Commercial property markets have all been under pressure over the last few years with cost of financing and performance impacting returns. In contrast the high price of construction and a mismatch in supply and demand has seen residential built form outperforming all other asset classes. For institutional investors, the lure of office assets as a trophy investment has disappeared. Occupancy issues hamper the sector and it's not due to a cyclical change but a structural shift by occupiers which will result in a drawn out recovery not seen ever before. Similarly retail has had a tough few years, with changing shopping habits impacting returns, both capital and income, deterring many investors.
The industrial sector and its limited supply and high demand, particularly as population grows, saw a swift uptick in capital values and average rental rates. High demand for institutional grade industrial assets resulted in significant tightening in investment yields from eight plus per cent 10 years ago to circa four per cent during 2022. The strong gains in rents over the last five years were instrumental in improving capital values and changing the investment perception of industrial as a prime asset class. While demand has not dissipated, and limited new supply is keeping occupancy elevated, investment yields have turned a corner in 2023 and 2024 rising inline with increased bond rates and re-rating of the risk profile of these assets. Despite capitalisation rates increasing, the demand and supply profile for industrial is anticipated to keep rates tight, particularly given limited industrial land availability and planning constraints during a time when population and consumption levels are tipped to increase.
Conversely, institutional residential stock has not been commonplace across Australian markets. Multi-family dwellings, build-to-rent and multi-generational homes are a large investment category, particularly in Europe and Asia, with long-term rentals a more acceptable housing structure. With the strong growth in median house prices across the country as well as sizable ongoing rental growth due to the lack of supply and increased population, institutional investors have turned to residential as a suitable, lower risk investment opportunity. While Australia has no track record regarding these assets, build to rent has grown in popularity over the past few years with land tax exemptions, improved planning and tax concessions for offshore investors/developers. Piquing interest of investors has been the long term stable returns of residential assets in Australia and robust capital value increases across the country.
Residential investment has been a long term favourite by mum and dad investors, while yielding below many other investment options, the long term capital uplift and wealth creation has been attractive. According to the 2021 census, more than 30 per cent of homes across the country are rented, and the private sector provides the bulk of this housing. This level is expected to grow strongly given the population gains and affordability concerns with buying a home putting even greater pressure on the residential rental market. The recent increases in rents and uptick in values saw unit capitalisation rates overtake industrial achieving 4.6 per cent in early 2023 when industrial yields averaged 4.2 per cent. Industrial yields since this time have increased due to a reduction in capital values, while residential yields have increased off the back of strong income gains during a time of robust capital growth, yet remaining within the long term band of between 3.6 per cent and 5.2 per cent seen during the last 20 years.
These long term, secure trends in income growth across the residential market, coupled with strong capital gains are now in full view of institutional investors. The significant reduction in industrial yields over the last five years does not allow for the risk premium associated with commercial investment, furthermore, the recent fluctuations in capital values highlights the unfeasibility of these low yields. Despite this, industrial assets do have similar fundamentals to residential - including constrained land, limited supply, and increasing demand - therefore the outlook for growth is greater than many other commercial alternatives. Institutional investors will continue to seek out strong returning industrial assets which factor in risk appropriately, however, demand will continue to turn a corner for a new era of residential property. making beds and sheds the most sought after assets for years to come across Australia.
