Solid Prime market fundamentals will underpin Auckland returns in 2023 and 2024

The Auckland property market entered 2023 on a highly favourable occupancy footing across some sectors. Industrial markets have tightened during the second half of last year from already low vacancy levels. Auckland’s is at a scarcely believable 0.1% across the entire market of 13.5 million sqm, with Prime fully occupied and less than 10,000sqm available and physically vacant in Secondary at the time of our survey. The main area of vacancy concern is in Secondary offices where vacancy reached 19.3% mid last year. In the second half of the year stock withdrawals of vacant Secondary buildings have started to provide some relief with vacancy reducing to17.7% by year’s end.

Auckland Vacancy – December 2022

Source: CBRE

Reflecting the expected profile of economic activity, the current strong occupier momentum in the industrial, retail and office sectors for good quality and well-located space will continue into 2023 but is expected to lose some steam into the second half of the year. In terms of vacancy outcomes, supply will likely have the biggest influence.

Supply doesn’t appear to be a significant threat in any of the major sectors. The forecast Auckland non-CBD office and retail supply pipelines to 2025 are modest relative to both the post-GFC average and in an overall sense, averaging 1.0% to 1.4% of existing stock annually. The CBD office supply pipeline to 2025 also averages 1.4% of existing stock per annum and is thus modest overall. It is more concerning that much of this supply is either yet to be committed or is pulling tenants out of existing, often high quality, buildings. Despite good levels of occupier take up in the Prime office sector it will take some time for the market to absorb the backfill vacancy backlog.

The industrial market has the largest supply pipeline relative to both the other sectors and the averages of the past decade. The current pipeline builds on an already elevated level of new completions in the past year. We are however quite sanguine about the outlook for industrial occupancy given that supply is strongly supported by occupiers. Of the under construction industrial pipeline of over 384,000sqm due for completion later this year and into 2024, only 78,000sqm does not have occupier commitment and remains available for lease. It is likely that industrial vacancies will trend higher in the next two years but, given their current negligible level and arguably overtight occupancy market, that is not necessarily a bad thing.

Auckland New Supply as a Percentage of Existing Stock

Source: CBRE

Sales volumes are forecast to increase through 2023 with more motivated sellers coming to the market driven by the need for greater liquidity considering debt financing pressures as higher interest rates flow onto lower interest cover ratios, and LVRs and gearing covenants get impacted by revised valuations.

More motivated sellers, combined with greater certainty around the interest rate track should help crystalise the price discovery process during H2 2023. Our calls on yield movements in the last few quarters have been largely theoretical constructs based on CBRE’s market interactions and available bidding statistics and aimed to find the middle ground between the diverging expectations of potential vendors and purchasers.

The market has been expecting that CPI will be back within the 3% target ceiling by H2 2024, but a wide range of opinion remains on how quickly inflation and interest rates will fall in next few quarters, with contrasting influences such as the rebuild implications of the recent local weather events and the weakness that has emerged in the global banking sector. This uncertainty has imbued a cautious attitude around how the RBNZ’s monetary policy moves may pan out in 2023. Longer term rates have also been volatile but are expected to provide some relief to fixed mortgage interest rates and property cap rates before the OCR starts moderating. Going forward, with little relief from interest rate pressures in H1 2023, the emergence of more motivated vendors will likely shift this middle ground towards buyers’ pricing.

Diverging sectoral yield trends and absolute yield levels are impacting sensitivity to interest rate moves.  During 2020-2021, more than ever, a significant difference emerged between cap rates across office, retail and industrial, with a spread of 270 basis points compared to 50 basis points at the onset of the GFC. This is influencing how different sectors respond to interest rate rises. While return expectations and the risks around these also differ from sector to sector, and will influence investor appetites and cap rates, we are still seeing material upward pressure emerging on the industrial sector in 2023. This is due to its low absolute level of yields and thus greater sensitivity to interest rate rises despite an extremely tight occupancy market and double-digit rental growth.

Office, Retail Centre and Industrial Sector Prime Property Yields

Source: CBRE

As the yield driven capital return component continues to be negative in 2023, total returns are forecast to moderate, with this year also seeing an additional handbrake from our forecast of somewhat lower rent growth. Average commercial market total returns over the 2023-2026 period are forecast at 6.7% per annum, but with significant sectoral variations.

In the office market, CBD Premium grade and Suburban A grade are expected to be the best performers, both achieving similar positive capital returns, but courtesy of higher income returns (due to higher market yields) suburban Grade A is forecast to achieve higher total returns. Both these sectors are benefitting from good tenant demand and occupancy relative to other office submarkets.

While retail yields are also being pushed out, they are relatively more insulated given their already high level compared to office and industrial. In particular, regional centres should outperform from a yield perspective. Combined with short term rent growth benefitting from the CPI basis of most specialty retail shop rent reviews, its relatively high-income return elevates Regional Shopping centres for total return expectations.

Prime industrial is forecast to produce the strongest capital returns courtesy of very high short term rent growth. While we forecast the supercharged rental environment to unwind by 2024, on an aggregate basis Prime industrial market rents are expected to lift by nearly 30% over the 2022-2026 period. Secondary industrial performance is forecast to be somewhat weaker but market rent growth of over 18% is still expected. As a result, both sectors are providing positive capital return prospects even with yields pushing out.

Auckland Commercial and Industrial Property Investment Returns - Base Scenario Forecasts

Source: CBRE