Industrial property's golden run to ‘lose steam' as debt costs riseWestern Sydney and Melbourne's south-east industrial precincts would lead the way on rental rises. Photo: iStock

Industrial property's golden run to ‘lose steam' as debt costs rise

The rising cost of debt will bring an end to the industrial property sales price boom, with sector investment returns set to soften sooner than anticipated due to surging bond yields, BIS Oxford Economics predicts.

Principal property economist Lee Walker said bond yields were well above 3 per cent and expected to stay elevated over the next two years, making finance more expensive.

However, Mr Walker said the shift to a higher interest environment would be partially offset by forecast rental rises of 30 per cent or more for key industrial precincts in Melbourne and Sydney.

“It looks like industrial property’s golden run will lose steam – investors need to be aware that yield softening is not too far off [and] industrial properties are unlikely to perform as well over the medium term as they have,” Mr Walker said

Since 2020, the value of prime industrial property in Sydney and Melbourne had grown by 52 per cent to 64 per cent, he said, forcing investment yields down by 140 to 150 basis points.

Average yields had potentially bottomed out at 3.6 per cent in Sydney’s outer west and 3.9 per cent in the south-east corridor of Melbourne.

“During that time, 10-year bond rates fell below 1.0 per cent, increasing the yield spread and attractiveness of industrial property to investors,” he said.

But the spread had since narrowed dramatically. “Facing a prolonged period of higher long-term interest rates, it is likely that the narrow yield spread is already unsettling some investors,” he said.

Low vacancy rates to remain

Mr Walker predicted industrial property yields could soften 40 to 50 basis points by the end of 2024.

“We calculate prospective internal rates of return closer to 6 per cent per annum over the next five years for Sydney and Melbourne prime industrial property,” he said.

“That’s still reasonable, but well below the 11 per cent or 12 per cent per annum of the last two years.”

Vacancy rates would stay exceptionally low, Mr Walker said, leading to strong annual rental growth in big Sydney and Melbourne industrial areas.

BIS Oxford Economics said that in Sydney, overall vacancy rates would stay at 0.4 per cent through to 2023, before increasing to 1.6 per cent the following year.

Melbourne vacancy rates would increase from 1.0 per cent this year to 2.2 per cent in 2024.

Western Sydney and Melbourne’s south-east industrial precincts would lead the way on rental rises with growth of up to 30 per cent or more over the next two years before levelling off.

“We think pandemic-triggered drivers of the market will remain prominent near term, before normalising as spending rebalances towards services, and supply chain pressures ease,” Mr Walker said.

“Then, rental growth is expected to slow for two to three years before another phase of growth, all influenced by the vacancy rate cycle and cost pressures coming from the pre-lease market.”

In conclusion, Mr Walker said: “We consider prime industrial property is fairly valued on both a five- and 10-year investment horizon.

“Future returns will be lower than in recent years, but still attractive in a historically low interest rate environment.”

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