Investors have 'less appetite for risk' after dramatic change in fortunes

Gerald Rundle. Photo / Supplied

Property investor behaviour over the next few years will reflect a changed risk profile, says Gerald Rundle, manager of Bayleys Research.

In a market overview in Bayleys' latest Total Property portfolio, Rundle says the length and strength of the prosperous economic period leading up to the global financial crisis resulted in many investors "de-risking" property.

Rundle says back in the early part of last decade investors in a property asset demanded an income risk premium of four to five percentage points over "riskless" 10-year government stock.

"By 2007, that risk premium had shrunk to a very skinny 1 per cent. However, the effect of the changed economic and property environment of the past two years has resulted in investors reassessing the risk-return relationship," he says.

"The market is now requiring a higher premium at just over 3 per cent for the greater risk involved in property investment and Bayleys Research anticipates that will remain at around this level for some time to come."

The increase in the risk premium has been reflected in an easing of yields with the latest Bayleys Research industrial median yield now sitting at just over 9 per cent, a significant increase from the low of 7.5 per cent recorded in 2007.

Rundle says investors' reduced appetite for risk will see yields consolidate at, or near, current levels. However, a greater spread of yields will continue to reflect investment quality in terms of location, tenant and lease terms - fundamentals that were sometimes compromised with the previous "de-risking" of the market.

"This will mean that prime sought-after properties, particularly in the retail sector, will continue to achieve low yields, but this will be balanced by high-yielding, higher-risk secondary property."

Rundle says anybody who acquired commercial and industrial property in New Zealand in the early 2000s will still be showing a good return on their investment, despite the substantial downturn in the market over the past couple of years.

Total returns (income plus capital growth) for New Zealand property steadily grew through the first half of the decade with the industrial sector peaking at close to 25 per cent at the end of 2005, while the commercial and retail sectors pushed on to peak in mid-2007 at close to 30 per cent, according to IPD New Zealand Property Indices prepared for the Property Council of New Zealand.

While industrial property came off the peak earlier, it was still providing an impressive 15 per cent total return right up until 2008 when all three sectors went into sharp decline as a result of the deterioration in capital values.

This resulted in total returns in the commercial and retail sectors slipping into negative territory in 2009, for the first time in the decade, with falls in capital values exceeding positive income returns.

While this represented quite a dramatic change in the fortunes of the three sectors, Rundle says the performance in general across the whole decade was positive. The IPD real capital growth index shows that peaks were achieved for all three sectors around the end of 2007 before declining, but to levels that are still 20 per cent to 40 per cent above where they were in 2000.

Retail property was the decade's standout performer, showing 40 per cent capital growth, with commercial and industrial values increasing around 20 per cent.

"When combined with income returns averaging 7 to 8 per cent per annum, long-term property investors have been well rewarded."

Rundle says commercial and industrial activity levels should continue to improve in 2010 with both investors and owner occupiers buying into the market as a result of the anticipated pick up in the economy.

"The appetite for risk is low, but history suggests this will return with time or, alternatively, we forget past lessons. In the meantime, property investors, financiers and developers will tread carefully as they look ahead into the new decade.

Many of the major economies have fared far worse than New Zealand, says Rundle. The IPD indices for real capital growth for the combined industrial, commercial and retail markets show that NZ real capital returns declined 22 per cent over seven quarters, Australia was down 26 per cent also over seven quarters, and the UK dived 46 per cent over 12 quarters. "The fact that NZ also had a greater, more sustained increase in capital values than these other offshore markets means it was the only one ... to show positive capital growth for the decade."