime soon.”

Risks to watch for

Despite interest rates being at historical lows, investors should continue to assess how various interest rate scenarios may impact the performance of property going forward. Although we expect rates to stay lower for longer, investors need to keep an eye on the long-end of the yield curve, as it is the long term bond rate (not the cash rate) that property investors use as the yardstick for comparing property ‘cap’ rates. Any rise in long bonds over the next two years is likely to be modest or even delayed if the Australian economy weakens further. However, the recent sell-off in bonds in response to comments made by the US Federal Reserve Chair Janet Yellen, served as a timely reminder of continuing volatility in global capital markets and one thing is assured, Australian non-residential property will not be immune from any future impending fallout.

Whilst interest rates are an important consideration in the purchase of property, they are not the only consideration. Investors need to exercise caution that acquisitions make sense on a through-the-cycle basis and capital structures (debt levels and LVR covenants) remain relevant through the cycle.

Property is a total return proposition and the current focus on yield may not entirely compensate investors for loss of capital down the track if yields blow-out. With below trend economic growth forecast in the next few years, we expect tenant demand to slowly improve across most Australian non-residential property sectors and sub-markets. The cost of securing tenants will remain high with elevated incentive levels leading to lacklustre rental growth. When asset prices are being driven by unprecedented liquidity being injected into the financial system rather than underlying real estate market fundamentals, we find ourselves heading into uncharted territory. As a result, we are now in an environment where investors need to exercise caution.

It is imperative therefore, that investors identify and quantify the risk in their property portfolios. Factors such as the supply and demand dynamics of the market, strength of lease covenants, duration of the leases, and rent review mechanisms remain fundamental to the assessment of risk. Answers to these will be critical in the investment decision to either buy at this point in the cycle or sell assets in order to take advantage of investors who are becoming increasingly aggressive in their requirement to deploy capital.

If there is one thing that remains a priority for all investors it is having a well-diversified portfolio. Bought well, non-residential property has a key role to play in a mixed asset portfolio.

 

Adrian Harrington is Head of Funds Management at Folkestone Limited (ASX:FLK). This article is for general information only and does not take individual objectives into account. Please seek personal advice before making investment decisions.

 


 

Leave a Comment:

     

RELATED ARTICLES

Outlook for Australia’s Industrial and Logistics property sector

Seven property depreciation tips for EOFY

David Harrison on the hot spots in property

banner

Most viewed in recent weeks

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Too many retirees miss out on this valuable super fund benefit

With 700 Australians retiring every day, retirement income solutions are more important than ever. Why do millions of retirees eligible for a more tax-efficient pension account hold money in accumulation?

Is the fossil fuel narrative simply too convenient?

A fund manager argues it is immoral to deny poor countries access to relatively cheap energy from fossil fuels. Wealthy countries must recognise the transition is a multi-decade challenge and continue to invest.

Reece Birtles on selecting stocks for income in retirement

Equity investing comes with volatility that makes many retirees uncomfortable. A focus on income which is less volatile than share prices, and quality companies delivering robust earnings, offers more reassurance.

Welcome to Firstlinks Election Edition 458

At around 10.30pm on Saturday night, Scott Morrison called Anthony Albanese to concede defeat in the 2022 election. As voting continued the next day, it became likely that Labor would reach the magic number of 76 seats to form a majority government.   

  • 19 May 2022

Comparing generations and the nine dimensions of our well-being

Using the nine dimensions of well-being used by the OECD, and dividing Australians into Baby Boomers, Generation Xers or Millennials, it is surprisingly easy to identify the winners and losers for most dimensions.

Latest Updates

Superannuation

Superannuation: a 30+ year journey but now stop fiddling

Few people have been closer to superannuation policy over the years than Noel Whittaker, especially when he established his eponymous financial planning business. He takes us on a quick guided tour.

Survey: share your retirement experiences

All Baby Boomers are now over 55 and many are either in retirement or thinking about a transition from work. But what is retirement like? Is it the golden years or a drag? Do you have tips for making the most of it?

Interviews

Time for value as ‘promise generators’ fail to deliver

A $28 billion global manager still sees far more potential in value than growth stocks, believes energy stocks are undervalued including an Australian company, and describes the need for resilience in investing.

Superannuation

Paul Keating's long-term plans for super and imputation

Paul Keating not only designed compulsory superannuation but in the 30 years since its introduction, he has maintained the rage. Here are highlights of three articles on SG's origins and two more recent interviews.

Fixed interest

On interest rates and credit, do you feel the need for speed?

Central bank support for credit and equity markets is reversing, which has led to wider spreads and higher rates. But what does that mean and is it time to jump at higher rates or do they have some way to go?

Investment strategies

Death notices for the 60/40 portfolio are premature

Pundits have once again declared the death of the 60% stock/40% bond portfolio amid sharp declines in both stock and bond prices. Based on history, balanced portfolios are apt to prove the naysayers wrong, again.

Exchange traded products

ETFs and the eight biggest worries in index investing

Both passive investing and ETFs have withstood criticism as their popularity has grown. They have been blamed for causing bubbles, distorting the market, and concentrating share ownership. Are any of these criticisms valid?

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.