How much has yield compression driven this cycle?

Tags: MSCI, Non-Residential, Yield

Australia’s commercial real estate markets have been enjoying strong asset value growth over recent years, helped by the low interest rate environment and increasing cross border flows. On average, commercial real estate values increased 40% over the last five years according to the Property Council of Australia/MSCI Australia Annual Property Index. However, it is important to note that most of this asset value growth has come from yield compression, with firming valuer cap rates accounting for almost three quarters of the growth in asset values over the five-year period meaning that income growth has played a much smaller role in driving asset value growth than in past cycles.

2019 May 02 - MSCI - Yield compression cycle December 2018

The amount of asset value growth that has been achieved and how much of it has come from firming valuer cap rates varies depending on property type. For example, industrial warehouse values have increased 63% over the last five years with over three fifths of that increase being driven by cap rate compression. By contrast, regional retail centres have seen asset values rise 25% with almost three quarters of that growth coming from cap rate compression.

“It seems just a few months ago it was hard to fathom cap rates firming further. And yet structural forces, political tensions, global uncertainty and weaker inflation expectations has resulted in yields on nominal 10 year treasuries in advanced economies dipping lower of late. However, in times of growing caution around the macro environment, it’s imperative to not be too bullish on the ‘wall of capital’ as it can dissipate, sometimes quickly.” Head of Research at Mirvac, Alexandra Gray said.

The end of cap rate firming has long been predicted but the Property Council of Australia/MSCI Australia Annual Property Index showed that firming has continued with the weighted average valuer cap rate falling to 5.3% at the end of 2018.

“Whether we have seen the end of cap rate compression or not, belies the fact that quality income streams and management skill has become central to sustaining asset value growth. In this next phase certain considerations become key for outperformance including how managers position their operating models and portfolios to remain relevant to both capital and tenants.” Ms Gray concluded.

Written by Bryan Reid, MSCI

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