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Conundrums in the property market

JLL Australia's Head of Research discusses a range of issues affecting the property market right now



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At the Property Council New Zealand's National Conference in Queenstown this week, Dr David Rees, head of research for JLL Australia, presented the various conundrums confronting participants in the property market. These ranged from interest rates and yields at all-time low levels to cross-border investment flows, and the impact of technology and demography.


Yields – lower for longer?

"Globally, and domestically, the low growth, low inflation, low interest rate economy seems to be here to stay. But we can't blame the GFC. The decline in global interest rates is a 30-year trend," Rees says.

Therefore, he says, delaying any decisions pending a future return to "normal" conditions is not a viable strategy.

"Implicit in JLL Research forecasts is a downward structural shift in interest rates and real estate yields – in other words, the 'lower for longer' theory is broadly correct.

"This does not mean that cycles have been abolished. But average yields are likely to be lower than in the past. This conundrum of investment yields at record lows despite relatively subdued market fundamentals is an issue facing many global commercial real estate markets," Rees says.  

"In New Zealand, interest rates have stayed low in recent years," JLL New Zealand research consultant Adam Vodanovich says. "Ever since spiking to 6 percent in 2009 (up from 4.9 percent at the end of 2008), 10-year government bonds have mostly headed downwards. In 2016, the 10-year government bond rates have averaged 2.74 percent. This is down on the one-year average of 3.4 percent in 2015, 4.1 percent in 2014 and 4.8 percent in the five years prior. The average for 10-year government bond rates since 2000 has been 6.2 percent.

"A key indicator in the property market is the spread between cap rates on commercial property and interest rates on 10-year government bonds. This represents the 'risk premium' evident between the risk-free rate and market pricing for assets. Typically, in parts of the property cycle with strong momentum, the spread between cap rates and interest rates tends to be zero or slightly negative. But this time things are different. New Zealand is experiencing momentum-driven re-pricing of commercial property, at levels higher than we've seen historically. The yield spread presents very differently from what would be normal in this part of the cycle," Vodanovich says.

Cross-border investment

"Globally, property is a popular investment choice right now. But will the current inflow of offshore investment reverse, or are foreign investors here to stay? Supported by growth in global pools of capital and a search for yield, JLL believes that global cross border investment will continue to grow over the medium term," Rees says.

"The three key drivers of cross-border real estate investment flows are risk reduction through portfolio diversification; a mismatch between growing domestic pools of capital and the availability of investment grade assets; and the search for liquidity and market transparency.

"All three of these motives are particularly evident in the Asia-Pacific region where savings rates are high, availability of investment grade assets in many markets is low and many real estate markets are relatively opaque. You can see the appeal of the Australian and New Zealand markets to Asia-Pacific investors when you compare their transparency."

The JLL Transparency Index (2016) ranks Australia (2) and New Zealand (6) as the only Asia-Pacific markets in the Top 10 globally. Other major Asia-Pacific markets are Singapore (11), Hong Kong (15), Japan (19) and Malaysia (28).

Technology – finally making a difference?

"Technology has the potential to make a big impact across all real estate sectors affecting choice of location, how space is used and ultimately asset values, development activity and investment returns. But with technology, the speed of change is hard to predict, as is the direction and impact of the technology," Rees says.  

"New Zealand is positioning itself as a country that welcomes technology and innovation. This is evidenced in the number of tech hubs, co-working spaces and innovation precincts that have appeared in recent years – particularly in Auckland," Vodanovich says. "Property industry players need to find innovative ways to offer extremely flexible accommodation."

Demography and urbanisation

"When we talk about demography, we tend to focus on the ageing population. As the baby boomer generation hits retirement age, there are consequences for New Zealand's economy and the property market," Rees says.

New Zealand has an estimated 700,000 residents aged 65+ years (as at June 2016) or 15 percent of the total population.

"Statistics NZ estimates, under medium scenario conditions, that by 2046 this will have risen to 1,340,000 residents or 24 percent of the total population," JLL New Zealand's demographer Angela Webster says.

​"Many of them will continue working, long past what we think of as 'normal' retirement age. At the same time those baby boomers who do have the necessary wealth to retire will need to unlock their assets," Webster says.

"Across the Asia-Pacific region JLL sees a broad correlation between median population age, market size and office market rents. Rents are higher where office markets are larger and where populations are older," Rees says. "This probably arises because older populations have a greater demand for financial services and greater wealth to invest.

"The message is that as a country's demography changes, so do its property needs. The relative ranking of office, retail and industrial markets is destined to change significantly in the future," Rees says.