Property Market Dynamics

Recent benchmark CBD office sales that have occurred have implied a degree of yield compression for “trophy” or newly constructed prime, passive assets. In Sydney, the recent internal transfer sale of 126 Phillip Street (6.35% core yield) implied up to a 50 basis point tightening in prime CBD yields since the peak in the yield cycle in late 2009. Similarly in Melbourne, the recent “fund through” sale of 150 Collins Street (6.75% initial yield on completion), also provides further evidence of a tightening in yields for prime CBD assets.

Some secondary and suburban asset yields have the potential to remain soft as the depth of purchasers remains thin relative to prime, passive assets and investors generally price in slightly higher risk. This has presented opportunistic buying and we expect syndicates, wholesale investors and private investors to increasingly seek high yielding secondary CBD and/or suburban assets as they represent good relative value. The industrial sector is going through a structural change with the likes of Stockland (AREIT) and various wholesale funds such as AMP and Colonial divesting their non-core industrial assets and reweighting their portfolios to other sectors. At the same time groups such as Goodman (the only pure AREIT industrial owner left), GPT, DEXUS and Australand are focusing even more attention on the sector via acquisition and growing their development pipelines. As domestic demand picks up and investor interest continues, we expect prime industrial cap rates will firm in 2013, with the most highly sought after precincts being those in close proximity to the main capital city ports and road infrastructure.

Secondary industrial assets will remain generally soft over the coming 12 months, as occupiers continue to seek modern, well located properties. There will be pockets of stress, which will be exacerbated by the recent and ongoing weakness in the manufacturing sector, with many of the older style facilities located in the traditional inner industrial precincts likely to be vacated over the medium term.

Whilst the macro drivers of the economy and capital market conditions may allude to minimal cap rate tightening in the near term, the longer term historical data suggest a tightening bias over the medium to long term. With the spread between real bonds and current property yields being at historical highs, the cost of debt continuing to fall and yields remaining above their longer term average, we expect cap rates, especially in the office and industrial sectors, to have a firming bias over the next 12-18 months.