It’s a roller-coaster ride ahead for property

Property as an asset class in Australia has generated strong returns in recent years, with listed trusts outperforming the stock market. But there are signs of a softening market ahead, warns John Wilkinson.

Property is approaching a late upturn in the cycle, although the past 12 months have seen some fluctuations in growth, says AMP Asset Management property research manager Louise Joslin.

"There has been an assumption that property will repeat the cycle as in the past, but there is likely to be some more ups and downs before the downturn comes," she told a joint Property Council/Australian Property Institute forum in Melbourne last week.

According to AMP, in the nine months to September 1998 overall property produced a 10.8 per cent return. Joslin predicts the return will be about 9.5 per cent for the next three years.

Both office and retail sectors showed stronger returns in 1998. But industrial, a recent investor favourite and 1998's top performer with returns of 14.4 per cent for the nine months to September, has started to decline.

Returns for office property were 9.3 per cent for the first nine months of 1998, but the sector is now coming under pressure as absorption rates are declining.

Joslin attributes this to the rationalisation of work-space ratios and large-scale mergers, which mean less space is required, especially in CBD locations.

"Sydney also has a number of new developments and, while they have good pre-commitments, absorption rates are not included in the figures until the buildings are completed," she says.

The vacancy rate for Australian office space has risen to 11.8 per cent and the rates for the Sydney CBD, North Sydney and Canberra are all rising. Other capital cities are enjoying a decline in vacancy rates at present, Joslin says.

As a result of this, rental growth in Sydney has declined to 12 per cent while Melbourne saw a slight improvement to just under 4 per cent in the nine months to September.

In the same period of 1997, Sydney enjoyed 16 per cent rental growth and Melbourne about 3 per cent.

"The office sector will enjoy positive rental and capital growth in the period 1999-2001, but business rationalisation will temper that growth," Joslin says. "The sector is in mid-cycle and softening, but will not suffer a downturn."

Retail property continues to perform well, with returns of 11.2 per cent for the first nine months of last year. However, growth in regional and sub-regional shopping centres continues to be soft, Joslin warns.

These centres are a mature market with lots of refurbishment underway, but it is possible to pick better performers in strong catchment areas, she says. "The problem with these big centres is they are all competing for market share."

Rental growth for regional centres has been strong in Brisbane (up 4 per cent) and Perth (up 3 per cent) but weak in Melbourne (up 0.5 per cent) and static in Sydney.

Joslin believes consumer confidence and low interest rates will support retail sales in the first half of this year, but rental growth will be subdued.

The industrial sector is driven by economic growth, which slowed last year.

"Building approvals in the industrial sector have been tapering off and the market is starting to slow, but investor demand is still strong,"

Joslin says. "Returns are still very strong but the question is whether they will continue."

Rental growth in the industrial sector averaged 3-5 per cent in Sydney, but was negative in Melbourne due to plenty of new developments.

Joslin believes the industrial sector investment cycle is peaking, but strong investor support should keep it rising.

Listed Property Trusts (LPTs) enjoyed a good year and outperformed the All Ordinaries Index, says APN Funds Management director Howard Brenchley. The return for LPTs was about 18 per cent in 1998.

"The best-performing sector in LPTs was retail, being driven mainly by the strong performance of the Westfield Trust," he says.

The large-cap trusts like Westfield, GPT and Schroders have driven the LPT market, with yields now moving to 6 per cent, Brenchley says.

Several trusts are still waiting to be launched, and these will push market capitalisation of the LPT sector beyond $30 billion by 2000.

Brenchley says 23 per cent of this has been raised over the last three years and investors are still demanding more LPTs.

"However, some managers are starting to reweight their property portfolios out of LPTs and into direct property," he says.

Asset class return forecasts (% per annum)

Asset class Last 5 years Next 3 years

LPTs 11.1 8.5

Direct property 10.1 9.5

Domestic equities 8.8 10.0

International equities 18.2 8.5

Source: AMP Asset Management