Where to next for industrial property?

The property market cycle continues its upward trend underpinned by strong interest from investors and increasing activity from owner occupiers along with growing activity from developers.  As with most recoveries, improvement can appear patchy at times and the pundits get nervous as the market strengthens.

By all accounts, Australia is steadily becoming an investment destination of choice for overseas investors, particularly the Chinese.  The combination of low interest rates, strong local demand for commercial and industrial property, prolonged shortage of quality investment stock and interest from overseas buyers is contributing to yield compression in investment grade property.

Given the strong appetite demonstrated by the Chinese for Australian property, the effect of the devaluation of the Yuan will be interesting.

Recent media reports of commercial yields as low as 5.1% in Melbourne are interesting; however, we see market conditions continuing to correctly price good quality industrial investment property between 7.25% and 8%, depending upon the property. Only exceptional investment properties can be expected to achieve superior prices.

The overall trend of the industrial property market is positive. Vacancy rates are steadily declining and with very limited new supply coming onto the market, sales and leasing stock is becoming harder to find, much to the chagrin of agents.

Prudent owners are offering competitive leasing rates and appropriate incentives to secure longer term leases from quality tenants.  Whilst some tenants remain slow to make decisions, this can be expected to change as business conditions improve and vacancy rates fall. As always, a premium can be expected to be paid for modern, well designed buildings in prime locations.  Owners of older properties, particularly some former manufacturing sites, may need to reduce their price expectations to achieve a result.

The 2015 Federal Budget has been well received; certainly it seems to have been a vast improvement on last year’s budget.  The $20 000 immediate deduction for small business capital expenditure remains available until 30 June 2017 and was welcomed by small businesses. This budget incentive has had a positive impact on retail sales.

With interest rates at an all time low, the Australian Dollar trending towards USD70c, inflation well under control and relatively low unemployment you would expect business confidence to be rising solidly.

There appears to be mixed news from the banking sector.  Recent decisions requiring banks to increase capital holdings and a general trend by banks in recent months towards tightening lending suggests there are some serious concerns in the minds of regulators and bankers.  Regulators and banks usually only make changes that affect lending policies in response to their evaluation of future market conditions, that is, when their forecasts tell them to expect declining asset values and/or they expect their clients to experience reduced cash flows.

More likely than not, the exceptional performance of the Sydney residential market will be at the front of their minds.

As with all markets property values are determined by supply and demand.  Right now investment activity in the industrial market continues to strengthen on the back of low interest rates and a prolonged shortage of supply of quality investment properties.  There is also significant activity by investors using superannuation funds to invest directly in property as opposed to more traditional indirect property investment through shares.  

The current business environment is ideal for businesses to purchase their own properties as opposed to leasing them.  Over the last year we have seen strengthening interest from owner occupiers and it is not expected to change in the immediate future.

With a cash rate of 2.0%, the interest rate cycle must be either at the bottom or very close to it. Although, increases in interest rates have been predicted many times over the last few years, it is inevitable at some stage in the near future.  Owners of industrial property should be mindful to take advantage of these times to build long term financial security by increasing their investment portfolio or alternatively reducing debt.  When interest rates start rising, each rate rise is likely to have a significant impact on the cost of holding property.

It is expected that the industrial property market will continue to perform quite well during the 2015/16 financial year.

Phil Ainworth
September 2015