Growing Need For Yield Spreads Causing Investors To Think Outside The Box

Asia Pacific real estate investors remain heavily focused on yield spreads as investment intentions move further away from capital appreciation strategies.

According to CBRE Research’s new report, New Channels for Old Favourites – Fresh Approaches to Investing in Australia, Japan and Vietnam, the search for yield is driving investors to more mature regional real estate markets like Australia and Japan, while simultaneously diversifying away from traditional markets including Sydney, Melbourne and Tokyo.

The report highlighted ‘overcrowding’ in the Sydney and Melbourne markets, which has seen yields compress by 140 – 150 basis points over the past four years, is bringing more risk adverse cities such as Brisbane, Adelaide, Canberra and Perth into focus.

CBRE Australian Head of Research Stephen McNabb said these markets could offer investors yields of between 100 and 200 basis points above those in Sydney and Melbourne – in addition to less buyer competition.

“As the Sydney and Melbourne markets reach their peak in terms of yield, investors are looking for new locations – in particular markets that offer a higher yield spread,” Mr McNabb said.

“The gradual improvement of Queensland’s economy, which has been gaining momentum over the past 12 months, is making Brisbane look more attractive – particularly given the yield in prime assets of 6% – 6.5%. Office vacancy is forecast to drop below 10% by the end of 2019, which will support rental growth and ultimately yield compression.”

Brisbane is expected to be the first tier II office market to see a recovery in 2017, amid solid flight to quality activity. Adelaide and Canberra are set to follow with both markets stabilising, while Perth will lag with rental growth not expected until at least 2018.

“For every year we spend above trend, the cycle tells us we spend one year below trend. After five years above trend, Perth is now in its fourth year below trend,” Mr McNabb said.

“Capital injection in Perth is expected to increase over the next five, with investors now focused more on relative income yield as the main motivation for investment.”

CBRE Executive Managing Director of Pacific Capital Markets Bruce Baker said Australia remained a compelling investment destination, with investors looking further afield from Melbourne and Sydney for opportunities.

“The favourable commercial yield spreads in Australia’s two largest cities confirms their status as amongst the most consistently sought investment markets in Asia Pacific.

"But given intense competition and limited available stock in Sydney and Melbourne, investors are now more willing to move up the risk curve into less familiar but stable markets like Brisbane,” Mr Baker said.

With more attention directed towards yield spreads versus capital appreciation in Australia and Japan investments, there are three areas of risk facing investors in the medium-term.

• Currency risk: Freely traded currencies like the Australian Dollar and Japanese Yen are both subject to volatility and require investors to operate active hedging programs to manage the associated currency risk of investing in both markets. However, hedging movements in the Australia Dollar and Japanese Yen are generally well understood by investors, supported by a sophisticated market of liquid instruments.
• Business party risk: Investors entering into mature real estate markets such as Australia and Japan, and emerging destinations like Vietnam, often opt for or are required to enter through a joint venture (JV) partnership. In order to align investment interests and views, CBRE Research observes investors scrutinising track records of potential partners more heavily and performing more thorough due diligence to assess investment and strategic objectives.