Commercial property returns shine as bond yields fall and capital gains kick in; income returns stable

Returns on New Zealand commercial property rose slightly in the March 2013 quarter and reached 10.6% p.a., according to the latest research done for the NZ Property Council by research house IPD.

From a survey of 566 major properties in 29 property portfolios, the total capital value has now reached NZ$11.7 billion.

Returns in the survey include both "income returns" and "capital returns".

The "capital returns" are based on revaluations, and 83.4% of properties surveyed were revalued in the March 2013 quarter.

Income returns were pretty stable across the three sectors surveyed - retail, office, and industrial - at about 8.2% pa. (the Capitalisation Rate).

Capital returns were highest for retail properties, adding 4.2% to the income returns for a total annual result of 12.4% pa.

The lowest total return is for office properties, coming in at 9.5% pa with the capital growth component of 1.3% p.a.

For industrial properties, the capital growth was 1.8% for a total average nominal return of 10.0% according to the IPD data.

This March 2013 data is substantially better than for the same quarter a year ago, due almost entirely to the capital gains.

Low interest rates have embellished prices as investors chase yield pushing down what they will accept for yield and that has allowed prices to firm substantially.

They are at their 'best' level since March 2009.

With average net income returns now at 8.2%, that means on average commercial buildings are selling for 12.2 times their net income. As investor yield standards fall, the price multiple over income will rise, pushing the capital returns higher.

Despite this, benchmark bond yields have fallen faster than commercial property returns, and that indicates cap rates have room to fall further yet and push capital gains even higher. Commercial property has some catching up to do.

Yields are also higher in New Zealand than Australia - the 8.2% income return here compares with 7.4% in Australia, even though we have similar bond yields.

IPD said there was a marked difference in performance between the two countries. Fundamentals were weakening in Australia, led by a decline in retail, while industrial property remained strong, but fundamentals were strengthening in New Zealand, they said.