Is the weak outlook for the commercial property market justified?

21 January 2019

In a recent article, experts warned of a weak outlook for Australian commercial property.

According to the latest Australian Property Outlook report by BIS Oxford Economics, the commercial and industrial property markets are predicted to weaken over the next five years.

The report predicts Sydney returns are expected to fall from an average of 17.8 per cent over the last five years to 9.2 per cent, a drop of 8.6 per cent. Melbourne’s returns are also set to halve, declining from 14.9 per cent to 7.7 per cent.

To get a local perspective, REINSW asked Bobby Suminoski, Principal Licensee at Four Walls Commercial and Chair of the REINSW Commercial Chapter Committee, and Kymbal Dunne, Director of Client Solutions at Knight Frank Australia and REINSW Commercial Chapter Committee member, for their thoughts on the market and predicted declines.

REINSW: What is the issue?

Kymbal Dunne: Simply put, capital gain expectations will fall as prices are high. However, this will impact residential pricing harder, as the yields are lower than the cost of borrowing. Office leases usually span periods of three to 10 years. It is quite common to see fixed increases of four per cent per annum during those terms, so office investment is very attractive and we know that overseas investors desire this prescriptive regular growth in rental income.

Bobby Suminoski: And this is why it’s important that commercial agents understand their market. This report takes a ‘big picture’ approach that is not consistent with what’s happening in the market locally. The market will not perform as well as it has been, but it’s definitely not as bad as this report suggests.

REI: How will this affect the Sydney market?

KD: In terms of Commercial (office), the yield is already above the cost of borrowing, so the capital gain is a bonus. While office rents are expected to increase in Sydney and Melbourne, so too will the risk of return as tenants start to pay very high rents. When will a business rent be too high?

BS: I agree with Kymbal that investors have seen major increases in rental yield and value over the last five to seven years. And while the market is prospering and rental returns increase, the cost of borrowing also increases reducing return-on-investment.

KD: Sydney rents must continue to rise over 2019 and 2020. There is a strong possibility that new supply, which would be useful today, won’t impact the market until late 2021 and beyond. This means the current vacancy rate, which is at record low levels, does not provide business (tenants) with much choice or bargaining power.

REI: How can commercial agents support investors and protect investments?

BS: Commercial agents must remind their investors that while value may not grow at the same rate as previous years, there will still be growth. 

Investors are looking for safe, solid returns and property is likely to still fare better than other investment opportunities.

There is so much volatility in the stock market, bonds are low and the All Ords is up and down. This unpredictability isn’t as prevalent in the property market, which keeps investors coming back. 

KD: To buy today will likely mean taking a long-term approach to investment. Investor views will vary on when the right time to enter the market is and, given there are so many different markets by location and property type, some opportunities will represent better value than others. Additionally, while salaries and wages are not growing, one of the strategies for business to attract the best employees is to provide an attractive, contemporary office. A good agent can educate their client that to stay ahead of the competition they must understand the tenant's desires for the property.

BS: Sydney and Melbourne still represent the safest opportunity in rent and capital value. More investors and development in these markets drives competition and results in better rents. This underpins rental growth and drives construction. This is good for the market, tenants and investors and proves that, despite the predicted outcomes, commercial property still represents a stable investment vehicle.

KD: I agree. However, Melbourne does offer pricing advantages over Sydney. Melbourne CBD is flat and not geographically constrained like Sydney and, consequently, supply is easier to provide. Currently Melbourne's rents are half that of Sydney's on a like-for-like basis. it would be interesting to see whether, if the property market and employment were in equilibrium and both not under supplied, national and international businesses would re-weight their workforces in favour of Melbourne. Certainly housing is cheaper in Melbourne and we are seeing in San Francisco a shift in employment to other cities like Austin, Texas and Denver, Colorado because housing is simply not available or affordable.

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