Despite the rapid growth in commercial property over the past month – some markets have gained more than 20 per cent – there is still a long way to go in terms of capital growth.
Here’s why.
Flight towards cash flow
In this current market, we are seeing many traditional residential investors move towards commercial in the search for better yields.
This is a capital growth driver because it’s increasing the demand for commercial assets as a ratio over the current low supply.
Driving this is the fact that residential yields are at record low levels and lending is getting increasingly more difficult – especially as APRA jumps back into the spotlight.
Prudent investors will be taking the flight towards higher yields to grow their wealth faster. As more non-traditional commercial investors start playing in this space, you should expect to see the extra demand create more competition over quality tenanted investments. This will inevitably push up prices for commercial assets.
Increasing rents
This cash flow is a driver of the asset class’s capital growth. As rents increase, so does the capital value of a commercial property.
As we exit long-term lockdowns in many parts of the country, business activity is expected to strengthen. This will put upward pressure on rents in general.
There is also the potential for higher inflation over the coming years. Since many leases are attached to inflationary-based rental increases (CPI increases), this should mean the rents grow at a faster rate than they have over the previous 10 years.
Yield compression
We’re still seeing net yields of at least 7 per cent, with interest rates under 3 per cent. That’s a 4 per cent gap.
Historically we expect to see a gap of 2 per cent. This means, right now, there’s the opportunity of a lifetime to get the best cash-flow returns you’ll ever see out of commercial property.
This, in turn, should result in strong capital growth as the gap between these two metrics narrows.
Post-COVID boom
Signs of economic life are on the up as we come out of lockdown.
With Australian households and businesses saving more than $200 billion during COVID-19, many people are cashed up and ready to spend big for Christmas, revel in their first post lockdown summer, and enjoy long-awaited travel. If the UK or the US are anything to go by, we are definitely set for a V-shaped recovery, and a boom not dissimilar to that of the roaring ’20s.
As business confidence reaches newfound highs, one would expect to see the demand for commercial properties also increase. This will flow through in the form of extra investor demand.
Still not mainstream
Commercial property has long been a well-kept secret among sophisticated investors, and although that’s starting to change, we are still in the early stages of the market.
If you can engage an experienced buyer’s agent and capitalise in this market before it fully takes off, you’ll secure an incredibly lucrative investment for yourself, one that will continue to pay dividends as the years go on.
Looking forward to 2022
Industrial
We have seen unprecedented strength in the industrial asset class over the past 18 months.
There are record low vacancies off the back of the booming e-commerce market.
As COVID has forced more businesses online, this has put stress on logistics, storage and local manufacturing – all good things for industrial warehouses.
Retail
The retail sector has been weaker since the pandemic hit.
However, some essential-services businesses have seen their strongest financial results of all time. For example, supermarkets and fast food.
As the economy opens back up, foot traffic should return for the shopfront sales model, so expect to see a bounce-back for retail in 2022.
Office
Office markets, particularly CBD offices, have had the toughest two years out of any sector.
However, despite the leasing risks, we have seen sqm rates for building sales continually climb.
This is due to cheap interest rates and strong demand from investors playing the long-term game.
As people return to the office, you will see the leasing risks stabilise and this should give the market another boost.
Changing landscape
Keep in mind, however, there are some business models that will change forever due to COVID and the associated government restrictions.
It’s important to understand the type of business you are investing in and if in doubt, seek professional advice.
Scott and Mina O’Neill are co-authors of best-selling commercial book Rethink Property Investing (Wiley $29.95).
They are also the founders of Rethink Investing.
