Bayleys Christchurch commercial and industrial salesperson Greg Mann looks at interesting anomalies in the city’s industrial property scene.
There are two contrasting trends currently occurring in the industrial market:
There are a large and growing number of vacant industrial properties in the 200m2 – 750m2 size range (258 listings on primecommercial.co.nz for vacant or soon to be vacant properties).
Record low yields are being paid for industrial properties - as there are more buyers than sellers in the market.
High vacancy levels and low yields are traditionally contradictory paradigms. Supply is clearly outstripping demand and there are new listings every day.
So it’s no surprise to see rental returns are already softening. Current supply surpluses are primarily a product of spec’ building and a preference by tenants for newer properties.
A quick look across listings on the website primecommercial.co.nz shows that approximately 80 percent are pre-quake age buildings. Areas such as Wigram and Sockburn have seen a lot of ‘new-builds’ and a corresponding occupancy uptake.
The question here is whether the huge vacancy rate in older buildings is solely due to the development activity, or is there an underlying economic driver coming into play?
There have been forecasts for the Christchurch unemployment rate to rise towards the national average of 5 percent as the earthquake rebuild starts to taper off and the economy returns to its normal reliance on manufacturing, agriculture and tourism.
Business confidence was showing some gradual weakening earlier this year, but there are more positive signs heading towards 2017 - so it’s hard to find any great underlying weakness in the economy.
We’re left thinking that most of the vacancy in Christchurch is due to new building activity over the last two or three years and the drive for tenants to be accommodated in newer premises.
Sales yields heading down
As happens frequently, commercial property valuers are behind the market valuation levels by approximately three to six months - as they assess historical transactions upon which to base their current conclusions.
I have sold three properties recently - and all have sold at lower yields (higher sales prices) than the valuations contrived for all three of those properties.
Owner/operators have been aggressive in their search for vacant properties to buy. Concurrent with this, supply of newer stock is very low.
So there are a large number of vacant older properties but, interestingly, few owners willing to sell. Why? - because owners of that older stock have enjoyed strong rental growth since the earthquakes, in conjunction with historically low borrowing costs. The result? Returns have been excellent and possibly their coffers are full… for now.
Many commercial and industrial property owners are reluctant to sell as there simply isn’t a better use for the money and they are not yet under any financial pressure – even with vacant premises.
We constantly hear the response “what would I do with the money if sell up?” As salespeople, we’re lost for a good response, and legally we can’t advise on alternative financial investment opportunities such as shares, stocks, bonds or currency trading.
Further to this, the Reserve Bank is indicating another drop of 25 basis points in August and likely another before the end of the year. So the downwards yield trend for commercial property transactions will continue unless the economy softens in the interim.
Remember, yields are more directly affected by the state of the economy (that is tenancy vacancy levels) than they are interest rates. Typically, when the economy moves negatively and vacancies increase, then interest rates are reduced to promote growth.
So why are owner/operators so aggressive in the buying market at present? Quite simply – it is now cheaper to make mortgage repayments than it is to pay rent.
Here is some math I did for one of those properties I sold... The 2,000m2 warehouse rental at valuation was $249,000 per annum. At 100 percent funding on the purchase price of $3.1million (a top-end calculation as most lenders will require 40 percent equity and interest costs are reduced) the interest cost at 5.25 percent (conservative as we have seen rates lower than this in recent months) was $162,750 per annum.
So this property was $86,250 per annum cheaper to own that it was to rent.
Strong tenants have realised “why would I rent a building if I can buy one and save money at the same time?” So yields are low because there is a very good financial argument for owner/occupiers to hold onto their investment properties, and an equally good argument for tenants to buy their own property. The result? Investors are increasingly being out bid by owner/operator tenants.