COMMENT: Prospects strong for yielding assets

Monday 16 September 2019

Commercial property can offer investors better options as the search for yields intensifies so NZ Mortgages & Securities director James Kellow provides his rundown on the outlook for the commercial market.

Interest rates are low and most likely going lower and investors, savers, and depositors need to search for a higher yield on their investment funds. 

That’s because Reserve Bank Governor Adrian Orr is correct when he says the likes of Baby Boomers need to start investing their money into yielding assets.

Yielding assets are where they’ll get a return and that’s where New Zealand needs them to be.

This combined with the fact that Kiwis love property should make the medium to long-term lease income profile and net return of commercial property leases attractive to them.

And with commercial properties, they get “bricks and mortar” security as well as growth.

Commercial property investment can be via direct property investment or purchasing a share in a property syndicate of listed property trust.

Either way with bank deposits rates low, there is currently strong demand for commercial property from investors.

However, for a vendor to be convinced to sell, the property needs to be at a low yield. So it’s about finding that sweet spot, where the yield is low enough to encourage the owner to sell, but high enough to secure a buyer. 

Regardless of this, commercial property buildings will increase in value because yield expectations are falling.

Whereas previously an investor may have wanted a 5% return, they now may accept 4%. This is a 20% increase in property asset value assuming rental stays the same. 

In this environment, property owners will tend to hold onto their commercial assets but because the returns are still higher than bank deposit rates others will now be keen to invest.

This means the outlook for commercial property owners is good: more demand for their buildings means higher sale prices. 

Business confidence is subdued so there is probably limited scope for any real rental growth in the short to medium term. However, this will be offset by yield compression on capital values.

This means that for well-located properties the outlook is good. But for vacant properties in fringe locations the outlook has always been relatively poor and will continue to be so.

Investors who get into commercial assets need to ensure the properties are up to modern fire and seismic standards. What’s more, they need to factor in that tenants may require flexibility as their businesses expand or contract.

Those investing outside of prime locations, also need to be aware that there will probably be limited rental growth pressure.

Adding to the surplus demand and price increases is the fact that there are very few quality commercial properties for sale.

Looking at the different commercial property sectors shows a mixed bag.

The office category is very strong in the main centres. There appears to be a shortage in Auckland perhaps intensified by recent apartment conversions reducing office stock.

Wellington has also experienced this. Any shortage is then exacerbated as the repurposed buildings are simply not being adequately replaced.

The market for good commercial buildings in downtown Auckland remains strong. This will probably surprise many given much of Auckland’s housing market is going sideways.

However, in the central city desirable contemporary office stock is limited, overall vacancy rates remain low, and rents are solid.

You’ve got to remember that many of the businesses currently looking for new office space see it through a very international lens.

They have international property managers making the decisions overseas based on international specifications and that means they demand international-grade buildings.

As well as all the technology and environmental requirements, they want features like large floor plates for connectivity and hot-desking, mixed-use spaces. The challenge here is that much of the city’s existing office stock simply can’t provide anything like that.

The industrial market is sound with warehousing a growth sector, assisted by online shopping and demand for distribution centres.

But the retail property market is relatively weak except for speciality retail, food and beverage – as they are sectors that are protected from online sales. 

Overall, yielding commercial assets continue to enjoy good growth. And there’s no evidence that this will change in the foreseeable future.

Good commercial properties in New Zealand are only going to increase in value in the short to medium-term, with their capitalisation rates now tracking down below 5%.”

New Zealand Mortgages & Securities [] is a specialist property financier. They have assisted with delivering nearly $2 billion of property development funding throughout Auckland.

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