Sydney, Melbourne, and Canberra office markets will see the strongest property returns in the next five years, while the commercial and industrial property sectors are predicted to see lower rates of return during the same period, according to a new study.
These forecasts are connected to the unusual market condition that started after the Global Financial Crisis (GFC). According to BIS Oxford Economics’ latest Australian Property Outlook report, returns have been driven by investment markets instead of leasing markets. In addition, decreasing bond rates and an inflow of funds into asset markets resulted in firming yields and prices.
The report highlighted that the extraordinary strength of total returns to property investment since the GFC-induced downturn has been mainly due to falling bond rates, which drive firming yields. Increasing rates, as well as cyclical strength of the Sydney and Melbourne office markets, also contribute to the gains.
However, returns will be significantly lower over the next five years than the last five – not just for property but across asset markets.
“Bond rates are unsustainably low, both here and in the US. We’re already past the low point for bonds. As recovery in the US proceeds, bond rates will rise, unwinding much of the stimulus to asset yields of the period of falling bond rates,” said Dr Frank Gelber, report author and head of property for BIS Oxford Economics. “The tide will go out, with softening yields leading to a setback to prices and impeding returns.”
The strongest markets will be those cyclical markets with the tightest leasing conditions driving rental growth. Sydney and Melbourne office markets’ strong rental growth will support price rises and delay the softening of yields.
It is important to note that while returns will be cyclically strong, the same strength will cause a subsequent cyclical downturn.
The weakest markets, on the other hand, will be those that are cyclically exposed to weak leasing conditions. These include the Perth, Adelaide and Brisbane office markets.
“[They] will be vulnerable as investors come to realise how long it will take to absorb the oversupply of stock and the cost of re-leasing space in weak markets with high incentives. As investor interest dries up, softening yields will weaken prices and returns,” BIS Oxford Economics said.
Where should investors direct their funds?
For investors with a five-year horizon, it is recommended to turn to cities with the best investment returns in office markets. They are Sydney, with a 9.2% internal rate of return (IRR), Melbourne (7.7%), and Canberra (6.1%).
However, these are down from the previous five-year period between 2013-2018 when Sydney (17.8%), Melbourne (14.9%) and Canberra (10%) all hit double-digit IRRs.
Large format retail property also boasts of strong returns of nearly 7.9% on a five-year horizon, higher than traditional retail centres but is down from the previous five-year period (16.7%).
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