Far-reaching changes in Australia's property markets are set to bring an imminent end to a long run of extraordinary returns, requiring investors to become savvier and more sophisticated in choosing where to place their money to capture the best returns, new analysis from BIS Oxford Economics shows.
After five years where investors have captured super-normal gains from Australian property investment thanks to record low yields and extraordinary prices growth driven by low interest rates, fundamental changes mean both local and global investors will need deeper insights to identify winning sectors.
Dr Frank Gelber, head of property at BIS Oxford Economics, says investors need a new approach.
"Investors are going to have to be smarter about cyclical and structural drivers of property, market by market, to do well in a more challenging investment environment," says Gelber.
Over coming years, a critical shift in the investment logic for Australian property is set to take place, as a period of sustained interest rates rises sees both yields and prices soften, BIS Oxford Economics' new Australian Property Outlook shows.
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, and will also mean marked differences in prospects between different Australian markets.
But Australia will continue to offer significant, even stand-out, opportunities for those local property investors who deploy the right insights for their decisions.
Global investors, helped by a lower cost of capital, will continue to find value from asset returns over the next five years that, despite being lower, will compare favourably to most overseas markets and global cities.
The need for all investors to make more sophisticated choices of properties and markets for their funds is emphasised by the greater divergence in performance of sectors already shown in the Australian Property Outlook.
BIS Oxford Economics projects expected total returns, based on passive investment with no gearing, to vary between two per cent and 10 per cent over a five-year investment horizon from now.
Already, capital city residential property is near the peak of the cycle, with inner-city apartments heading towards oversupply, most notably in Brisbane. Capital values are likely to plateau, and in some cases to fall, reducing total returns over the next five years. Sentiment has also turned against the retail sector, which is experiencing tough trading conditions and looks unlikely to see any near-term improvement.
For investors with a five-year horizon, the best investment returns are offered by office markets in Sydney, with a 10 per cent internal rate of return (IRR), Melbourne (8.2 per cent) and Canberra (7.5 per cent), with Sydney and Melbourne benefitting from an upswing in leasing conditions. Large Format Retail property also offers strong returns (of around 8.5 per cent) on a five-year horizon, outperforming traditional retail centres.
"Sydney and Melbourne office space remains under-valued on a five-year horizon, despite strong price growth in the recent past," says Gelber.
"We expect further strengthening in rental income off the back of strong demand-supply fundamentals and tightening vacancies."
"Total returns on a five-year horizon will outpace those on offer from other cities and sectors, both within Australia's property markets and, indeed, across many global cities."
Canberra also offers strong prospective returns on both a five and 10-year basis. However, care is needed when investing. This is a two-tiered market with the government as a dominant tenant and it faces associated risks.
In the longer-term, BIS Oxford Economics expects a recovery in the "mining city" office markets and stronger returns across the retail and industrial sectors.
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.
Business News Australia
Get our daily business news
Sign up to our free email news updates.