Commercial and industrial real estate is predicted to achieve double-digit capital growth for the sixth consecutive year in 2020, marking a significant change in the outlook after many expected current cycle of broad-based yield compression to retreat.
The Knight Frank Outlook 2020 report predicts the investment market will reach new highs next year, riding the impact of lower interest rates and the prospect of further RBA action, accelerating conditions for yield compression.
Knight Frank head of institutional sales Paul Roberts pointed to increased activity from local wholesale funds and superannuation groups as well as international investors from Hong Kong, Singapore and Europe for the uptick.
“The shift in interest rates has changed investor perception of pricing and the outlook, and we now see major investor groups, both local and offshore, gearing up for the next phase of investment in the Australian office market.”
Investment, spurred by foreign institutions, has helped to increase market-wide investment volumes in commercial real estate to a new record rolling annual peak of $45.6 billion.
Foreign investment activity over the year was concentrated in the office sector, which accounted for 66 per cent—or $13.2 billion—of all foreign investment across the commercial property sector.
Commercial property returns, office and industrial
Based on the historic lagged relationship between bond yields and prime office yields, Knight Frank also expects significant further yield compression during 2020 and 2021, with Sydney's office property yields to decline over the next two years to 4.1 per cent.
“Sydney and Melbourne have dominated occupational market performance in both the office and industrial sectors over the past five years, substantially out stripping Brisbane, Adelaide and Perth in terms of rental growth, capital growth and overall returns,” Knight Frank associate director research Chris Naughtin said.
“In 2020, we expect to see the start of a shift to a more even pattern of growth moving forward.”
Knight Frank's top predictions for 2020
• Economic growth set to improve in 2020 but remain slow
• Interest rates to fall further
• Office property yields will tighten
• Capital growth to pick up after slowing in 2019
• Lower interest rates will boost investment activity
• Capital raising and yield compression to drive more development starts
• Office vacancy in Melbourne set to increase in the Docklands and Western core
• Rents to grow at a more even pace across office markets
• Strong capital inflows into the industrial sector
• Property owners to focus on education and density regarding cladding
Driven by e-commerce demand and strong population growth, assets within the industrial market remain highly desirable with vacancy rates falling to five-year lows in Sydney, Melbourne and Brisbane
Industrial yields in Melbourne (5.73 per cent), Brisbane (5.94 per cent), Adelaide (7.56 per cent) and Perth (7 per cent) have significantly tightened amid a global investor push into prime logistics property driven by ecommerce, urbanisation and last-mile delivery.
Even as capital growth slowed from 7.7 per cent in 2018 to an estimated 60 per cent in 2019, Knight Frank now expects it to pick up to 6.4 per cent in 2020 and 7 per cent in 2021.
Melbourne's tight officer market conditions, which has benefited from a sustained run of high net absorption, is experiencing a low vacancy rate of 3.3 per cent across the CBD.
Strong leasing market conditions and limited office vacancy, combined with strong demand for new office developments, have driven strong office rental growth with prime market rents increasing by 26 per cent over the past three years.
An anticipated 600,000sq m of supply will also be delivered to the CBD across 2020 and 2021, focused in and around the Docklands and Western core.
“This new supply will see the vacancy rates rise from historically low levels and will be the largest increase in supply since the early 1990s,” Naughtin said.
“While strong tenant demand is expected to continue, and the and the new schemes are substantially pre-committed, the sheer volume of new development set to be completed over the next few years will push the prime CBD office vacancy rate from 3.3 per cent to 7.7 per cent in 2021.”
Meanwhile, occupiers are increasingly putting pressure on real estate to respond with innovative solutions to ensure work environments deliver a positive workplace experience for their staff.