The so called ‘yield trade’, which has pushed valuations in the Australian real estate market across the various segments right up to their long term averages, will continue in 2018.
Even though this ‘search for yield’ phenomenon has been playing out for some years – while interest rates remain low and investors to be pushed into riskier assets in search of income – the real estate segment is still fairly priced overall and there are even some pockets of value for discerning investors.
For instance, high quality CBD commercial assets still offer well-placed investors strong outperformance potential.
Meanwhile, the arrival of ecommerce players in the retail segment is boosting demand for industrial spaces in inner urban areas.
Finally, ahead-of-the-curve shopping centers building out multi-purpose social infrastructure finding demand from new mix of tenants.
Office Sector
Investors are becoming increasingly competitive in their desire to secure high quality, core assets in growth markets. Sydney and Melbourne have benefitted from this, however Brisbane and even Perth have not been immune to ‘weight of money’ driven capital appreciation.
Fortunately, in some markets, tenant demand has kept pace with capital deployed, meaning that mispricing is less likely and fair value is still being paid.
Markets with economies aligned to financial services, business services, technology and government have prospered in this cycle. However we are now seeing resource led states such as Western Australia and Queensland exhibiting signs, albeit small ones, of a sustained recovery.
Overall in the office segment we’re seeing demand to rising due to low unemployment and and business confidence.
We’re also seeing a flight to quality in the office segment – investors are aggressively pricing quality and long-term cash flows.
We’re factoring in a National Effective Rental growth in the office segment of 5 per cent p.a. for the next three years led by Sydney and Melbourne with Brisbane to improve.
Retail Sector
Our in depth, asset and consumer level research tells us that shopping centres that can be expanded to capture market share, offer experiential services, improve accessibility, and embrace ongoing vibrancy, will be well positioned for rental growth during the current period of structural change.
The recent launch of Amazon in Australia and the introduction of Amazon Prime same day delivery within twelve months will have immediate implications for retails assets in Australia. AMP Capital has been proactively managing for this divergent environment and the repositioning of our major malls and the shift in our portfolio construction towards dominant experience malls, and local convenience malls is based on the longer term thematic “retail of the future” research.
Overall in the retail segment we’re seeing weaker sales growth as a result of lower wages and lower consumer sentiment.
But we’re expecting online sales to grow as share of all retail sales from 8% to 15% by 2020.
We’re also seeing electronics, discount department stores and clothing retail categories under pricing pressure. 50% of tenants in centres today weren’t there five years ago.
Industrial sector
While the retail and the office sectors are facing headwinds from technology disruption, industrial property will benefit from rising logistics and e-commerce demand. Rising demand from domestic and global e-commerce operators will lift rents and take-up across highly populated east coast markets with well-located infrastructure.
With online sales forecast to increase significantly in the medium term this will provide favourable demand side conditions for inner urban fulfillment centres.
Overall in the industrial segment e-commerce will drive demand for new facilities but supply level increases will be constrained by land scarcity.
Rental growth is still weak but it will improve in the medium term as vacancy rates falls and absorption rises due to increased demand.
We’re also expecting yields to compress further in 2018-19 as investors chase higher income growth.
In summary
As we approach the end of 2017, we are finishing the year with commercial real estate values continuing their upward trajectory.
While it’s true that the weight of money chasing real estate assets has pushed valuations up considerably in recent years, real estate remains in line with long-term averages overall.
For example, east coast prime office yields are over 280 basis points above the risk free rate, right in line with the 10 Year Government Bond yields at 2.8 per cent.
Even super prime real estate transactions in the range of 4.5 per cent to 5 per cent are still comfortably above long-term average spreads.
Australian real estate capital values are expected to continue to remain strong with the weight of capital showing few signs of abating in the near term but we are anticipating 2018 to be the peak of the cycle for capital value appreciation for real estate.
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Source: AMP Capital 14 December 2017
Author: Luke Dixon, Head of Real Estate Research, AMP Capital
