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Q1-17 - Commercial Markets Wrap Up
April 2, 2017
Commercial Markets Wrap Up - Q1, 2017
The first quarter of 2017 reveals a great deal about the changing nature of commercial real estate in Australia.
Commercial property transactions in Q1, 2017 dropped 62% in volume to $1.4 billion compared to Q1, 2016 at $3.7 billion, a 60% drop also against the previous quarter.
There are several reasons for this significant slump in sales which will attempt to explain shortly. Firstly, it is also worth mentioning that in addition to the value of transactions falling, the actual number of transactions fell by circa 33% to 22 this quarter, down from 33 last quarter and 34 in the 1st quarter last year. The statistics also show the median asset price fell from $59.8M last year to $30.1M this year.
NSW and Queensland recorded most of the transactions however due to some very large transactions in other states, the value of transactions was evenly spread between NSW, QLD, VIC and ACT.
What does this mean ?
The nature of the assets sold this year has changed significantly. In Q1 2016 a larger number of A Grade and big ticket sales in excess of $100M were recorded (11 in fact) including 420 George, 839 Collins, 161 Collins. In Q1 2017 however we've seen a larger number of smaller assets sold along with only 3 over $100M.
The largest transactions was the $321M acquisition of 50 Marcus Clarke Street, Canberra by CIMB, followed by Abacus & KKR's acquisition of the World Trade Centre in Melbourne for $267m.
The drop in sales above $100M this quarter is also a significant indicator of the overall market. Since July 2015, there has been an average of 10 commercial sales above $100M each quarter, however this quarter, just 3 were recorded.
This drop in high value sales is typical of end of cycle transactions where the quality assets are traded in the early end of the cycle with less quality assets trading toward the end of the cycle. Simply put, those who intend to sell high quality assets do so when the market is timing right and once sold, there is little stock available to sell.
Agents say that 2016 was in fact an anomaly as many of the large deals were hang overs from the Dec 15 quarter which didn't quite complete by year end. This may account for some of the disparity, however removing the assets over $100M from both quarters still shows a 35% drop in median prices for assets under $100M. So the affects are felt somewhat across all price points.
Are these results supported by softening yields ?
Through the most part of 2016, commercial property yields were firming. The graph below shows that from July 2015 to December 2016 (18 months), the average commercial property yield firmed by 96Bps from 7.22% to 6.26%.
The 1st Quarter 2017, however shows a marked softening back to 7.3%. I must caveat adopting this this figure because the volume of transactions is low, there were only 2/3 of the transactions revealing their passing yield and there were a number of low quality assets distorting the number. A more accurate measure would be the yield weighted by price and this would show an average yield of 6.7%, which is still a 50Bps softening against the previous quarter.
If this softening continues, there are likely to be valuation changes across the board and REITs may see NTA's falling.
So What has changed ?
Clearly things have changed over the past quarter. The new US government has begun to have an influence on the global market. Ten year Aussie Bonds yields rose 40Bps shortly after the election and continued to climb to a high of 2.98%, and now settled to 2.72%. The prospects of higher US interest rates has elevated as has the prospects of higher local interest rates to counteract what may become a strengthen Australian economy and a falling Aussie dollar. As these factors play out, there also remains the prospect of foreign capital returning offshore to chase better returns.
On the flip slide, a strengthening Australian economy will continue to support employment growth and occupier demand. Low vacancy in Sydney and Melbourne will support rental growth and reduce incentives. Brisbane, Adelaide and Perth will gradually follow but remain hampered by high vacancy rates.
Asset pricing under these scenarios is challenging and most sophisticated investors will err on the side of caution, particularly with respect to any assessment of a terminal yield and rental growth.
What Next ?
In the meantime, Australia continues to be a favoured destination for global capital. The commercial returns relative to 10 yr bonds is still within the normal premium spread of 150 - 350bps as indicated in the graph below. For long term investors who are able to properly price an asset, and stick to their fundamental beliefs, there remains a valid reason to participate in the market.
There is a growing list of assets that are available or haven't been announced as sold (see below). The quality assets among these will continue to find capital from long term investors at prices of 6.0% - 6.5%, however lower quality assets will find fewer buyers and see average yields moving back above 7.5%. The challenge is to be able to sift the wheat from the chaff.
The next few months will be interesting to see how the prime assets in the above list end up and whether this signals a shift in pricing.
Propel is a property based advice, research and economics group providing support to institutional investors. We provide assessment on direct investment and development transactions, listed real estate, and investment strategy.
We are part of Capital Management Australia, a boutique funds management business.