Short Term Gain or Long Term Pain?

Recent press has identified that the property market is extremely strong and is being driven by the desire for yield combined with a weight of capital, both onshore and offshore. This has resulted in a tightening in capitalisation rates across the board. As a result, value is now hard to find in the market, but it is also worth noting that sometimes value is hard to define.

By way of example, is the $12.5m purchase of a Woolworth Supermarket in Malvern Road, Toorak on a yield of 3% crazy or astute? On such a tight yield one might think the vendor has overpaid. Add to this the fact that there were four (4) other buyers within a few hundred thousand dollars. Has everyone in the market has lost their mind or was there something about the asset that appealed beyond its cash return alone?

It is important to spend the time to analyse a deal, as often a transaction might have more than meets the eye. A site with a tight yield may be a large land bank, or have massive redevelopment potential that is not reflected in the current rental but is reflected in the price paid for the asset. Alternatively the rent could just be very low and thus substantial future rental growth is possible. However, there are often transactions we see, such as the supermarket referred to above, where there is no “twist” and the price paid appears to be over the odds. The point we make is that it is dangerous to assess an opportunity on just a single metric alone as often it is not reflective of the bigger picture and this value can be hard to define. Long term, secure cash flow has always been attractive to investors.

    However the addition of freehold title with no sovereign risk are considerations attracting additional competition for property assets, where capital preservation outweighs yield considerations.

The other dynamic to be aware of is the sheer volume of capital looking for a home in property assets. Onshore we have SMSF’s and institutional super funds whose balances are growing at 9.25% per annum plus any returns they made from the previous period. Add to this the “wall” of money coming in from offshore destinations, much of which is just looking for a destination where they won’t lose control of their capital, and you can start to see a trend emerging. Certainly broader traditional industry fundamentals do not suggest we should be seeing a tightening in property prices, yet prices continue to increase due to the supply/demand friction created by this surplus capital.

Will it last? We are not sure, as capital can distort a market in the short term. However, longer term, unless there are substantial structural changes, a market will typically revert back to its underlying fundamentals. The pertinent question is, are we seeing a structural shift where the “information age” has eliminated global boundaries and made investing offshore as easy as onshore? One thing we do know is that this ongoing supply/demand tension makes finding value difficult and requires a keen eye and oodles of patience in order to find opportunities that “stack up”.

We are certainly not advocating investors to pay more, as you make your money when you buy. What we do say is, take the time to do your homework and understand the broader trends going on around you, as this will define what represents value and what doesn’t.