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NZ commercial and industrial property raising global eyebrows

New Zealand’s commercial and industrial property market is riding a wave of success according to a leading international market intelligence company, which says in an Australasian and global context, this country’s investment credentials are looking sharp.

Latest quarterly data from IPD, which monitors property performance in over 30 countries, shows that in terms of annualised total returns, New Zealand is currently tracking at 10.4% – ahead of its historical long run average of 10% but slightly down on the brief upturn to 11% seen in the previous quarter.

Of this 10.4%, roughly three-quarters – 7.8% – comes from income return, and the remainder from capital growth. IPD says this strong performance is underpinned by sound lending conditions and continued robust demand for space.

These encouraging financial indicators have been reflected in Bayleys’ deal numbers with Bayleys Real Estate national commercial director John Church saying more deals have been done in the first half of 2014 than for any six-month period since the global financial crisis.

“Auckland is leading the way, with volumes up 26% from January to May of this year compared to the same period last year.

“Investors are displaying confidence and optimism. Our Auckland central auction room has been a-buzz this year with some high-profile sales confirming there is a robust appetite for good stock.

“The bulk of the market activity remains in the sub-$5 million bracket however; we are observing increased enthusiasm for properties sitting in the $5-10million range on the back of an improving economy and low vacancy rates.”

Mr Church says from an investment perspective, tightening vacancy rates have substantially reduced the need for owners to provide incentives to secure tenants, which in turn has stabilised net effective rentals. 

“Rental increases, which are the main contributor to capital growth, are occurring but are still at relatively low levels. with many leases having CPI-related rent reviews. 

“This is confirmed by IPD’s latest New Zealand property performance indices, which show that total returns [income yield plus capital growth] are running only slightly ahead of their long-term average of 10% a year.

“However, it is inevitable that significant increases lie ahead, l,” Mr Church says. “It takes time for rentals set on new leases to work their way through the market. Companies are also once again under competitive pressure to provide market leading premises to attract and retain staff and this will contribute to the upward push on rentals as well.”

Australasian IPD executive director, Anthony De Francesco recently presented the latest IPD findings at a Property Council New Zealand-initiated presentation for the commercial and industrial property industry in Auckland. 

Mr De Francesco says that, having looked at research and metrics for large scale assets from an index database of 26 participating funds across listed property vehicles, unlisted wholesale property funds, unlisted retail property funds, property syndicates and private investors, the indicators for New Zealand are in good heart.

“Placed in a global context, IPD data suggests on the back of the GFC, New Zealand experienced a far more muted downturn than in other parts of the world – particularly the UK and US. 

 “The fallout in the UK and the US has been far more pronounced when looking at the interplay between demand for commercial space and capital markets. On the flip side, in Australia and New Zealand, relatively strong demand versus supply conditions helped cushion the downturn,” Mr De Francesco says.

 “And then there is the lending environment to consider. Banks in Australasia seem to be saying now – ‘as long as you can maintain a cashflow, we can live with a balance sheet hit’.” 

Mr De Francesco says that looking at the comparative return performance of the New Zealand commercial property market against Australia’s, New Zealand has outperformed the Australian property market since September 2012 and compares favourably against other global markets. 

“Currently, the New Zealand market delivers a premium of 1.10 percentage points over the total return of the Australian property market and in terms of income return, New Zealand property assets are yielding 7.8% as opposed to 7.1% in Australia.” 

Sector-wise, New Zealand office market returns rose from 9.8% to 11.6%, reflecting strong space demands in light of buoyant employment conditions, while industrial returns remained steady at 10.5%.

At the last market peak in 2007, IPD measured overall total returns for New Zealand commercial and industrial assets at 24% a year – driven by double digit capital growth on the back of sharply rising rentals. 

 “While we may not return to that sort of level again, history suggests that there is still plenty of rental growth upside left in the market for investors,” Mr Church says.

This is backed up by Bayleys national research manager Gerald Rundle, who says that market fundamentals are continuing to improve – particularly in the Auckland market – with research confirming that occupancy levels are on the increase, rental levels are firming and the economic outlook remains positive. The wild card in the deck is interest rates.

“Just what impact higher interest rates may have on the commercial and industrial market will ultimately come down to investors’ perception of market risk,” Mr Rundle says.

“We could expect to see the risk premium remain where it is, or narrow slightly – particularly at the prime end of the market where the greatest improvement in market conditions has been recorded.” 

Mr Rundle adds that, with limited new construction in the market and prime space being soaked up, active and less risk adverse investors may also look more favourably at more accessible secondary stock.

Sydney-based Mr De Francesco says our neighbours from across the Tasman are increasingly casting their eyes toward New Zealand for property acquisitions having ascertained that our market fundamentals are stable.

 “Before the GFC, there was quite strong Australian exposure in New Zealand and we are anticipating it will pick up again now. You just can’t dismiss the benefit of proximity when talking about property investments,” Mr De Francesco says.

Comments and questions

The returns from industrial/comercial property have not kept pace with the increased costs of maintenance, rates or the ongoing compliance requirements for the last ten years for the provincial towns of NZ. One only needs to follow the collapse of the share price in property companies such as AMP as evidence over the years.

Given that almost all commercial leases are net: that is the tenants pay outgoings in addition to the rent, you do not have to take such costs into account when looking at the yield. I dabbled in commercial real estate for years but no longer bother as the listed property trusts give a satisfactory return with the benefit to investors that they all qualify as Portfolio Investment Entities, or PIES., meaning some investors gain a tax benefit. I hold shares in all these trusts. I mention that because the stand-out performer in my portfolio is Precinct properties (PCT), formerly known as AMP office. While some regional centres will not make it in the 21st century, overall commercial and industrial real estate is performing brilliantly.