Sydney and Melbourne offices will be best-performing property investments over next five years: report

Commercial property – led by Sydney offices – will deliver the greatest profit prospects to investors over the next five years, according to a new report ranking Australia’s major markets.

The next best returns – a measure of capital gain and rental growth – will come from offices in Melbourne and Canberra. Brisbane factories are also a good bet, the report by research house BIS Oxford Economics found.

But not one residential market made the Top 10 of their 2018 Australian Property Outlook, which was released on Wednesday.

The long-term projections for Australian real estate investment are patchy following what BIS Oxford Economics’ head of property Frank Gelber described as five years where investors captured super-normal gains thanks to record low yields and extraordinary price growth driven by low interest rates.

Even in the strongest markets of Sydney and Melbourne office towers, annual returns are forecast to drop by almost a fifth between now and 2022.

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“Over coming years, a critical shift in the investment logic for Australian property is set to take place,” Dr Gelber said, as imminent interest rate rises soften yields and prices.

“The changed conditions mean the main driver of property prices and total returns for investors will shift from yield to leasing conditions and rental growth.

“It will also mean marked differences in the performance of different Australian markets.

“Sydney and Melbourne office space remains under-valued on a five-year horizon, despite strong price growth in the recent past,” Dr Gelber said.

“We expect further strengthening in rental income off the back of strong demand-supply fundamentals and tightening vacancies.

In Sydney’s CBD, the withdrawal of office space for new buildings and the Metro rail line cut supply at a time that demand was high. The result would be big rental gains, Dr Gelber said.

Canberra also offered strong prospective returns on both a five and 10-year basis, Mr Gelber said – a bullish assessment following the release of vacancy rates last week showing a rise from 11.6 per cent to 13.1 per cent for the best “A-grade” space. A staggering 21 per cent of C and D grade office space is empty in the nation’s capital, according to the Property Council of Australia’s Office Market Report.

Andrew Stewart, the managing director of Savills ACT office, said a half dozen major office lease renewals have been signed in Canberra over the past 18 months. The market has also seen steady private (non government) tenancy requirements, with many businesses aiming to establish close ties to Canberra-based departments.

This trend, Mr Stewart said, should continue in the medium and long term, with an increase in government tenders calling for private consultants expected.

BIS Oxford Economics expects a recovery in the “mining city” office markets in the longer term.

“Perth, Brisbane and Adelaide are still suffering at present from the effects of the mining investment downturn and remain over-valued and over-supplied. There will be a time for investors to come back into these markets, but it is not yet,” the analysis suggests.

International investors, with their lower costing capital, will find long-term value in Australian assets, and while it won’t be as strong as before, it will still “compare favourably” to most overseas markets and global cities, Dr Gelber said.

According to BIS Oxford Economics, Sydney offices will see a 10 per cent internal rate of return, ex-gearing, over the next five years. This is followed by Melbourne offices at 8.2 per cent and Canberra offices at 7.5 per cent (see table below).

Large format retail – as opposed to traditional shopping centres – are expect to see an 8.5 per cent return over the five-year horizon, BIS Oxford Economics found.

Dr Gelber described Australia’s retail environment as challenged, having seen more volatility since the global financial crisis.