Sydney, Melbourne office markets to be “absolute screamers”

Sydney’s office market is tighter than ever.
Sydney’s office market is tighter than ever.

The long run of extraordinary returns from the property market is coming to an end as rising interest rates eat into yields and prices soften, according to analysis from BIS Oxford Economics. 

The Sydney and Melbourne office markets present the best opportunities for investors in the next five years, the researcher says.

Its new Australian Property Outlook suggests a critical shift is looming in the investment logic because of rising interest rates.

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BIS Oxford Economics head of property Frank Gelber says the changed conditions would mean the main driver of property prices and returns for investors shifted from yield to leasing conditions and growth.

“Post-GFC everyone was looking for yield but now returns will be driven by rising incomes or rents and capital growth, and we’ll see a switch in the way markets ­operate,” Dr Gelber said.

“Sydney and Melbourne office markets are going to be an absolute bloody screamer.

“Returns in those markets have been above 20% per annum for the past two years, and people are worried about whether they’re overvalued. They’re not, and there is a lot more to go.”

Melbourne CBD office rent

Melbourne’s office market will offer some of the strongest returns in the country in the coming years.

The report forecast a 10% internal rate of return for Sydney office markets, and 8.2% for Melbourne.

Dr Gelber says what will work most in those cities’ favour is the lack of supply in the next few years. “In Sydney, we’ve got about a 4% vacancy rate on our forecasts for the next three years and there’s nothing like a tight leasing market to drive rents and hence prices,” he says.

“So we could see yields steady or firming further in Sydney and Melbourne but we’ll see them soften elsewhere pretty much across the board, including industrial and retail.”

One of the issues facing the broader property market was rising bond rates, which Dr Gelber describes as the “elephant in the room”.

Sydney and Melbourne office markets are going to be an absolute bloody screamer

“You can see the impact of that on the sharemarket at the moment and we think bond rates have further to rise,” he says.

“That will have an impact on property yields.”

In Perth, Brisbane and Adelaide, the effects of the mining investment downturn are still being felt and as a result those markets remain “overvalued and oversupplied”.

“There will be a time for investors to come back into these markets, but it is not yet,” Dr Gelber says.

On the other hand, Canberra offers strong prospective returns of 7.5% on both a five and 10-year basis, but the report warned that care was needed when investing.

“This is a two-tiered market with the government as a dominant tenant and it faces associated risks,” the report says.

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