Cuts & Yield: I've had worse ...

Low global interest rates, in addition to already crowded markets, have caused investors to seek out alternatives, to move beyond their core markets, to move outside of 'usual business' and up the risk curve, all of which has shifted capital flows and compressed yields, in even the most far flung of places.

Since the start of the GFC in 2008 slack global monetary policy and the quest for yield has driven cap rates to historical highs and, despite increasing concerns over the past few years that commercial real estate is fully priced, the latest central bank cuts around developed markets appear to have done little, in some quarters at least, to curb interest in this sector.

In New Zealand the Reserve Bank recently slashed 50 bps off the official cash rate ("OCR") taking it down to 1.00%. The move has once again buoyed sentiment and observers have re-voiced their confidence in the value left in the market. We've been here before, many times over the past couple of years, but whilst "investment theory" is playing out before our eyes, to achieve some objective balance this ongoing confidence ought now to come, at the very least, with a word or two of caution.

There are a number of reasons to exercise caution but, principally, investors should tread carefully because transactions coming to market at present come with yield expectations which, in our view, go beyond long-term fundamental property value and are driven by low interest rates alone. Such low rates portend weaker growth in an environment of heightened risk and are an attempt to fend off economic contraction; in real estate terms this means a deteriorating outlook for demand and occupancy, so rising values in these circumstances are almost paradoxical.

Understandably, more experienced buyers are left scratching their heads trying to find deals that "make sense", as against the economic headwinds mentioned it's difficult to see the value required in properties with short WALTs ( (not driven by IFRS or WeWork design), and physical issues, or perhaps which feature design and locational obsolescence.

The rise of syndication, especially of new entrants, is also one to watch as syndicators are increasing competition and underpinning asset prices, using the cost of debt as the main driver to overcome investment hurdles as opposed to relying on the investment characteristics of properties themselves to generate the required return, which potentially leaves investors exposed should vacancies arise and interest rates increase.

Generally speaking, investors can still access "remaining value" in the New Zealand real estate market within the higher-value price bracket where there is less competition amongst buyers, or in the value-add space when the buy price is sensible, two areas that we are actively targeting at present. More specifically it is paramount to ensure investments are supported by strong fundamentals (such as logistics) or are underpinned by structural changes such as the BTR sector, working practices or geographic preferences.

"Come back here and take what's coming to ya! I'll bite your legs off!"

Otherwise investors are left to rely on further rate cuts to achieve capital growth but is there any more leg-room? The Black Knight, unchecked from over-confidence, would say "tis but a scratch".

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If you wish to learn more about real estate investment opportunities in New Zealand with Tascott & Co please contact:

NEW ZEALAND

Toby Scott, Director

Tel: +64 (0) 27 5299 879

Email: toby@tascott.co.nz