Real Estate

Look to commercial property for strong yields

By Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist, AMP Capital Sydney, Australia

As we move into a new part of the investment cycle, a rise in bond yields will in time make them more attractive for investors, however there is still a long way to go according to Dr Shane Oliver, Chief Economist. Here, Shane explains why commercial property will be attractive for investors looking for yield.

Commercial property remains an attractive hunting ground for yields, even in this current environment where bond rates are improving.

Australian unlisted commercial property has been very strong this decade notching up returns of 11 per cent per annum on average over the combined office, retail, and industrial space.

Now we are moving into a different part of the cycle.

The US Federal Reserve raised rates three times last year as the economy grew, and as the risk of deflation receded and was replaced by the risk of higher inflation. We expect the Fed to raise rates about four times this year, while rates in Australia are probably not likely to rise until 2019.

The rise in bond yields will over time start to make them more attractive for investors but there is a long way to go as yields are coming from such a low level, and in the meantime parts of the commercial property space is enjoying stronger fundamentally driven demand.

Rising rents, particularly in the south-east Australian office markets, combined with a strong industrial sector, stemming from demand for logistics related real estate; is more than offsetting weakness in the retail space and is keeping returns solid for now.

Our expectation is for a gradual rise in bond yields, to around 3.5 per cent by end 2019 for Australian 10-year yields. We also don’t see US recession a risk until around 2020.

Against this backdrop, overall returns from unlisted commercial property are likely to remain strong for a while yet as stronger leasing conditions take over from falling yields as a key return driver.

Interestingly, the choice between unlisted commercial property and A-REITS is now line ball with the latter having reversed their recent outperformance and now offering similar yields to unlisted.

But returns are likely slow to around 9.5 per cent over the next year or so as the “search for yield” tailwind fades.

However, a key point is that even though commercial property yields have fallen sharply they still offer a strong premium relative to bond yields suggesting we are a long way from a major cyclical downturn in commercial property.

The key threats to watch for are a sharp rise in bond yields and a deterioration in the global/Australian economic outlook. 

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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