Why commercial yields may keep rising
Now that the Reserve Bank of New Zealand (RBNZ) has signalled that it won't increase the official cash rate (OCR) beyond its current setting of 5.5%, commercial investors are wondering: what will this mean for yields?
In a new report, multinational property group Colliers said that while some would assume that yields would peak in line with the OCR, they may continue to grow a little more in the short-term.
“This is a result of property valuations lagging the movement in interest rates due to sufficient numbers of sales taking place as well as reporting lags and therefore it takes time for the full extent of changes to crystalise,” according to Colliers.
“While, for many sectors, the risk premium between property yields and fixed interest rate alternatives sit at below longer-term norms, much of the adjustment has seemingly been made indicating that under current expectations of the peak in the OCR, peak yields are not far away.”
Yields have been ebbing and flowing
Colliers said there was a close relationship between interest rates, yields and prices, with financing costs affecting a property's rate of return and capital growth.
To illustrate the point, Colliers pointed to recent trends in the Auckland industrial market, which it said was a good case study given the high number of sales.
Between December 2019 and December 2021, average yields fell from 5.3% to 4.1%, as falling interest rates triggered a surge in property prices. But by March 2023, average yields had risen to 5.6%, as rising interest rates led to reduced buyer demand and falling prices.
“While yield movement varied across sectors and locations, the overall trend remained consistent. Data released by MSCI reveals the impact of this cycle on property values. Average annual capital gains for all commercial and industrial properties peaked at 14.5% in the year ending September 2021. However, over the year to March 2023, average capital values declined by 6.3%,” Colliers said.
How rents are performing
Colliers also noted that price movements can have a direct impact on rental rates.
“In this respect the industrial property sector has been the strongest performer, with an extended period of tight market conditions resulting in significant rental growth over the past two years. This growth has mitigated the impact of rising yields on property values,” Colliers said.
“Rental growth has also been apparent within the prime grade sub-sector of the office market, driven by increased demand for high-quality office spaces as employees have returned to workplaces in increasing numbers.
“Conversely, the secondary office sector faces further downward rental pressure as vacancy rates increase. The retail subsectors have displayed mixed fortunes, with strongly performing malls and large format centres experiencing mild rental increases. However, strip retail assets face challenges, as weaker demand has made it increasingly difficult for landlords to maintain rental levels.”
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