Milk Money

Strong dairy returns can create an interesting investment question: where should the money go next?

New Zealand dairy farmers have had a strong run. Fonterra’s final Farmgate Milk Price for the 2025/26 season was $9.69 per kilogram of milk solids, following a season in which strong global dairy prices supported farm incomes. Organic milk suppliers received an even higher final organic milk price of $14.13 per kgMS. Forecasts for 2026/7 are a still-strong $9.50/kgMS for 2026/27, albeit with a wide $8.50–$10.50 range, which serves as a useful reminder that dairy returns remain cyclical.

When combined with a record full-year dividend of 73 cents per share (boosted by the sale of the Mainland brand), Fonterra's total cash return to shareholder farmers reached a massive $19.6 billion.

For a farmer who has spent years focused on the farm, strong payouts can create an opportunity to do something different with surplus capital. Debt reduction is an obvious option, as is investing back into the farm. But there are other temptations and New Zealand's farmers have historically demonstrated a fondness for another income-producing asset, commercial property.

On the surface, the logic is compelling. Commercial property can provide rental income, diversification away from the rural sector and, over the long term, potential capital growth. But the important question is not simply “Is commercial property a good investment?” It is “What price am I paying for the income?”

Commercial property is moving into a different part of the cycle

The New Zealand commercial property market has spent the past few years working through the consequences of tighter credit and weaker economic conditions, but there are now signs of a recovery.

CBRE's 2026 outlook describes improving liquidity and occupier conditions, with its forecasts anticipating moderate yield compression and positive rental growth as the recovery develops. Its forecast for prime property yields across office, industrial and retail centres is for an average move from 6.53% at December 2025 to 6.37% by December 2026.

A recovering market however doesn't mean that every commercial property represents good value. It means we are entering a part of the cycle where pricing discipline becomes increasingly important. For an investor coming into the commercial real estate sector with a substantial amount of newly available capital, that distinction is an important factor to be considered.

Interest rates impact the equation

Commercial property is often discussed in terms of its yield or capitalisation rate. For example a property producing $500,000 of net income and purchased for $10 million has a 5.0% yield. That percentage number means something in relation to the alternatives available to an investor. If largely risk-free government bonds or other low-risk investments produced the same 5.0% yield, an investor would generally require a greater return from the commercial property to compensate for the additional risks of ownership.

This "risk-free rate" is important as when that rate rises, the required return from commercial property ought to rise too, placing upward pressure on property yields or, put another way, causing cap rates to loosen. And because property value is fundamentally linked to the relationship between income and yield, even relatively small movements in cap rates can have a significant impact on capital value.

For example:

Net income	Cap rate	Indicative value
$500,000	5.00%	$10.00m
$500,000	5.50%	$9.09m
$500,000	6.00%	$8.33m

Stated more starkly, if the cap rate paid for a property loosened by 1%, all else being equal, there would be a ~16% drop in value and it would take about 7 to 8 years (even with assumed annual rental growth of 3%) to return to the price paid - that in itself is a significant change, not to mention the impact that timeframe might have on the remaining lease term and capital expenditure requirements. That is why the relationship between income, interest rates, risk and cap rates is so important when considering investing in commercial property.

Interest rates affect more than valuations

Higher interest rates don't only affect property values. They flow through the entire property ecosystem. For landlords, higher borrowing costs reduce returns and impact debt servicing ratios which could lead to unplanned debt reduction requirements. For tenants, higher financing costs can put pressure on profitability and cash flow which can affect their ability to absorb rental increases, expand their premises or renew leases on existing terms.

The danger of buying yesterday's yield in tomorrow's interest-rate environment

This is perhaps the most important consideration for anyone looking to deploy a large amount of capital into commercial property today. The Reserve Bank increased the Official Cash Rate to 2.75% in September 2026, citing inflation at 4.1% in the June quarter and noting that further increases could be required during the year. NZ 10yr government bond yields have increased to over 5% and upward pressure from around the globe remains.

That does not mean commercial property values must necessarily fall. But it does mean that an investor should be careful about assuming that today's price automatically represents tomorrow's value. These questions are particularly relevant when moving capital from an asset class that the investor knows intimately, the farm, into one where the risks can be less visible.

What does this mean for the dairy farmer?

For a farmer considering investing some of a strong Farmgate payout into commercial property, diversification can make sense. But diversification alone isn't a sufficient investment thesis. The investment needs to stand on its own merits, risks need to be understood and yields need to reflect those risks - a relevant question is not whether a percentage looks attractive in isolation, rather it's does it adequately compensates the investor for:

• market risk

• sector risk

• tenant credit risk;

• vacancy risk;

• lease expiry and rollover risk;

• capital expenditure;

• seismic and building compliance requirements;

• management costs;

• borrowing costs;

• potential rental growth; and

• the possibility of further cap-rate expansion.

Off-farm thinking

There is a natural tendency after a particularly strong year to think about what can be done with the additional income. But extraordinary income should not necessarily lead to extra investment risk. Commercial property can be an excellent long-term investment. It can also be unforgiving when an investor pays too much, relies too heavily on leverage or mistakes a strong current tenant and lease for permanent income security.

For us, the role of commercial real estate management begins well before something goes wrong. It is about getting involved early, understanding the income, the lease, the tenant, the building, the capital requirements and the wider market, and how all of those factors interact with the value of the asset.

In commercial property, income is only part of the story. The other half is ensuring the price paid for that income encapsulates all risks.

October 2026

Tascott & Co.