This article is from the Australian Property Journal archive
INDUSTRIAL yields will begin softening by the end of 2022 and rise by 40 to 50 basis points over the next two years, according to BIS Oxford Economics, with the narrowing yield spread bond rates already unsettling some investors.
However, the one saving grace for industrial property capital values is expected to come in the form of stronger rental growth, driven by low vacancy rates.
“It looks like industrial property’s golden run will lose steam. Investors need to be aware that there is a risk that yield softening is not too far off,” said Lee Walker, principal property economist at BIS Oxford Economics in the Sydney and Melbourne Industrial Property Prospects 2022-2032 reports.
“Overall, industrial properties are unlikely to perform as strongly over the medium term as they have done in recent years. We calculate prospective IRRs closer to 6% per annum over the next five years for Sydney and Melbourne prime industrial property, which is still reasonable, but well below the 11% or 12% per annum of the last two years.”
Ten-year bond rates have been rising in Australia over the last 18 months and are unlikely to return to the lows seen in recent years, increasing the risk that industrial property yields will soon soften. Yield firming in the Sydney and Melbourne prime industrial property markets underpinned average capital value growth of 26% to 32% per annum respectively over the last two years.
“This was propelled by the weight of funds pouring into industrial property, which made industrial property the star performer,” Walker said.
Over the last two years, average prime yields in Sydney’s outer west and Melbourne’s south east fell by 140 to 150 basis points, reaching 3.6% and 3.9% respectively. During that time, 10 year bond rates fell below 1.0%, increasing the yield spread and attractiveness of industrial property to investors. However, in the past 18 months 10 year bond rates have risen to over 3.0%, influenced by rises in the US, and the yield spread to industrial property has narrowed dramatically.
“BIS Oxford Economics anticipates bond rates will stay above 3.0% for at least the next two years, before settling well above levels reached in previous years. Facing a prolonged period of higher long-term interest rates, the pressure will be on industrial property yields to rise. Indeed, it is likely that the narrow yield spread is already unsettling some investors,” Walker said.
The firm expects industrial yields to begin softening by the end of this year, with a forecast 40 to 50 basis point softening over the next two years.
However, a positive for capital values is the likelihood of stronger rental growth, largely driven by low vacancy rates. Prime net stated rents are forecast to rise by circa 30% in Sydney’s outer west and Melbourne’s south east over the next two years, working to offset the phase of yield softening, Walker said.
According to Knight Frank, the volume of vacant space in Sydney declined by 20% in the March quarter, for a 75% year-on-year drop, while Melbourne has seen a 19% quarterly decline in vacanct space and 45% annually.
