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Commercial Property

Commercial property yields compelling

Unlisted commercial property is likely to remain attractive to yield-hunting investors even as bond rates improve, according to AMP Capital.

AMP Capital chief economist and head of investment strategy Shane Oliver said Australian unlisted commercial property – office, retail and industrial – had returned 11 per cent a year on average since 2010.

“Now we are moving into a different part of the cycle,” Oliver said.

“The rise in bond yields will over time start to make them more attractive for investors, but there is a long way to go as yields are coming from such a low level, and in the meantime parts of the commercial property space are enjoying stronger fundamentally driven demand.”

Rising rents, especially in the south-east Australian office markets, and a strong industrial sector propelled by demand for logistics-related real estate are offsetting weakness in the retail space, he noted.

After the United States Federal Reserve raised rates three times last year as the economy grew and with the risk of deflation being replaced by the risk of higher inflation, he said he expected the Fed to raise rates about four times this year.

Meanwhile, Australia will probably not raise rates until 2019, he said.

“Our expectation is for a gradual rise in bond yields to around 3.5 per cent by end of 2019 for Australian 10-year yields. We also don’t see US recession a risk until around 2020,” he noted.

“Against this backdrop, overall returns from unlisted commercial property are likely to remain strong for a while yet as stronger leasing conditions take over from falling yields as a key return driver.”

Australian real estate investment trusts are now offering similar yields to unlisted commercial property, but returns will likely slow to around 9.5 per cent over the next year or so as the “search for yield” tailwind recedes, he noted.

However, despite commercial property yields falling sharply, they still offer a strong premium relative to bond yields, indicating the market was some way away from a major cyclical downturn in commercial property, he said.

“The key threats to watch for are a sharp rise in bond yields and a deterioration in the global/Australian economic outlook,” he noted.

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