With residential property markets showing signs of improving as low interest rates and improved consumer sentiment start to kick in, what do the experts think about the outlook for commercial property and where should investors be looking for returns now?

Jason Huljich, CEO of Direct Property Funds at Centuria Property Funds, which manages over $1.1 billion in property through 28 unlisted funds, says that there are still good opportunities to be found in many of the major commercial markets. You just need to know how to identify them.

Ever since the onset of the GFC there has been general weakness in many of the major commercial office markets.  A lack of local buyers, combined with weaker offshore demand due to the high Australian dollar, kept prices subdued and presented good buying opportunities for astute investors. In addition, many A-REITS, normally active buyers, were trading at discounts to their net tangible asset backing (NTA) and as a result focused on share buy-backs rather than purchases of hard assets as the more efficient use of their capital.

As we move into 2013, a number of these factors have started to reverse. Offshore buyers have returned to the market, A-REITS are moving back into acquisition mode and other institutional and wholesale investors are again looking at property and driving demand for quality assets. 

Despite the pick-up in activity, our view at Centuria is that there are still good purchasing opportunities in major markets. Most of the offshore and institutional demand is focused on “core” or “premium” assets which consist of the larger modern office towers in the major CBDs. However, Centuria believes there is value in secondary commercial assets. These are generally assets in the $50 - $100 million range. Most A-REITs and Superannuation Funds target properties above $100 million, and private investors rarely look at stock over $50 million, leaving a gap in the market. Yields for secondary assets are at higher than historical levels and are likely to revert to mean levels over the medium term.

On the leasing front, different markets have seen quite different results. Both Brisbane and Melbourne were strong leading into 2012, but have slowed since mid-late 2012. Vacancy rates in both centres have gone up markedly, with Brisbane moving from 8 per cent at the end of July 2012 to 9.1 per cent at the end of January 2013 and Melbourne moving from 5.6 per cent to 6.9 per cent over the same period. The Brisbane slowdown was caused by new supply coming into the market and the easing of the mining and energy sectors, as circa 25 per cent of Brisbane’s office space is leased to companies associated with these sectors (this compares to circa 50 per cent in the Perth market and 10 per cent in Sydney). Melbourne on the other hand has had a very strong run for the last 5-6 years and its slowdown had been caused by a slowdown in the state economy and a lack of investment by the state government. Some new supply has also not helped.

By contrast, Sydney is holding up well. Vacancy rates have reduced by nearly 1 per cent between the end of July last year and the end of January this year and now sit at 7.2 per cent. We anticipate this trend to continue, as supply remains constrained. There has been some speculation about the effect of Barangaroo when it comes online between 2015-2020, but given that it represents only 300,000 sqm of new space in a total of over 4.86 million sqm of existing space, we don’t expect the effect to be dramatic. This contrasts with Melbourne, when you consider that the Docklands development equates to almost 1 million sqm of space in a market that has totals only 4.22 million sqm.

At Centuria, we continue to favour the Sydney CBD market for a number of reasons. Rents and property prices have only just started to improve from their low levels, but they are still very much at the bottom of the cycle. Looking forward, strong demand combined with constrained supply will continue to put pressure on vacancy rates and it is essentially this tighter leasing market that we anticipate will drive growth in prices and value over the medium term. In addition, even though business confidence remains weak, we do expect NSW to record higher growth over the next few years, in part driven by increased investment.

However, even though Sydney is our pick, Melbourne and Brisbane, which are experiencing short term challenges, also continue of offer good buying, but only where we can see potential outperformance. Our focus is on what we characterise as ‘core plus’ opportunities, where we can add value through our hands on expertise, including leasing and refurbishment programs as well as active management of the tenant mix and profile.

Ultimately, while some markets are definitely better performers than others, market conditions in general favour unlisted property at the moment. Yields are high by historical standards and there has been a marked increase in the quality of the property purchased by managers of unlisted funds.  Of the major commercial markets, Sydney looks the most positive overall, but a careful assessment of all opportunities shows that the right property in some of the other commercial office markets can still provide strong yields and the potential for excellent capital growth.