The Valuers' View - Industrial Property
The Valuers’ View
To assist lenders, investors and owners, the Valuers at m3property have contributed their opinions on the current performance of the property markets and where they expect those markets to head over the short to medium-term.
The survey examines nine property sectors, looking at the key measures of market yields, internal rates of return (IRRs), rents incentives and value. Occupancy rates and average daily room rates were added to the survey for the hotel sector. Indicators including zeros indicate stability was also selected by respondents.
The key themes that will drive the real estate markets in 2021 will be:
Economic recovery as restrictions ease and confidence returns
Low population growth, but likely to rise as the vaccine rollout continues and borders re-open
Record low interest rates
Continued focus on Environmental, Social and Governance (ESG) factors when investing and managing portfolios
Growth in inflation resulting in rent growth for landlords, where rent increases are linked to inflation
The gap between prime and secondary yields is likely to widen
Government spending to remain high, despite stimulus starting to reduce
‘Flight to quality’, flexible terms and convenience expected to continue to drive tenant demand
Rebound in investor demand due to cashed-up investors, low cost of debt and global interest in strengthening countries with stable property returns
Continued investor focus on defensive assets, particularly in sectors with government backing and for properties with long WALEs and minimal need for capital expenditure
Despite strengthening residential markets, the official cash rate is likely to remain on hold in the short to medium-term due to continuing economic uncertainty, low wages growth and labour markets not being at full capacity. The appearance of an asset price bubble is more likely to be remedied with macro-prudential constraints on lending rather than rising interest rates, which could derail the economic recovery if used too early.
If the post-COVID-19 economic recovery does surprise on the upside resulting in asset price bubbles, full employment and rising wages, this would drive up inflation, bond yields and the cash rate. This scenario would represent a risk to the property markets as it could flow through to the cost of capital and yields. That said, the RBA is likely to continue to implement yield curve control to keep bond yields in line with the economic recovery and a strengthening economy would provide stronger cash flows and vacancy would reduce.
Continued growth in e-commerce is likely to fuel further demand from logistics companies.
Manufacturing is likely to revert to more normalised levels as supply chains recover. Manufacturers who have embraced automation of processes and technology to streamline production and distribution are likely to outperform due to lower ongoing costs.
- COVID-19 has not prevented capital from moving into the industrial market, with prime property enjoying continued yield compression. The premium between prime and secondary property has expanded as investors have shown some caution when dealing with older assets with inferior WALEs and tenant profiles.
- With the low cost of debt and high levels of capital chasing acquisitions, the expectation is for a further 25 basis point firming of yields into 2021. Investors seem to have transacted up the risk curve in late 2020 with expectations that this will continue into 2021.
- Prime grade tenants have generally weathered COVID-19 conditions, and shortages of industrial land, particularly in Melbourne and Sydney, have contained downward pressure on prime rentals.
- Income growth projections have tapered since the onset of COVID-19, and incentive levels appear to have increased, with the effect being that total return projections have firmed by up to 50 basis points.
Rents and Incentives
- A shortage of available prime property has outweighed the impact of COVID-19 in regards to prime rentals in some areas.
- Secondary rents have stabilised
- Investors appear to be focussed on tenant retention and, therefore, are more willing to grant slightly higher incentives than were being offered pre-COVID-19. It is expected that incentive levels may increase further in 2021 as investors focus on total capital value and have the ability to finance higher incentives through slightly stronger capitalisation rates and the low cost of funds.
- Sales evidence indicated that industrial values have increased since the onset of COVID-19 in many areas. With the low cost of debt and high levels of investor interest, there is the expectation of further value gains in the 2021 calendar year.
- Value expectations moving into 2022 are largely dependent on the cost of debt/interest rates. We note that long-term bond rates have risen recently and we will closely monitor this and the potential impact on the weighted cost of capital.