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AUCKLAND INDUSTRIAL FIRST HALF 2008

MAY 2008

YIELDS SOFTEN

Industrial yields in the Auckland region showed the first signs of softening in the final quarter of 2007 as the effects of the increasing cost of money and greater risk aversion began to tell.

At the end of 2007 the median industrial yield sat at 8%, according to the latest results of the Bayleys Research Industrial Yield Index, up from the 7.65% recorded a year earlier.

The latest result had been anticipated given that the cost of borrowing has increased significantly over the last year due to a combination of local and international influences. Recent turmoil on the international stock exchanges and credit markets has seen investors reassess the relationship between risk and return.

 

 

The graph above illustrates the changes to the risk premium which investors have been willing to accept in recent years. The risk premium is the difference between the return derived from a risk free investment, in this case 10 year Government stock and the median industrial yield. Prior to 2003 industrial yields were generally returning approximately four percent more than the risk free investment. In recent years however as yields have firmed the premium has fallen to slightly below 2%.

Greater risk aversion, however, as a consequence of the recent events affecting global financial markets is likely to result in investors seeking a return to greater risk premiums through obtaining higher initial yields from their property investments.

The Reserve Bank of New Zealand (RBNZ) remains concerned about inflationary pressure within the economy and in an attempt to hold the Consumer Price Index (CPI) within the target band of 1%-3% raised the Official Cash Rate (OCR) four times during the year from 7.25% to 8.25%.

 

 

In addition to the above, the global credit squeeze brought about by concerns over the American sub prime mortgage market has resulted in banks becoming far more risk averse and reviewing their lending criteria. The result has been reduced liquidity in the market and an increase in the cost of money.

The results of the above are illustrated in the attached graph which tracks the median Auckland Industrial yield against the cost of borrowing represented by the 90 day bill rate plus two percent. While a negative yield gap has existed since late 2004, the recent surge in lending costs had widened the gap. Investors are therefore beginning to look for a better return on their purchases through a higher yield.

 

 

With the cost of borrowing unlikely to decrease in the near future, Bayleys Research forecast a continued softening of the median yield of between 25 and 33 percentage points over the next six to 12 months. The increased median will, however, be driven predominantly by the secondary sector which will see a greater easing of yields. There is no evidence to suggest that yields for prime investment stock will move significantly, if at all. There remains a shortage of this quality of stock being brought to market while there are a number of cash rich purchasers.

The secondary market is, however, undergoing a change, with a greater number of properties being brought to market and a smaller number of purchasers resulting in property owners having to re-price their product in order to secure a sale. Therefore, while it is anticipated that the softening of yields will continue, this will largely be the result of a widening of the differential between returns on prime and secondary stock.