Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 242

The hot spots in commercial real estate

Seven years into an upcycle, Australian non-residential (commercial) real estate returns have stabilised according to the latest PCA/IPD Australian Property Index published by MSCI. The Index, which tracks the performance of more than 1,470 institutionally owned office, retail, industrial, hotel, and medical properties, generated a total return of 11.9% in the year to December 2017. This is below the peak of 13.7% recorded in the year to 31 March 2016 but is still above the 5- and 10-year averages of 11.5% and 8.3% respectively (Figure 1).

Figure 1: Non-Residential Real Estate Total Returns: 2007 – 2017

Source: MSCI

Non-residential real estate, like most asset classes, has been buoyed in recent years by bond yields falling to record lows. Most of the returns from real estate in the past few years has been due to capitalisation rate (yield) compression (as cap rates go down, values go up) rather than income growth (Figure 2).

Figure 2: Drivers of Non-Residential Property Investment Returns: 1995 – 2017

Source: MSCI

Direct real estate (returning 11.9%) and unlisted real estate (12.8%) typically have gearing between 20% and 50%, and they outperformed infrastructure (11.1%), listed real estate (8.5%) and bonds (5.8%), but underperformed equities (13.1%) during calendar 2017 (Figure 3). Investors hunting for yield were well rewarded if they invested in infrastructure and direct real estate with income returns of 8.6% and 5.8% respectively.

Figure 3: Asset Class Returns: Year to 31 December 2017

Source: MSCI

Sub-sector performance highlights demographic trends

Drilling down into the various sub-sectors shows a wide variation in performance. The best performing sector was ‘Other’ (medical, health, seniors living, and car parks) with a total return of 19.8% in the year to December 2017 followed by hotels at 14.5%. Notably, both these sectors were also the best performers in 2016.

Health and medical assets are now well and truly on the radar of institutions, as are the other alternate assets like childcare, seniors living, student accommodation, and data centres. Medical and health centres are benefiting from the aging population, changes in the delivery of medical services, and their higher yield relative to office, retail, and industrial assets, although the re-rating of the sector has seen the yield gap narrow in recent times.

Hotels, particularly in the gateway cities of Sydney and Melbourne, are booming. Strong growth in international and domestic tourism and buoyant business conditions in both cities has occupancy levels and room rates at near-record levels. Sydney’s average occupancy in 2017 was 85.9% (on some nights it was near impossible to find a room) and the average daily rate increased by 4.7% to $230 per night. Melbourne’s average occupancy in 2017 was 83.1%.

Figure 4: Non-Residential Real Estate Sectors: Total Returns 2016 and 2017

Source: MSCI

Retail real estate was the worst-performing sector with a total return of 10.1%. Given the challenges facing the retail sector, both structural (Amazon, on-line retailing) and cyclical (high household debt, low wage growth), many would be surprised that retail generated a double-digit return in 2017.

One explanation is that Super and Major Regional Centres (the mega retail centres) comprise almost 60% of the market capitalisation of the Retail Index, and those centres generated an average total return of 10.3% for the year (Figure 5). Globally, institutions are lining up to buy these so-called tier one ‘fortress malls’. The rationale: they dominate their trade area and are perceived to create a community destination (retail, entertainment, restaurants, medical etc.) rather than just a shopping experience. Therefore, they are best placed, of all the retail centre types, to withstand the onslaught of on-line retailing.

Figure 5: Retail Centre Total Returns: 2016 and 2017

Source: MSCI

In November 2017, the AMP Capital Shopping Centre Fund and the AMP Capital Diversified Property Fund each acquired a 25% stake in Indooroopilly Shopping Centre in Brisbane with management rights, in a deal worth more than $800 million on a yield of 4.5%. This was the biggest single-asset retail transaction and represented the first super-regional shopping centre to be sold via an on-market campaign since 2010. Other notable transactions in 2017 include GPT acquiring the 25% interest they didn’t already own in the 153,000 square metre Highpoint Centre in Melbourne for $680 million from their JV partner, the Besen Family, on a yield of 4.25%. GIC, the Singaporean Sovereign Wealth Fund, exchanged a 50% stake in Queen Victoria Building, The Galleries, and The Strand Arcade, all in the Sydney CBD, for a 49% stake in the ASX-listed Vicinity’s Chatswood Chase. The $562 million deal was struck at a yield of 4.75%.

The easy money has been made

Overall, at Folkestone we are underweight retail as we believe the headwinds will continue and there are better opportunities in other sectors. Deploying capital at this point in the cycle requires patience and discipline. With real estate yields across most sectors at record lows, the easy money has been made.

We expect the pace of cap rate (yield) compression to slow and the focus to move to asset-level income generation as the primary driver of non-residential real estate performance. Investors should recycle out of assets that have limited capacity to grow the cashflow and retain or buy assets where there are opportunities to actively manage, refurbish, or reposition to drive income growth. Asset specific factors will be critical including landlord tenant relationships, quality of tenants, lease expiry profile, location, and the active management of the building’s facilities. With record high electricity prices and electricity being one of the major costs of operating a building, efficient operating of the building will be crucial to optimising the bottom line.


Adrian Harrington is Head of Funds Management at Folkestone, a sponsor of Cuffelinks.


Offices will live on in a post-COVID world

Not all non-residential real estate performs the same

Strong capital flows support non-residential real estate


Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

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

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Latest Updates


'It’s your money' schemes transfer super from young to old

With the Coalition losing the 2022 election, its policy to allow young people to access super goes back on the shelf. But lowering the downsizer age to 55 was supported by Labor. Check the merits of both policies.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.


Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.


Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.


Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.



© 2022 Morningstar, Inc. All rights reserved.

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.