The price of blue ribbon commercial property is likely rise in 2015, as major investors, many from abroad, look for real estate security in an era of low growth globally.
The surest sign of that looming revaluation is the squeeze on investment yields delivered by Australia’s tightly held CBD office towers.
By the end of last year, yields on prime Sydney and Melbourne towers had closed to between 5.5 per cent and 6.5 per cent.
Several landmark deals in both capitals helped establish that pricing.
In Sydney, local pension fund REST Industry Super snapped up 52 Martin Place, owned by QIC, in a $555 million deal on a yield of 5.17 per cent.
It was the biggest single office property transaction in the Australian market in the past five years.
Meanwhile, in a blockbuster $1 billion sell-off of Melbourne office real estate by Cbus Property, one Docklands asset was sold to AMP’s Wholesale Office Fund for $433.5 million on a 5.71 per cent yield.
The other asset in that divestment was sold to GPT and its wholesale office fund for $608.1 million on a 6.53 per cent yield.
Market players now expect those prime yields to tighten another 50 basis points or more over the year.
Investa Office chief executive Campbell Hanan is unwilling to predict the extent of the compression, but says he would “not be uncomfortable” with a 50-basis point tightening.
“I wouldn’t be surprised if you did better than that”, he said.
With an $8 billion property portfolio – comprising more than 1 million square metres of office space – under its management, Investa is one of the country’s biggest office landlords.
Those tightening yields will eventually carry through to higher portfolio values, despite some softness in the leasing market.
There is a global driver behind that yield compression. Continuing low growth worldwide, despite historically low credit costs, makes property yields especially attractive.
“Slower growth and lower growth for a longer period of time, puts more emphasis on the value of yield; people in turn pay more for that,” Mr Hanan said.
Australian property yields remain high compared to comparable yields in other world markets. Add to that, the falling Australian dollar, which has been depressed by falling commodity prices.
In the past year, the revaluation in office towers despite weakness in white-collar employment has led some observers, including the Reserve Bank of Australia, to warn of a disconnection in asset prices.
Mr Hanan agreed that in a “normal world”, for valuations to rise there should be an improvement in operating conditions.
“But you need to say, what is a fair and reasonable return in a low-growth environment? If you look along the risk spectrum, real estate still looks cheap on a relative basis compared to other asset classes.”
Mr Hanan expects vacancy rates in Sydney and Melbourne to improve as small and medium enterprises start to expand. As well, a swathe of proposed residential conversions, in Sydney especially, will absorb extra stock.
Savills research head Tony Crabb agreed that prime office yields could fall to between 5 per cent and 6 per cent this year and that the search for yield – and the disconnection that it creates – could last for the next decade.
“It’s a slow grind. In the past if we had rates this low, the place would be buzzing. This time around it’s more subdued,” Mr Crabb said.