By Matthew Page, Knight Frank Tasmania’s Director – Valuations.
Recent sales across the retail, commercial and hospitality property sectors indicate firm competition for assets leading to yield compression and increases in property values.
This yield compression has been, to varying degrees, more pronounced for prime assets although secondary markets have recently shown recent strong yield compression as well.
Commercial property markets are now trading on returns below their long-term averages.
Whilst it is difficult for assets in a buoyant market to continue trading below lower term averages, the trend does indicate general asset property pricing and cyclical risk exposure.
Compression of commercial property returns and the subsequent increases in property values has correlated to the accepted trend of interest rate movement.
Many vendors have been more than willing to dispose of assets in the current economic environment, noting the upturn in the market associated with a low cost debt environment for buyers. There have been higher than average numbers of investment property sales and at yields well below 6.0%, even as low as 3.5% in the last twelve months.
Whilst returns are the benchmark for commercial property values, valuation of property takes account of income perpetuity. The market will generally be confident in a strong business location to sustain ongoing income certainty. The issue in the current market with strong demand is the weight of money pursuing a better return than other asset categories such as cash and equities. Investors appear more focused on the current income.
Investment property will and should exhibit a higher return to account for times when issues such as income uncertainty or building capital expenditure fall due.
This is the major, and more costly, characteristic of investment property and it is at the investors peril if capital expenditure is not addressed. Tenants will not accept such situations and it normally forms part of the lease covenant anyway. These are but a few examples of why property is risk rated higher than other asset categories.
So now and into the short term, valuation of commercial property will focus not just on the property investment market dynamics such as the number and type of investors, the state of the tenancy market and physical attributes of the property itself.
There will be further focus on factors influencing interest rate movements.
For a longer than average time frame now, investors have been able to access funds from a historically low cost debt market. Lenders have been factoring their own risk into debt pricing and the costs of prudential requirements set down by the Australian Prudential Regulation Authority (APRA) raising capital adequacy requirements on banks to higher levels.
All this is outside the Reserve Bank settings that might be set for change if the US Federal Reserve start increasing rates by the number of occasions speculated over the next twelve months.
Further interest rate rises cannot be discounted and APRA prudential requirements on lenders have been one reason the RBA have kept interest rates at the historic low levels aside from the main objective as a consumer price lever.
The Australian government budget 2017 announcement of a 0.06% levy on banks with liabilities above $100 billion may influence the cost of lending.
The cost of funds seems set for a few changes which will continue to influence commercial property market returns and values.