A buoyant economy, reduced interest rates, positive market fundamentals and the 'weight of money' flowing into the commercial property sector have driven strong growth in commercial property values in recent years.
This has forced property yields down to levels hitherto unseen, prompting concerns of a burgeoning ‘bubble’ in commercial property prices.
Here ANZ attempts to identify the major drivers of commercial property prices over recent years and develops some basic valuation tools to assess whether or not markets have gone ‘too far’ and to determine how significant is the risk of a commercial property market correction.
After significantly underperforming through the 1990s, commercial property prices have rebounded strongly in recent years, buoyed by renewed investor enthusiasm, particularly in retail and office markets. Up until recently rental growth has remained relatively subdued, consequently investment yields have firmed.
The renewed upturn in capital values has been driven by a number of factors including:
- strong underlying economic conditions & outlook;
- tightened property market fundamentals;
- a structural fall in the risk-free interest rate
- decreased ‘risk aversion’ across all asset markets which has seen a generalised compression of yields; and
- the ‘weight of money’ flowing into commercial property.
Many of these factors are interrelated and it is impossible to disentangle individual influences. However, importantly, in the near-term we expect each of these influences will remain supportive.
While recent price growth has been impressive, it needs to be placed in a historical context. It is worth highlighting that the recent improvement in capital values follows a period of significant underperformance, particularly in office and industrial markets.
Capital values for office and industrial property have never fully recovered from the late 1980s/early 1990s ‘boom/bust’. Even after their recent spurt, real average office prices are 37% below 1984 levels, while average industrial prices are 29% lower.
In contrast, over the same period real retail property values are up 33% while real house prices have jumped by a massive 128%.
In light of these figures it is initially difficult to understand the recent concerns regarding excess price growth in these sectors.
However, unlike the residential market, commercial property values are almost wholly dependent upon rents and the fact is that both office and industrial rent growth have been remarkably subdued. Since 1985 real office rents have fallen by 41% and real industrial rents are down 37%.We therefore need to use commercial property yields (and capitalisation rates) to assess ‘fair’ value rather than property prices per se.
By Paul Braddick, Ange Montalti and Jasmine Robinson, ANZ Banking Group.*
