Strong commercial property market softens

Strong commercial property market softensAustralia’s strong property investment market shows signs of moderating and capitalisation rates continue to firm, finds the latest Property Council / IPD Australia All Property Index.The Index, which records direct investment in property, tracks more than 1,400 commercial assets valued at around $165 billion representing approximately 60 per cent of the institutional investment market. The average annual return on commercial property was 12.2 per cent for the September 2016 quarter, compared with the long-term average of 10 per cent, and the market peak of 13.7 per cent in March this year.Dr Anthony De Francesco, executive director of MSCI says the market remains above the long-term average, but shows signs of being past its peak.”We are seeing the start of a moderating cycle that is likely to continue well into next year,” he says, adding that all sectors are now off their peak.Of the core sectors, annualised returns for the office sector have moderated over the quarter by 1.5 percentage points (to 13.4%), retail by 0.8 percentage points (to 10.5%) and industrial by 1.8 percentage points (to 11.9%). The hotel sector continues to outperform the core markets with returns of 17.2 per cent, although this has dropped 0.2 per cent from the last quarter.De Francesco notes that a key driver of capital return has been the firming of capitalisation rates, which he says continues, “although signs are emerging of cap rates starting to stabilise and even soften across some sub-sector markets”.”We’ve seen steep cap rate compression over the last few years which has delivered very firm cap rates across all property sectors. In fact, pricing within the property market is now far more aggressive than at the peak of the market before the Global Financial Crisis hit,” he adds.In the days leading up to the GFC, the overall cap rate for commercial property stood above 6.3 per cent, De Franceso says, compared with the current six per cent.”A key risk factor for the property sector is the prospect of a narrowing cap rate spread to the bond rate, which could occur if we see tightening interest rate cycle in the near term. “Another risk factor is the generally soft space market fundamentals which have not translated into strong net operating income growth,” De Francesco concludes.Download the Property Council / IPD Australia All Property Index snapshot.