Record low yields drive offshore focus to other Australian cities

Foreign investors represented the lowest proportion of all purchasers since the beginning of the property boom in 2013, as a result of fewer Prime Grade, 100% holding assets available for sale. Instead, investment activity in Melbourne and Brisbane office markets showed greater activity from foreign investors.

There is now a notable spread between Brisbane CBD and Sydney CBD yields with Sydney CBD’s standout performance at a tenancy level driving yield compression well below other capitals.

In 2017, foreign purchasers made up just 35 percent of total buyers compared to 43 percent in 2016 and 53 percent in 2015. Interestingly, all foreign buyers in 2017 originated from Asian countries.

According to the latest data from Savills Australia’s ‘Sydney CBD Briefing Notes’ report, a rebound in activity from local institutional investors helped to keep total sales volumes near record high levels, with more partial share offerings in landmark Sydney assets transactions (such as The MLC Centre which sold a 50% stake to DEXUS for circa $722 million mid last year).

According to Shrabastee Mallik, Senior Analyst – Capital Strategy at Savills Australia, aggressive competition for limited assets drove yields to record lows with multiple sales transacting at yields below 4.00 percent.

“The vacancy rate in the Sydney CBD office market, at 4.6%, was the equal lowest (with Melbourne CBD) among the national capitals, which has driven exceptional performance in both capital values and rental growth, with the vacancy rate in the CBD’s Core precinct recorded at 3.9%.

“While the most globally-recognised city in Australia, Sydney CBD’s investment performance differs from every other market in the country due to a single factor; its landlocked nature and lack of greenfield development sites”.

Ms Mallik went on to say that the typical requirement for material stock withdrawals to facilitate any type of development (be they commercial, residential, hotel or infrastructure) is apparent with total stock levels rising by just 7.0% over the past decade – a figure less than one third of the national CBD average.

“With owners of Prime quality buildings more likely to hold onto their assets for income return purposes, intense competition for Secondary grade assets led to capital values growing by 47.4 percent over 2017, unlike a level of growth unrivalled anywhere globally. Prime grade capital values grew by 17.9 percent over the year to December 2017.

Signs of the strengthening economy are evident with employment growth at its highest levels since 2008, with a resurgence in full-time employment growth and steady growth in professional job advertisements likely to keep demand for office space buoyant in 2018.

“With development activity likely to remain muted over the next 12 months, Sydney CBD’s office market looks likely to maintain its market ‘darling’ status over the coming year, at least,” she said.

In any other market, the exceptional rental performance Sydney has seen would likely drive a period of oversupply, the landlocked nature of Sydney means that major project completions in 2019 are more likely to absorb pent-up demand.

This will help to stabilise growth rates in Sydney CBD and enable continued expansion if tenants.

Savills Research anticipates continued rental growth as tight leasing market conditions drive benchmarks further through to 2019/20. While significant supply will enter the market at this stage, whether it is adequate to satisfy tenancy demand for a city where the sector-weighted five year employment forecast is well above 1 percent per year, and how much potential upward movement in bond rates IRR expectations can tolerate are the primary questions for investors moving forward.