Looking to invest in commercial real estate? Make Melbourne your focus   

While commercial real estate investment performance has been strong across Australia’s capital cities in the past few years, it is increasingly apparent that Melbourne is the place where astute investors should be focusing their efforts.

An article in Domain’s website cited Collier’s International Research that for each year over the past 10 years a gross average of 120,000 square metres of new office supply has been added to Melbourne’s commercial real estate market.

However, building commercial real estate space is one thing, filling it with tenants is another. And that’s where Melbourne really stands out. The article goes on to note that Melbourne has the highest absorption rate of any Australian capital over the past three years, at 309,000 square metres – about 85% of newly created space. The vacancy rate in Melbourne’s CBD is 3.2%, the lowest in Australia and the lowest in Melbourne for more than ten years.

Drivers for this positive situation are several and include Melbourne and Victoria’s continuingly robust economic performance, as well as significant state government infrastructure investment in motorway upgrades, rail infrastructure and level-crossing removal programs.

On the back of this infrastructure investment, industrial property capital values grew 20% over the three years to the end of 2018 with net face rents up by 8%.

Much of the value creation for investors has come from conversion to other uses creating higher returns, although in Melbourne’s city fringe value is being driven by substantial rental growth.

Overall, the benefits of strong jobs growth and low unemployment are seen as strong drivers for commercial real estate performance. Both commercial tenant and investor demand are strong, leading to a win-win for both current investors and those looking to enter the market – in essence, the pie has grown bigger!

Commercial real estate marketer CBRE’s Australian Investors Intentions Survey that more commercial real estate investors (37%) prefer Melbourne to any other capital city, well ahead of Sydney at 30%. Strong performance in the sector is seeing sales churn at significant levels – some 35% of investors indicating that they were planning to increase divestment activities and 32% looking to increase acquisitions. This is highly indicative of both strong capital and return performance in current investments and a strong sentiment about future performance among potential investors. CBRE also noted that Australia overall lists third on the preferred list of countries where global investors are looking to place capital.

Some of the trends to keep an eye on include:

  1. Shifting retail landscape

Retail was once considered one of the safest commercial real estate investments. However, it has been heavily dampened by both the growth in online shopping and lack of growth in retail spending generally, associated with low wages growth over the past few years. That said, there has been little impact on rental yields yet, probably because of the significant amount of retail space that has closed. However, the structural shift is likely to see yields impact in the future particularly for retail centres that are structurally unsuited to adaptation to change.

  1. Increase in build to rent projects

Build to rent is one of the best performing sectors globally but historically has not been as popular in Melbourne, or indeed Australia. However, build to rent has now climbed to third place in investors’ favoured focus points – ahead of retail. This has been partly driven by changes in the Managed Investment Trust structures in 2018, making this investment type more attractive in Australia.

  1. Low vacancy rates for industrial and office buildings

Reducing vacancy rates means higher demand which results in rental growth – a great outcome for building owners and investors. It is also taking some pressure of retail stock, with conversions in use to industrial and warehousing as a response. Jobs growth and declining unemployment are also key drivers.

  1. Lower demand for development sites

Credit restrictions on Chinese investors and risk aversion among Australian investors, particularly prior to the May election this year, have seen demand for development sites drop. It may be that with the Coalition elected and the prospect of a negative tax regime now gone, that sentiment will improve.