The dramatic fall in interest rates over the past few months has helped to kick life back into the commercial and industrial property agency business, says Chris Bayley, general manager commercial and industrial for Bayleys Real Estate.

"It remains to be seen whether this continues, given the challenges the New Zealand economy will face from the global downturn this year, but it's been an encouraging start to 2009."

Bayley says a lot of the renewed inquiry is coming from investors who have had substantial funds parked in the bank and have witnessed their income returns almost halved in a matter of a few months.

"They are looking for alternatives and in an uncertain investment market like we have at present, there tends to be a bit of a retreat into 'bricks and mortar' because of the stability that property provides."

Stuart Bode, commercial investment team leader in Bayleys' Auckland office, says several of his clients who are borrowing are opting for floating rates, anticipating that continuing falls in interest rates mean they will be able to lock into a fixed rate of closer to 5 per cent later in the year.

"There has been a lot of talk about how credit has dried up and how difficult it is to raise finance or how expensive it is. That may be the case for properties of projects that aren't producing any income and certainly the days of not long ago are gone - when close to 100 per cent funding could be obtained in some instances," Bode says. "We're not hearing of too many clients having difficulty securing funding on good-quality investment properties with a sound

cash flow and they are securing that funding at very attractive rates."

Gerald Rundle, manager of Bayleys Research, says borrowing costs on property acquisitions are now substantially below property income yields for the first time in four years.

He says the return of a "positive yield gap", where the interest rate costs on a leveraged property transaction are more than comfortably covered by the property's income return, is the result of the substantial fall in interest rates in combination with a significant softening of yields.

Rundle says income returns on most properties have risen by at least 1.5 per cent over the past year and have now assumed more of their traditional cushion against 10-year government stock, generally seen as the risk-free benchmark against which to compare other investments.

"What we witnessed until about a year or so ago in a market of strong rental growth was a considerable 'de-risking' of property with investors prepared to accept what were historically very low yields on the assumption that their income return was likely to increase substantially at the next rent review," Rundle says.

"That is no longer the case and income returns from property have returned to more normal levels, which more realistically reflect the additional risk that property has over an investment like government stock."

Over the past decade the margin Auckland industrial property median yields have enjoyed over 10-year government stock has ranged from over 5 five per cent in 1999 to just over 1 per cent in the September 2007 quarter.

The differential is now sitting at around the long-term average of close to 3 per cent and reflects the increased tenant risk that investors face in the current economic environment.

"Investors are still buying into the same property fundamentals as they were two years ago - good-quality buildings in strong locations with long-term leases - but in a different financial and economic environment with a higher-business-risk exposure for tenants. It is therefore not surprising that yields have pushed up."

But Rundle says the biggest factor in the return of the positive yield gap has been the dramatic fall in borrowing rates.

He says the big attraction for investors in this type of market is that they can now achieve a return on equity that is higher than the income yield, even on a property that is relatively conservatively geared.

He cites the example of property that sells at an 8 per cent yield. Borrowing costs for commercial and industrial properties are typically based on the 90-day bill rate plus a 2 per cent margin. This puts current borrowing costs at around 6 per cent on a fixed rate for a number of years.

With most commercial and industrial property loans involving interest-only repayments, on a $1 million property geared at 60 per cent, borrowing costs would be $36,000 per annum against income of $80,000. The $44,000 difference represents a return on the equity of $400,000 of 11 per cent, says Rundle.

If a property sells at a 9 per cent yield then that return on equity climbs to 13.5 per cent and the return also gets correspondingly higher as the level of debt funding increases.