Will we see yield compression in the Aussie super-prime cohort?March 15, 2013 / By
Prime-grade assets in gateway cities are, increasingly, being viewed as substitute products. Australia’s gateway city is Sydney, but international investors would also include Melbourne, Brisbane and Perth as plausible investment destinations.
The specific investment criteria of passive offshore capital, unlisted funds (including superannuation funds) and some A-REITs are generating competition for a specific type of product. The characteristics of the product include: Premium or A Grade (in excess of 20,000 sqm to 25,000 sqm and less than five years old), strong covenants, long weighted average lease expiry (with fixed increases) and, increasingly, the highest sustainability credentials.
We have termed this product the “Aussie super-prime”. While Jones Lang LaSalle monitors more than 4,000 assets across 19 office markets in Australia, at a market value of $151.5 billion, the super-prime cohort is limited to between 50 and 55 assets.
Development is the main source of product creation in the super-prime cohort. Australia, like other mature economies, has experienced a cyclical slowdown in development activity since the financial crisis. Jones Lang LaSalle has identified 13 qualifying developments that would meet the definition of super-prime across office markets. Very few of these assets, however, will present an investment opportunity for offshore or well-capitalised domestic investors. The assets are being developed by a property company or superannuation fund that intends to be a long-term holder of the finished product or have been acquired under a fund-through agreement.
The vacancy rate across Australian CBD office markets is 8.8%. Historically, equilibrium vacancy was assumed to be between 7% and 9%. There is, however, a symbiotic relationship emerging between tenant, developer and investor. Large corporate occupiers are looking for the next generation of office accommodation, incorporating the latest sustainability credentials, to make efficiency gains and improve productivity across their business. However, a high proportion of Australia’s stock reflects the design and characteristics of the 1980s or earlier. Across the CBD office markets of Sydney, Melbourne, Brisbane and Perth, 42% of stock is in excess of 30 years old. Developers seek to secure pre-commitments to under-write future earnings, while investor demand is strong for product with long dated leases that are offered through development stock.
The inter-play of these factors is supporting asset creation in Australia and accelerates the obsolescence of older assets, creating structural vacancy within this sector of the market. As a result, the equilibrium rate in Australian office markets is likely to be higher, at between 8% and 10% over the next decade.
Property yields have remained relatively sticky following the decompression throughout the global financial crisis. Nevertheless, Jones Lang LaSalle is not a subscriber to the argument that property yields will precipitously follow Treasury yields down to the extent recorded in a number of offshore markets.
However, the increased depth of investor demand for Aussie super-prime assets and the relative scarcity of these assets will generate pricing tension and yield compression. This year will be the year that yields on the super-prime cohort of assets will start to lose their adhesiveness.
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