Why Australian commercial property looks a good investment

Commercial real estate is too cheap, according to one of the world's leading real estate academics, Professor Andrew Baum, the visiting professor of management practice at the Saïd Business School at the University of Oxford.

Professor Baum acknowledged the extremely attractive risk premium over bonds.

"If you get 1.8 per cent on a bond, why is real estate trading at 5 percent? It would not surprise if the yields went down to 3.5 percent," he told the Australian Financial Review.

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Professor Baum said most people assumed bond yields would rise but with a glut of savings around the world it could be some time till they turn.

"It is possible that yields will stay low for a long time, in which case property yields could go lower."

Professor Baum outlined three possible scenarios.

1) Bond yields stay low, in which case, "property is a screaming buy".

2) Bond yields rise with Professor Baum estimating that the current yield gap could absorb a rise of 1 percent rise in bond yield without any more in real estate yields.

"Real bond yields you have to rise 2 percent before it affects real estate pricing," he said.

3) Inflation expectations and real bond yields surge beyond the 2 percent cushion.

"The question then is whether property is an inflation hedge," he said, pointing out that over 35 years in the UK, inflation had averaged 3.2 percent a year – and so had commercial rents.

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Professor Baum says the second scenario is the most likely and Australia looks good with a relatively high property yield relative to local bonds.

Professor Baum is a chartered surveyor who will speak at the University of Sydney Business School CBD campus on the lessons from the European experience of real estate in a low interest rate environment on Thursday.

His visit comes as the latest Australia All Property Index has been released by the Property Council/IPD Australia. It provides a broad measure of investment returns for the commercial property market in Australia.

The index database is comprised of property assets from 61 funds with a combined asset value of A$165 billion representing 1,419 assets.

The index details total return, income return and capital return for office, retail, industrial and other sectors on a quarterly basis.

The annualised total return for the year ending June 2016 was 13.3%.

This result is above the 11.8% return of June 2015 and above the 15 year annualised return of 10.5%.

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Office returns were 14.6%, industrial 13.5% and retail 11.2% as at June 2016.

Cap rates for the quarter at an all property level tightened to 6.2%.

Retail cap rates tightened to 5.9%, office cap rates tightened to 6.2% and industrial cap rates tightened to 7.2%.

The composition (by value) across the sectors is retail (42%), office (44%), industrial (9%) and other (5%).