Competition for industrial investment options drives yields to record low.

Competition for industrial investment options drives yields to record low.

Competition for industrial investment options drives yields to record low.

The combination of a low interest rate environment, which has increased investor demand for property assets and competition from owner occupiers has resulted in yields tightening to historic lows across the Auckland Industrial property sector.

The latest figures from Bayleys Research’s industrial yield index shows the median yield recorded during the September quarter to have fallen to 4.9% the lowest recorded since the inception of the index in 1998. It should be noted that a vast majority of the sales recorded occurred at below $2,500,000, the sector of the market facing the most intense buyer competition. Institutional grade sales would no doubt reflect a higher yield given their higher price tag.

The latest figures reflect the current strong market conditions which are driving the industrial market. Vacancy rates are sitting at historically low levels. Earlier this year Bayleys Research found the vacancy rate across all major industrial precincts to have fallen to 3% as demand for space ramped up, driven by Auckland’s rapidly expanding economy.

The super tight market conditions have led to upward pressure on rentals which, as a result has made industrial property an even more attractive investment option.

It is however the low interest rate environment, which has been in place since the Global Financial Crisis which has brought about the yield compression which has been apparent over recent years. With central banks across the western world lowering official cash rates, to record low, and in some cases to negative, levels investors have turned to other investment options in search of higher returns. Property has, in this environment, been one of the favoured options and has therefore attracted high levels of competition when assets have been presented to market. The consequence of the competition has been yield compression.

Despite the tightening of yields however, the gap between industrial property yields and the “risk free” alternative, 10 year government bonds, has remained fairly stable with yields having tracked the bond returns.

At the end of the September quarter the median Auckland Industrial yield of 4.9% stood 2.6% above the average rate of return generated by government bonds over the same period, this compared with a gap of 3% in September 2015 and 2.7% a year earlier.

Future outlook

It seems extremely likely that global interest rates are close to or at the cyclical low. There seems to be a growing consensus amongst central banks that any further reductions in rates, which could now only be incremental, are unlikely to have a positive impact on economies. The speed at which interest rates will rise, however, remains unknown. Attempts to push rates higher have, until now been unsustainable with increases in the OCR both in New Zealand and Australia in recent times being quickly reversed. Given this it appears likely that a cautious approach will be taken. The new wildcard however, has been the change of presidency in the United States. Donald Trump has indicated that he favours a policy of large scale public spending on infrastructure in order to stimulate the US economy. Economic commentators have pointed out that such policies are generally inflationary. The prospect of this shift in policy has already had an impact on global bond rates, with rates of return rising.

Should the recent trend of increasing bond rates continue then property yields will respond and we would anticipate therefore that the September quarter figure will mark the bottom of the yield cycle with yields softening over the short to medium term future.