The rebalancing act

The rebalancing act

Total Property - Issue 3 2018

The unlisted commercial property market has enjoyed incredibly strong returns over the last eight years due to investor demand for attractive yields.

The hunt for value within the commercial property market came in response to falling interest rates and bond yields post-GFC, which in turn has pushed up property values and pushed down property yields to record lows.

But the numbers all point to change within the market. Offshore bond rates are starting to tick upwards and the cost of servicing debt is going to increase as central banks, keen to exit the era of easy money, push up interest rates.

New supply of office stock is set come on stream in the next 18 months, which will impact vacancy rates and rental growth. So, with yields unlikely to drop much lower, the question is: Where can investors find value?

Anecdotal evidence suggests that market players who are either highly geared or over-weighted in one asset class are already starting to talk to the banks and brokers about rebalancing their portfolios.

Active investors who are even a little bit stretched might want to crystalize their gains now, before getting back into the market at a different part of the cycle.

But who will be, or should be, looking to acquire commercial property in the current market?

Baby boomers with high levels of equity and who are new to the commercial property market are the buyer group with the most to gain.

That generation of Kiwis faces the challenge of how best to manage capital preservation and regular income streams in retirement. They just can’t see themselves eking out an existence over their next 20-25 years of retirement on, after tax, real returns of between one and three percent.

Commercial property – even with yields at present levels – represents good value for those who want to a defensive tilt to their investment portfolio, because for them it’s a long-term play that’s not dependent on where the cycle is in the next three years. They can see through that, particularly with long-term leases of seven years or more.

And the total returns on commercial property compare favourably to the returns offered by shares or term deposits, commercial property offers a strong premium Even the returns on residential property are shrinking as the market is subject to stricter regulations and increased maintenance costs.

In the current market, there is a short window of opportunity for both buyers and sellers. For sellers that window represents their best chance to recalibrate their portfolios before the market tops out. For buyers with long investment horizons, the current market represents their best chance to acquire a defensive income stream for their retirement.

That’s the corollary of it. Those who want in to acquire lower-risk assets will find their match in sellers who need to rebalance their books by selling the assets that are now more passive in nature.

The figures all emphasise the need for those groups to act now – inertia is their enemy. For active investors it’s about recycling their capital and leveraging their professional management expertise. They should have the courage to sell now, because of the buyer pools out there that are interested in their product because of the stable returns and, in many cases, the strength of the lease covenant.

The environment is positive right now, but it may not be in 12 months’ time.

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