From an Australian perspective, the fundamentals for the office market are somewhat weak.
Limited white collar employment growth within the Private sector and a decline in the Public sector, together with generally low business confidence has led to increasing office vacancies as new stock is completed. As increasing vacancies lead to higher incentives and static rental growth, conditions for local investors are relatively subdued.
However, foreign investment in Australia is driven by external market fundamentals which more than counter-balance domestic market conditions.
Weak property markets in USA and Europe, and volatile markets in South-East Asia are forcing overseas investors to consider alternative markets. Australia offers stable economic and political conditions together with generally attractive property yields.
The cost of debt for foreign investors is low, between 2.0% and 3.0%, compared with 5.5% to 6.0% in Australia. Accordingly, prime Australian investment yields ranging from 6.0% to 7.0% provide offshore investors with immediate positive gearing and a generally stable investment climate.
In addition, while currency risk can often be a dis-incentive for foreign investors, an anticipated fall in the currently high Australian dollar could provide an added attraction for overseas buyers.
IT ALL ADDS UP TO FOREIGN INVESTMENT DRIVING DOWN PRIME YIELDS
Given the intent of offshore property investors to take advantage of the economic and investment conditions in Australia, interest is focused on assets with stable investment profiles. To date, these assets are generally new or modern prime commercial properties with long leases and secure tenants.
As foreign investors are motivated by external market fundamentals, they have the ability in many instances to pay a premium compared to domestic investors to secure a particular asset. This premium is resulting in an overall tightening in prime property yields.
This is not to say domestic investors have not been active. Partly on the back of lower domestic interest rates and accumulated property investment fund allocations, there is now evidence to suggest local institutional investors are re-entering the market, in spite of the lower yields and soft market fundamentals.
GAP BETWEEN PRIME & SECONDARY GROWING
Despite evidence of yield compression for prime grade assets, this trend is yet to be reflected in secondary grade properties, creating a widening gap between yield spreads. Demand for secondary grade assets remains weak, with investors only prepared to transact at a bargain price generally when a vendor is under some pressure to realise a sale.
We anticipate the gap between prime and secondary yield spreads to continue to grow in the short-term to the point where investors will be attracted by the yield premium for secondary grade assets.
This article first appeared in the Urbis Think Tank. Urbis is an interdisciplinary consulting firm offering services in planning, design, property, social planning, economics and research. Working with clients on integrated or standalone assignments, Urbis provides the social research, analysis and advice upon which major social, commercial and environmental decisions are made. With over 300 staff Urbis is uniquely positioned to handle projects from the simplest to the most complex.
