As institutional buyers shift towards alternative assets and office transaction volumes reach historic lows, is commercial real estate investment undergoing a transformation? Could trophy office buildings be on the verge of becoming the new "alternative" investment? By Vanessa Rader, RWC Head of Research.
Historically, investors have been drawn to unconventional property assets, seeking high returns despite increased risks. While these properties offered attractive rents, they also came with uncertainties about vacancies and difficulties in securing tenants at the required rental rate if becoming vacant. Many investors of niche properties found themselves with difficult assets and uncertain prospects for recovering their investments.
In the last ten years, alternative investments have gained broader appeal. Institutional investors have shown interest in larger assets like data centres, student housing, private hospitals, pubs, and even caravan parks, elevating the sophistication of these asset classes. Meanwhile, in the smaller market segment, private buyers have taken advantage of available financing and properties with secure tenants, long-term leases, and fixed rent reviews, which provide stable returns. Consequently, yields for these property types fluctuated due to high demand, with buyers prioritising returns over traditional fundamentals such as location.
As the commercial property market cools, investors are refocusing on fundamental principles of property investment. While potential and location remain crucial, factors such as occupancy, lease covenant, and WALE (weighted average lease expiry) have regained prominence in decision-making.
Among all asset types, the industrial sector boasts the lowest vacancy rates, with national figures reaching only 1.6 per cent. This trend is likely to maintain upward pressure on rents. High occupancy rates grow confidence in secure returns and future capital and income growth, though location remains a critical factor. For those investing in residential properties, a similar logic applies. Low vacancy rates are expected to remain in the short to medium term, driven by population growth and limited new supply. This is likely to keep investment yields competitive and maintain investor confidence.
The once-considered "alternative asset classes" such as childcare facilities, service stations, and medical centres now command yields comparable to more established asset types. These investments have shed their former reputation as high-yield, high-risk opportunities. Instead, they are now valued for offering long-term, secure leases, potential for rental growth, and favourable exit strategies. Furthermore, these assets boast high occupancy rates, with very few facilities nationwide sitting unused. Vacancy rates for these asset types remain below 2.5 per cent. The few vacancies that do exist are primarily found in regional markets or in locations where crucial factors were overlooked, such as competition, new supply or oversupply, or population driven demands.
As alternative assets maintain their low vacancy rates, what implications does this hold for our once prized trophy office buildings? The persistent high vacancies across the nation signal a transformation in how businesses operate and engage with their workforce. This structural shift suggests elevated vacancy rates may become a longer-term reality for our office markets. According to the January 2024 Property Council office market report, CBD vacancies (excluding Hobart) range from 8.5 per cent to a concerning 19.3 per cent, while suburban assets grapple with rates up to 26.3 per cent. In this climate of uncertain occupancy and stagnant effective rental growth, have office assets become the new high-risk investment option?
With institutional buyers pivoting their focus to alternative assets and office transaction volumes plummeting to long term lows, are we witnessing a shift in commercial real property investment? Could we be on the verge of a redefinition, where the trophy office building becomes the new "alternative" investment, while industrial sheds, retail centres, medical facilities, childcare centres, data hubs, and service stations emerge as the new "traditional" assets?
By Vanessa Rader, RWC Head of Research
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