Demand from local and offshore investors for good quality, investment grade commercial assets is creating an environment of intense competition in Melbourne’s commercial property market.
Performance Property Advisory’s (“PPA”) first-hand experience in 2016 and discussions with Melbourne selling agents suggests that this competition is underpinned by several factors, but importantly reflects the scarcity of good quality stock and a thirst for parking capital. We are consequently witnessing yield compression for prime and good quality secondary assets with secure income streams to good quality tenants in several sectors. As a general observation, assets within the CBD and inner metropolitan areas are more appealing to investors looking for reliability (in terms of locational benefits, etc.), however the lack of stock is causing a geographical push away from the CBD as many investors search for investment grade stock at a more affordable price point. In many cases investors are being drawn to properties in suburban growth areas which offer more palatable yields, secure lease terms and in some cases better development scenarios in gentrifying areas with growth prospects over the medium to long term. Broadly speaking, we are finding that investors are hungry for yields greater than 4.00-5.50% as CBD and inner metropolitan prime yields edge closer towards the 10 year bond rate (i.e. sales are setting record yields at sub-3.50% in prime strips and precincts) and as much of the prime freehold and strata stock continues to sell at, or close to record low net yields, further limiting options for investors looking for better cash flow.
Who is buying?
We don’t expect a significant drop in demand from local and offshore purchasers for commercial real estate despite the barriers in place for foreign purchasers, as long as interest rates remain low, particularly having regard to Melbourne’s continuing ‘most liveable city’ status and its identity as a safe haven for foreign capital. However, the government and lending restrictions are making it more difficult for foreign purchasers to justify and undertake some investments. As long as local and foreign rational investors continue to act in a similar manner, it is unlikely that demand and consequential yield compression will subside in the coming 12 months.
What are we seeing in each market?
Over the past year we have noticed continuing average prime yield compression in many key retail submarkets up to 50 or 60 basis points in some cases. High levels of competition between landlords to secure tenants, a solid rental market and good levels of enquiry and competition for stock from purchasers should result in steadily tight or continuing yield compression in the CBD. We are noticing a continuing trend from investors searching beyond the CBD, with assets such as large format retail centres becoming an increasingly popular choice for yield driven parties. More broadly speaking, we are still finding record-pushing yields in areas outside the inner-CBD ring in many submarkets.
A similar story has unfolded in CBD office markets with yield compression continuing as stock becomes increasingly scarce. We’ve also noticed strong competition translate into healthy capital growth. Inner suburban office markets continue to perform well as investors stretch outside the CBD in search of stock. Generally speaking, we have noticed average prime yields in the city fringe and outer metropolitan regions compress to (or close to) pre-GFC levels. In a similar fashion to the retail market, high demand freehold properties are breaking these already low boundaries, with sales between 3.50-5.50% being recorded on the back of strong demand and views of value add potential. On the supply side, conversion of secondary CBD and fringe commercial office assets into residential stock is further affecting the supply of commercial stock in the marketplace.
As the more traditional office and retail markets become increasingly competitive, many investors are taking a sideways shift and looking to the industrial market which has been continually outperforming the other key sectors. This has similarly led to average yield compression in the industrial market, however average yields still remain above 6.50%. We are witnessing sales for some blue-chip industrial stock creeping in excess of 50 basis points below this benchmark.
Substantial capital and a declining amount of good quality investment opportunities are characterising many industrial submarkets, thereby limiting opportunities for investors. We are also seeing investors turn to affordable secondary grade stock showing softer yields however the inherent risk of the lettability of the asset and its marketability at the end of its investment life is often reflective in the higher yield.
Continuing infrastructure spending will be a key driver of growth in the industrial market. We see good value in quality, well placed industrial assets moving forward however the increasing competition in the market may begin to limit viable opportunities.
Investment in certain industrial properties does present additional risks if markets are not understood correctly, particularly given the volatility of some manufacturing industries and shifts towards more effective and cost efficient work processes offshore. This risk can be managed with good advice, analysis and strategic investment choice.
Where do we see value in this market?
In a market that is becoming somewhat difficult to penetrate for investors, PPA identifies opportunities that investors may not see on their own, whether they are for sale on or off market. We leverage our extensive professional relationships and expertise of our advisors to develop portfolio strategies that align with investor requirements. Our advisors have a wealth of experience in identifying value drivers and analysing the commercial market opportunities.
Whilst our investment model tends to focus on sourcing commercial opportunities for our clients that comprise strong income-based security, as well as solid returns and growth prospects, we do understand that in this market these opportunities are becoming scarce, even in outer suburban areas for office and retail assets, and in some industrial submarkets. We are increasingly identifying assets in the marketplace with good, often immediate value add potential by way of strong rental and capital growth prospects, which aligns with our proven investment strategy in our residential business. Despite the competition in the market, PPA has sourced investment opportunities for our clients that sit above yields being achieved in many submarkets.
To discuss your investment strategy and to receive further insight into our investment model and how it can benefit you, please contact myself or one of PPA’s other skilled advisors.