Three keys to unlocking a good year

Get ready for a big year ahead in the commercial and industrial property market. That’s the message from Bayleys’ national director of commercial real estate, John Church.

“2015 is already shaping up to be another cracker of a year for New Zealand’s commercial and industrial property market.” There are three key factors Church believes will sustain high levels of activity:

1- Continuing strong economic growth

In its half-year economic and fiscal update, released just before Christmas, the Treasury said it expected economic activity – which grew by 2.9% in the September 2014 year – to continue expanding at a “solid pace” over the next two years, with the key drivers being construction, business investment and population growth.

Strengthening business investment is reflected in improving job numbers, with employment growing 3.5% over the past year.

A growing workforce means increased demand for business accommodation, which drives occupancy demand up. This is expected to put continuing downward pressure this year on office and industrial vacancies, which are already reaching historically low levels in some parts of the country.

Annual retail sales growth is also solid, at 5.4%. Spending is supported by firm consumer confidence, the improving job market, as well as high tourist and net migration numbers. This is good news for the retail and tourism property sectors as it fuels demand for premises from both tenants and investors.

What does this mean for property owners? A strong economy and low vacancies means less tenancy risk and increased rental growth prospects. Landlords are in a much stronger position at rent review and lease expiry time to be able to ‘put the rent up,’ unless of course rent reviews are linked to the consumer price index (CPI) which is currently at a very low level.

The move toward greater use of CPI linkages post-global financial crisis, in conjunction with the standard ratchet clause, was understandable given the need to at least keep abreast of inflation in a market where rents were dropping.

But in the more buoyant market of 2015, New Zealand is likely to see a move back to regular market rent reviews on new leases, or perhaps the higher of market or CPI plus possibly a top-up percentage on the latter.

New developments will also help lift rental levels. Increased land prices in some strong locations exceeding what they were at the last market peak just before the global financial crisis, mean developers are justifiably having to ask for higher rentals to make their margins. And of course businesses are now much better positioned to pay a fair price for quality premises.

2- Low inflation/lowinterest rates

The big drop in oil prices late last year was the best Christmas present the commercial property market could have hoped for. Inflation, already at low levels, has been pushed even lower. Low inflation means low interest rates, with some economists now forecasting they are likely to stay at around their current low levels for another two years. 

The commercial property market thrives on low interest rates for a variety of reasons:

• property yields generally remain firm-to-holding in a low interest rate environment;

• income yields on property are more attractive than on bonds or bank deposits; and 

• these returns can be made even more attractive by borrowing to buy at a lower interest rate than a property’s income return.

Recent syndications, which generally fund close to 50% of their purchase price through a bank loan, are a good example, offering a return on investors’ equity of 8% or more on properties that have been acquired at yields of less than 8%.

The higher the leveraging, the higher the return on equity. However, there is obviously a risk trade-off here because once interest rates go up, the equation changes very quickly.

Low interest rates also excite owner/occupiers in a rising rental market because they can borrow to buy vacant premises at a similar or lower cost to tenanting.

3 - Demand outstripping supply

You only have to visit one of our commercial and industrial portfolio auctions to see just how much unsatisfied demand there is in the market. There were many bidders on 30 properties that sold at our December Total Property auctions around the North Island. That adds up to a lot of unsuccessful potential buyers who will be looking for opportunities this year.

We are likely to see increasing numbers of investors bidding on more than one property at auctions to increase their chances of success.

Expect plenty of competition at the higher-value end of the market as well, where local buyers will be competing with offshore investors. Southeast Asia, and particularly China, will be a big focus for Bayleys again this year, with enquiry also expected to pick up out of Australia.

Probably the biggest challenge for 2015 will be securing sufficient good-quality stock to satisfy demand. Investors will face a competitive market in 2015 but it will be a market where there will still be plenty of opportunities and, most importantly, plenty of upside to come.

While yields may be getting close to as low as they are likely to go, rentals can be expected to steadily increase over the next couple of years on the back of continuing economic growth. This should translate into capital growth for most property owners. 

Neil Prentice writes for Bayleys Real Estate.