After taking a hit during the GFC, non-residential real estate is well and truly back.
According to the Property Council/IPD Index (Property Council/IPD Australia All Property Index) which tracks more than 1,600 properties valued at $140 billion, the annualised total return over the past three years was a solid 9.8%. This is higher than equities (S&P/ASX 300 Accumulation Index) (8.5%) and bonds (UBS Composite Bond Index) (6.3%) and just below the 15 year average of 10.4% per annum.
In 2013, non-residential real estate returned 9.6%, outperforming bonds at 2.0% but underperforming equities at 19.7%.
Investors turning to non-residential real estate for yield were not disappointed – the average income return was 7.2% in 2013 and 7.4% per annum over three years.
The best performing sector in 2013 was industrial (11.0%) underpinned by the strong performance of industrial warehouses (12.3%). Warehouse and distribution space is running hot as the major logistic players, and both the bricks and mortar and online retailers, seek out larger ‘sheds’ strategically located around major transport nodes.
Healthcare was next best performer (10.3%). This was driven by a recognition that not only are the healthcare companies such as Ramsay, Primary, and Sonic benefiting from changing demographics and an explosion in medical innovation but so is the underlying real estate. An aging population needs more health and aged-care related services. Governments don’t want to foot the growing bill, so the private sector will fund both the services and the accommodation. Going forward, we expect health related real estate to offer compelling investment returns to astute investors.
Despite the Australian office vacancy rate rising from 8.4% to 10.4% during the year (Property Council of Australia Office Market Report – January 2014), the sector generated a total return of 9.7%. Investors have been chasing prime office assets (10.0%), particularly those with long-term leases backed by strong tenant covenants, at the expense of secondary assets (7.4%).
Retail posted a respectable total return of 9.3%, despite a particularly tough retail environment. The standout retail sub-sector was neighbourhood centres (12.0%). Investors flocked to these centres, pushing yields down and values up. They sought exposure to non-discretionary retail spending and rental income streams backed by the supermarket giants – Woolworths, Coles and Aldi. Centres more exposed to discretionary spending (fashion, homewares, electrical and white goods) generated less spectacular returns. Super and major regional centres returned 8.2% and bulky goods centres returned just 5.6%.
Folkestone expects much the same in 2014. Non-residential real estate performance will continue to be driven by the sheer weight of money chasing assets. As the economic recovery gathers momentum, the underlying real estate fundamentals should improve, underpinning the rise in values.
As always, there will be winners and losers. The key to success is not only developing an effective real estate strategy but being able to execute. This requires good asset selection, a proper pricing and management of risk and active management of assets to deliver superior risk-adjusted returns.
Adrian Harrington is Head of Funds Management at Folkestone, an ASX-listed real estate fund manager, investor and developer.
