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Commercial property outlook

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Overseas investment into Australian residential and commercial property markets dominated headlines in 2014, and for good reason. According to figures released by global real estate specialist, Savills, sales in the Sydney CBD office market in the 12 months to December 2014 totaled $4.7 billion, almost double that of the previous 12 months. And foreign investors were responsible for 45% of that total spend.

In 2014, the majority of this foreign capital was focused on two areas: premium grade office towers and development – much of which was conversion of office stock into residential assets.

This year we expect overseas inflows, in particular from China and Malaysia, to continue. Some will be focused on premium office assets in the major CBD markets of Sydney and Melbourne, but residential conversions will also continue. The effect of these inflows is already apparent, with yields down between 25 and 50 basis points over the last six months.

In our view, this trend will continue. Ultimately we expect yields in core office markets to fall from 6-7% to 5-6%. We even believe we could see a sub-5% transaction for a core Sydney asset this year. Despite this, we expect local yields will remain attractive to Asian investors compared to the 3-4% on offer at home.

Onshore demand to ramp up

Demand from onshore players will come primarily from the listed sector (A-REITs) as managers continue to aggressively seek high-performing assets.

Continued scarcity of assets is likely to continue, however there are a number of assets and portfolios expected to hit the market this year. The recent decision by Morgan Stanley to exit the Investa Group, and sell down its estimated $2.5 billion in property assets, has already sparked strong interest among investors. Some of the assets up for grabs are premium, including 126 Phillip Street and 225 George Street in Sydney and 120 Collins Street in Melbourne. It will be interesting to see the sale process unfold.

On the leasing side, we expect improvement in market fundamentals, with increased demand and incentives stabilizing and then reducing. Savills expects more businesses to be in a position to commit to a new building, having spent the past seven post-GFC years consolidating and working their existing accommodation harder. 

Supply pipeline manageable

The bulk of the future office supply pipeline in Sydney will come from the three commercial towers at Barangaroo. The first represents 89,000 sqm of office space and will be ready for occupation later this year. It is almost 80% pre-committed. The second, 78,000 sqm, will be ready early 2016, and is 77% pre-committed. The third, and largest, tower, 101,000 sqm, is due for completion in early 2017, and is only 34% pre-committed.

There have been concerns that this volume of new office space could distort the Sydney market. However, given that Barangaroo represents only around 8% of the office space on offer in Sydney, we think it unlikely. In addition, as Barangaroo comes on line, significant back fill office space will be withdrawn from the market. Some will be refurbished, some re-developed and some converted to residential or hotels. All in all, our expectation is that any new supply, including Barangaroo, will not negatively affect market fundamentals as materially as first thought.

In Melbourne, supply will be more muted as the remainder of the Docklands space is absorbed.

Industrial property benefits from online revolution

We expect a continuation of industrial property’s strong performance this year. Logistics is the buzzword here, as the traditional ‘dirty’ industrial sites make way for larger warehouses to meet the growing demand of online retailers to provide quick and efficient delivery.

Our focus is again on the markets in Sydney and Melbourne, although their different fundamentals will affect both price and performance. Land for industrial development is scarce in Sydney, with the ocean on one side, the Blue Mountains on the other, and a desperate residential shortage. In Melbourne, on the other hand, development land is more available and therefore cheaper.

Asset-specific choices key to success

Ultimately, regardless of the economic factors driving property markets, there will always be opportunities for investors, even in a downturn or a weak market. The key to success is focusing on the fundamentals of each asset, assessing how it is likely to perform within its market and paying a price which reflects its ability to both generate an acceptable income stream and provide the potential for capital gains in the future.

Published: Monday, March 09, 2015

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