Prognosis For Commercial & Industrial

Hi Michael,

My research and also being in the market tells me the following; 
 

With the economy slowing the demand for commercial and industrial space is easing. Many companies are putting expansion plans on hold and staying where they area. A lot of completed speculative development is therefore sitting around empty causing an increase in vacancies.  Vendors are looking for tenant pre-commitment at present before commencing development.

Lease rates will likely stay level to moderately increase over the next couple of years unlike the big increases of the last few years. Cap rates are rising however; sales volumes are thin so in many cases there is little real sales evidence to support any major softening.

There is more discounting at $2m+ as the larger property funds are deleveraging are need to rebalance their portfolios.

Sydney commercial – Most  research reports will tell you that cap rates are 7 – 8% however, having a couple of deals on the go at the moment ourselves at 8%+, I dare say that the sales evidence will shortly support 8%+ as where yields are.

Sydney Industrial – Research papers are reporting 7.5% – 8.5%, we just contracted on a prime industrial, international tenant, 7 years to go out of 10 years on the lease at 9.4% net return, so again cap rates are moving.

The same for Brisbane Industrial, over the 9% mark now. Brisbane office is still on the watchlist as it has been too hot recently to touch however should come back a bit now.

Finding the deals isn’t easy though; some of them are off market as these vendors do not want the spotlight on them or what they are selling.

Good to time to buy well in these sectors for well capiltalised investors with low gearing. I suggest good solid tenants, long leases and prime locations as the way to go.

G’day Michael,

There are certainly some areas with a lot of unsold and unleased stock. This applies to various areas of Sydney and Brisbane; I am not as familiar with Melbourne.

I would certainly not be buying a commercial property at the moment unless it came with a long lease (5 – 10 years), has a 6 month bank guarantee (bond) in place and I can find out enough information about the tenant, their business and stability to feel confident that they are traveling ok. The 5 to 10 years depends on the specific areas current or looming supply situation and what kind of market reviews and lease terms apply. For example; a seven year lease to a national tenant, with 3 – 5% fixed annual increases and a ratchet clause (rent cannot decrease) may be sufficient to ride out the current bumps in the economy.

Unsold and unleased stock in any area will put downward pressure on capital values and rents. As with an oversupply in residential, the more motivated owners reduce their sales prices and rents to facilitate a transaction rather than keep the property on their books vacant or unsold.

In many areas there is an oversupply of smaller strata industrial units or sheds. I see this as quite risky at the moment as these will be harder to sell or lease. (I.e. < 400 – 500sqm)

Sydney industrial sector has approx: 5 – 6 regions. The outer west region (Erskine park  and surrounds) has the most industrial land available to be developed however, most developers at the moment want tenant pre-commitment before they start building and certainly their banks demand this, even for established developers with a sound track record. (So minimal spec developments going forward). There is more of a glut of older stock for sale and lease in the central west (Smithfield and surrounds), I would be very careful around there.

I agree that the commercial cycle has traditionally followed the residential property cycle; a buoyant commercial property market relies on a buoyant economy. If there is a lot of a residential construction going on, then in turn, manufacturing, warehouse and distribution companies expand and need more space. Also new residential construction causes a demand for shops, places to work and other infrastructure etc.

Catch 22 at the moment, you want to buy when things are low however, you do not want to buy a commercial property only to have it vacant for a year or so if the tenant goes bust. Also you do not want your rent to go down at the next market review as may happen if there is a glut of properties around and rental rates have been forced down.

Whilst we may not move into an upward cycle for a couple of years, the financial crisis is causing some vendors to sell at very low prices. This coupled with there being few willing buyers in the market at the moment is presenting some good opportunities.

Generally with commercial interest rates at around 6% and net yields at around 9% (more for some and less for others) there is good scope to buy commercial property and achieve a very good positive cash flow.

There are many factors and scenarios to consider on a case by case basis.

Happy for you to contact / call me directly if you want to run a few specific scenarios past me.