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The PCA’s January 2016 CBD Office Market Report revealed the current vacancy rate at its highest level since the late 1990’s.

 

Graph - Adel CBD Office Vacancy - 1997-2016 - use


During the late 1990’s the South Australian economy was beginning to show solid signs of recovery from the depths of despair that had encircled the state through the earlier part of that decade.

We recently questioned whether there are comparisons to be drawn from the experiences which the property market has been through over the past 10 to 15 years which can help us navigate the CBD investment market over the next few years.

Our CBD vacancy rate declined steadily, from its 1997 peak of almost 20%, for over 10 years, down to a low of 3.4% in 2009 as demand for “project space” from the mining sector filled offices with consultant teams planning numerous new and expanded mine opportunities.

As these projects moved from the planning to development phases, the vacancy rate began to rise once again.

Most of these mining projects did not proceed and we are now firmly into an industry downturn which has had a significant impact on the South Australian economy generally.  The decisions by major international car makers to cease motor vehicle production in Australia, including General Motors Holden at Elizabeth, have dealt a further blow to our State, together with continued uncertainty about the levels of Commonwealth Defence spending in the State going forward.

The flow on impacts for South Australia of these decisions and uncertainties has been immediate and has impacted significantly on business confidence, currently the lowest in the nation.

Our State’s unemployment rate is now the highest in the nation.

 

Graph - Unemployment - Use

 

Despite these negative factors the State’s economy has continued to grow, albeit at low levels in comparison to the national growth rate.

These economic factors have manifested themselves in the CBD office market not only in the vacancy rate, but also in regard to tenant demand, which is as weak as those at MRS Property can remember, and incentives, which are now approaching levels not seen since the 1990’s.

In consideration of these factors, all of which dictate a significant degree of risk to the cashflow of investors in office buildings, it seems irrational that investment yields are contracting to lows that cannot be recalled in our memory.

So, in the words of the our famous local TV “professor”, the late Julius Sumner Miller, “why is it so”?

Historically low interest rates and a weight of capital seeking yield – simple!!

The ability to borrow money at 3.5% to 4.0% makes property investment at, even as low as, a 6.0% to 7.0% initial yield look attractive.

The question which MRS Property continues to ask is, is it sustainable?

Our view, given the risk factors highlighted above is that no, it is not sustainable.

Whilst there has been no increase in official rates from the RBA, bank interest rates are beginning to move upward, albeit slowly and with little likelihood that it will become a rapid increase, nevertheless the expected medium term trend may already have commenced.

   Graph - Interest Rates

If this is the case, in the face of continued weak demand and increasing incentives, the pressure to maintain investment returns will exacerbate and investors will (surely) demand higher returns (increased yields) to compensate for this risk.  The current market appears to be under-pricing these risks and, in our view, may have pushed the market past 12.00 noon on the investment clock.  As Warren Buffett said “be fearful when others are greedy”.