Australian CBD Office Investment Market – Q3, 2018 Update
Sentiment - Stronger market, shortage of investment grade stock
Valuation - Becoming more expensive, lower yields reflect supply and demand dynamics
Debt is expected to remain relatively cheap at a domestic and international level, ensuring strong competition for limited quality investment stock in the foreseeable future. There has been solid investment sales recorded in the Sydney and Melbourne CBD markets over the past 6 months, although this may slow down due to the limited amount of investment grade stock entering the market.
Increased market activity is attributable to high levels of liquidity, attractive yields and strong demand (institutional, private and foreign investors) for quality CBD properties. A substantial firming of yields has been evident in Prime and A-grade properties in the key Melbourne and Sydney CBD markets. Total transaction volumes remained lower in the other capital cities. The ongoing lower cost of capital and positive yield spread for quality assets compared to the risk free rate of return (10-year Bonds), has led to increased demand for Prime and A-Grade office buildings. This has resulted in increased property prices despite generally softer occupier fundamentals.
In reality, the growth in CBD office prices is mainly due to capitalisation rate compression, rather than increased market rents. Therefore, to sustain lower capitalisation rates, market rents will need to increase over the medium term. Real rental growth is unlikely over the next 6 - 12 months. This is due to a high level of vacancies, coupled with a very competitive leasing market and ongoing high incentive levels, for both existing and new tenants. An ongoing trend is a ‘flight to quality’ as tenants upgrade without a high differential in rent (say from B-Grade to A-Grade space).
Given the current strong demand coupled with a shortage of quality Prime and A-Grade stock, some purchasers have moved up the risk curve. Investors are actively chasing buildings with high weighted lease expiry’s to lock in the long duration income streams. As a result, there may be a further tightening of yields in quality secondary stock over the next 6 months. In many cases these buildings are suitable for redevelopment, or residential conversion (or hotel use).
The following table indicates the average Australian CBD Office Yields as at July, 2018. For example, the indicative yield range for Premium grade property in Sydney is 4.9% - 5.25%, with a mid-point of 5.00% adopted for the graph.
Note: Indicative only