Positive - with cautionary notes

5:00 AM Saturday January 14, 2017 Colin Taylor

Despite monumental events such as the Kaikoura earthquake, the property market continued apace. Photo / Mike Scott

Chief executives and managing directors of New Zealand’s commercial real estate agencies and business/franchise brokerages believe this coming year will largely mirror last year’s successful market performance.

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Mike Bayley, Bayleys Real Estate.

Mike Bayley, managing director of Bayley Corporation Ltd, says many of the factors that made 2016 a record year for the commercial and industrial property sector are still intact.

“These include low interest rates, high occupancy rates — which have reduced tenancy risk for investors — and a strongly performing economy,” Bayley says.

“Tourism and hospitality related businesses and properties are set for another boomer of a year on the back of record visitor numbers and major events such as the World Masters Games and the upcoming Lions rugby tour. Our maturing syndication market should also have another strong year with further large offerings and an increasingly active secondary sales market providing smaller investors with plenty of choice.”

Bayley believes positive features of the market will continue to outweigh the negatives this year but warns that global influences, along with domestic credit constraints, are likely to pose some challenges.

“Internationally, rising bond yields and interest rates will dampen recent very strong commercial property returns. Increased borrowing costs here, coupled with a tightening supply of funding, could put pressure on buyer demand and hence sales values. There’s already evidence of this happening in the land sales market.”

Ongoing global economic and political uncertainty is likely to bring significant opportunity for our property sector.

“Our isolation has historically been our Achilles heel, but it is now one of our greatest attractions.”
Bayley says 2017 is election year which traditionally means less sales activity in the latter part of the year.

“There is also a degree of uncertainty around how our new Prime Minister will perform and the possibility of New Zealand First holding the balance of power. It would therefore be prudent for those considering selling to do so in the first half of the year,” he advises, adding that Bayleys is launching its first national Total Property commercial portfolio at the beginning of February to enable vendors to make the most of current strong market conditions.

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Mark Synnott, Colliers International.

Mark Synnott, CEO of Colliers International, is similarly optimistic.

“Following another record year of sales volume, low vacancy rates and yields, we see little reason for that trend to change heading into 2017,” he says.

“Two key features will underpin the confidence and demand in the commercial property market for the next 12 months: (1) continuing record low yields; and (2) the over-riding appeal of ‘New Zealand Inc’ in the global market for investors and businesses — as well as tourists and new migrants.

“Record low yields will again feature in 2017, purely because of demand and a lack of alternative investment options for comparable returns,” Synnott predicts.

“Indications are that interest rates are likely to rise during 2017 — a world phenomenon. However, attractive purchasing opportunities are still available for yield-hungry investors locally and globally.”
Synnott expects a record number of offshore buyers to participate in the commercial, rural and agribusiness sectors with New Zealand’s returns being among the most attractive within mature global markets.

“As forecast last year, New Zealand’s commercial property market is still only seeing the beginnings of the ‘great wall of money’ on offer from China. The sheer weight of capital available from Asian investors wanting to find a home for it in international markets is massive, and New Zealand is a very desirable location.”

Synnott says there have been clear signals from banks about a continuing tighter supply of money next year with the banks being more selective with their lending. This will lead to an increase in lending from international and domestic non-bank sources and institutions.

He also expects a continuation of the past record-breaking tourism season that will see the performance of the hotel sector continue to grow, lifting hotel sales values to record levels.

“There is a critical shortage of accommodation in the key tourist destinations of Auckland and Queenstown and this will remain throughout 2017 due to virtually no new supply entering the market. New development in this sector may also be hampered by constraints in the construction industry and challenges in primary funding lines,” says Synnott.

“Following on from an extremely active office leasing market for Colliers in 2016, predictions are for record-high office rentals in Auckland and Wellington this year from individual, bespoke projects.

“More cranes on city skylines will continue to tell the story that ‘expansion is needed’ — driven by the demand outweighing supply in what is a positive business environment.”

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John Urlich, Barfoot & Thompson Commercial.

John Urlich, commercial manager for Barfoot & Thompson, says the natural inclination is to remain enthusiastic about prospects for the commercial property market with 2016 having been another great year.

“And we are enthusiastic. Demand will remain high for good productive property. But it would be remiss not to share that we envisage some change in the liquidity of certain sectors.

“For the first time in some years, rigidities have been introduced into our market. In Auckland, the Unitary Plan has made for a large supply of potential development but it is coming at a time when the cost and availability of finance is becoming increasingly restrained.

“Bank margins are going out and loan to value ratios are being tightened. Building industry capacity remains at near maximum and, as we have already seen, the cost of development is proving prohibitive.

“Vendors have been slow to recognise the change in the environment with many continuing to value their holdings on a residual basis assuming some notional feasibility under the Unitary Plan. From agents to valuers, this will be a challenge for the entire industry this year.”

Urlich says Auckland, as the nation’s major “gateway city”, remains the best bet at a time of inherent risk in most other centres, with more than 400 new jobs forecast to be required weekly.

“City vacancy rates will remain at historic lows and the subsequent case for rental growth remains similarly strong. We recommend more acquisition into our biggest market. Its prospects are simply irrefutable.”

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Nick Hargreaves, JLL.

Nick Hargreaves, managing director of JLL New Zealand, anticipates New Zealand continuing to benefit from international trends in “asset allocation” this year.

“This country is a fashionable place to invest right now with global funds wanting to get their money into our transparent, reliable markets. Investors are seeking exposure to the growth markets of Asia-Pacific, while reducing volatility across their portfolio.”

Hargreaves says New Zealand is well placed to benefit from the trend because it offers geographical diversification and is ranked as the second most transparent real estate market in Asia Pacific and sixth in the world on the JLL Global Real Estate Transparency Index. [This measures transparency by assessing factors like data availability, governance, transaction processes, and the regulatory and legal environment].

“It is also worth highlighting New Zealand’s projected economic growth rate,” Hargreaves says. “The OECD [Organisation for Economic Co-operation and Development] estimates that the New Zealand economy increased by 3.5 per cent in 2016 and will grow by a further 3.4 per cent in 2017.

“If New Zealand’s growth rate is put in context, the OECD ranks New Zealand as the seventh fast growing economy in its coverage of 45 countries in 2017. The strong economic growth rate, low unemployment rate and upward pressure on wages in certain sectors of the economy, is certainly part of the attraction for international retailers seeking to expand their footprint in New Zealand.”

Hargreaves believes the recent change of prime minister will make little difference to New Zealand’s attractiveness to investors. “Our new PM has indicated his commitment to spending on infrastructure; so the message is clear: ‘We will invest in our country’ — and of course, investors follow investors."

Like Bayley and Synnott, he expects tourism to continue to play a big part in New Zealand’s ongoing economic success this year and observes the same restraints. “In the hotel sector, we see increasing interest from international firms not having a presence here and that are attempting to connect the dots across Australasia and the South Pacific.

However, there are few opportunities for them to break into this country. In Auckland and Queenstown, in particular, there is a 'frustrated development' scenario.

Developers are not able to respond quickly enough to favourable market conditions due to constraints on labour and resources."

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Brent McGregor, CBRE.

Brent McGregor, senior managing director for CBRE New Zealand, similarly mentions tourism in his market prediction for 2017, stating that “the ongoing tourism boom should result in a number of new hotels and accommodation conversion projects across the country”.

McGregor sees the country’s continuing economic growth supporting the occupier markets and strengthening prospects of capital gains through rental growth.

“Although yields firmed considerably during 2016, these still remain attractive in the global markets and offshore capital will continue to seek quality opportunities here. For prime properties, this should support yield levels at around current rates, even with small funding cost increases throughout 2017.”

McGregor says the occupier market in Wellington will be “an interesting one to monitor” due to seismic activity last year and recently.

“Many buildings removed from the market due to the November earthquake will be upgraded, strengthened and/or converted, raising the average quality levels across the market and bringing about lower than normal vacancy levels for the foreseeable future. The dynamic occupier situation in Wellington is exciting for the capital.”

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Greg Clarke, NAI Harcourts.

Greg Clarke, general manager of NAI Harcourts, also feels the commercial property market is headed for a year much the same as 2016.

He says a question to ask could be: “What will it take to change the direction of the market?”

“Several monumental and unexpected events occurred in 2016 including Brexit, the election of Donald Trump, the Kaikoura earthquake and the resignation of John Key as our prime minister.

“However, the property market continued apace. It is testament to the strength and stability of the New Zealand economy that none of these have caused any negativity or lessened demand for quality commercial property.”

Clarke cites the effect of immigration on market prospects for this year.

“Perhaps it is as simple as looking no further than the fact more people are coming into New Zealand than leaving, creating a continuing demand which exceeds the supply.

"Add in low interest rates, a strongly performing economy and a confidence that seems to grow each year and it appears obvious that 2017 will provide more of what we have seen over the past 12 months.”

He expects: “continuing demand from businesses that need space, from investors that are looking for reasonable returns, from customers who are looking for retail experiences, from tourists who are looking for somewhere to stay, and from tourism operators looking to create and enhance the experience of visitors.”

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Bruce Whillans, Whillans Realty Group.

Bruce Whillans, managing director of Whillans Realty Group, has notes of caution when it comes to his predictions about this year’s market performance.

“It is likely that 2017 will mark a departure from the bull market we have enjoyed since 2014 and it is possible that our local commercial real estate markets could receive a wake-up call,” Whillans says. He believes rising interest rates will be a central theme this year for asset prices globally.

“In New Zealand, we expect the steady tightening of commercial yields to flatten over 2017. A healthy margin still exists between investment yields and funding costs.

"However, any surge in interest rates could see yields begin to unwind, although there is still room for capital growth, particularly in Auckland where demand and a lack of industrial, office, and retail space continue to put upward pressure on rents.”

He says a stronger US dollar propelled by higher US bond yields could lead to a weaker New Zealand dollar this year.

“This will feed through to higher inflation and, ultimately, increased interest rates. We have seen New Zealand’s four major trading banks begin to tighten the screws on lending conditions, particularly for development funding.

"Rising construction costs and delays have already tipped over several apartment schemes, with cautious bank credit controllers only willing to fund those projects with exceptionally robust development margins.”

Whillans says the land beneath many of these unsuccessful development projects is being quietly sold off-market, and land values will face a litmus test in 2017 as resale data flows through.

“Experienced developers with strong balance sheets and good banking relationships may find that the land market is far less competitive than it was in 2016,” he says.

“However, if banks are willing to reinvest capital into the market, lending conditions could ease as developments reach practical completion and settlements begin flowing through. Additionally, a three or six-month lending hiatus would see banks rebalance their loan books, enabling them to re-enter the market.”

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Paddy Callesen, Savills.

Paddy Callesen, managing director of Savills, says some heat has already come out of the commercial property market with the banks tightening up on development funding and pulling back on credit facilities.

“However, owner-occupiers still prefer to own their commercial properties as long as servicing debt is cheaper than paying rent. They have been driving values so this dynamic will gradually change as interest rates rise.”

Callesen does see some stability or consolidation of yields at current levels.

“Yield compression should no longer be assumed to justify future capital gain,” he says.

“A property’s value will be solely a multiple of the income generated — not its future development potential.

“In the absence of yield compression, property development will require higher rents or lower input costs, such as dropping land values, fewer inducements and competitive building costs or a combination of these factors.”

He also says growth in both domestic and overseas tourism will continue to benefit the hospitality sector; while strong annual population growth of almost 3 per cent a year will drive an uplift in residential activity which in turn will drive the retail market.

“A continuation of positive domestic New Zealand economic conditions and market-specific supply constraints will continue to underpin local commercial and industrial property markets,” Callesen says.

“Barring overseas shocks, more of the same is expected in the year ahead, but the property market is at a cyclical high and caution needs to be exercised.”

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Steve Smith, ABC.

Steve Smith, managing director of ABC Business Sales, expects 2017 to see more activity in the in the purchase and sale of businesses; and franchised outlets and services.

“We have a greater number of people cashing out of their over-valued Auckland properties and moving into regional New Zealand where they see opportunities for improved lifestyles and often investing in a business so that they can be the author of their own destinies.

"Along with the highest net migration numbers we have seen for decades, this will help create more demand for business opportunities.”

Smith notes that interest rates are still at historically low levels. “This makes it extremely affordable to invest in business ownership where cash returns far exceed that of many traditional forms, such as commercial property.

“On the flip side of this demand we are seeing more baby boomers coming to the market, divesting themselves of their business assets.”

Like Clarke, Smith refers to “the uncertainty and surprises seen at the end of 2016 such as: Donald Trump winning the US Presidential race, the devastating earthquake in Kaikoura and the shock announcement of John Key standing down as Prime minister.

“Many of the baby boomers will be looking to the future with some caution after these events, perhaps expecting the unexpected,” he says. “No doubt thoughts of the 2008 global financial crisis are still fresh in their minds, which may in fact be the catalyst for them to cash up and look to more relaxed and indulgent retirement schemes.

“So, 2017 could very well be a year of positive change, with more purchasers looking to control their future through business ownership, and the baby boomers looking forward to embracing retirement.”

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Nick Stevens, director, LINK Business Broking.

Nick Stevens, director at LINK Business Broking, agrees with Smith’s last observation stating that “the baby boomer factor is the biggest reason for excitement” in regards to the sale and purchase of businesses, and franchised outlets and services.

“There has been talk for a while now about the wave of baby boomers that will be looking to sell to retire or for health reasons. A ‘boomer’ is someone born between 1946 and 1964 so the first of the boomers turned 70 last year.

“We are now starting to see a lot more businesses owned by this age group coming to the market and expect to see an increase over the 2017 year. A lot of these businesses have a long trading history of about 20 years plus, so they have stood the test of time.”

Stevens says recent research has shown that more than US$10 trillion of “boomer” owned businesses will be passed down or sold by 2025 in the US alone.

“It has been reported we are going to see the single largest change of business ownership in New Zealand’s history over the next 10 years.

“We feel we are on the crest of the wave and with a national coverage of experienced specialist brokers we are well positioned to achieve excellent results for business owners.”

Another factor favouring the sale and purchase of businesses and franchises is government restrictions on the housing market.

“This is not such an attractive game to play anymore and buyers are starting to see that there are solid businesses out there that can produce an ROI [return on investment] on EBITD [earnings before interest, tax and depreciation] of between 33 and 25 per cent.

“Of course, this can vary up or down depending on many factors such as leases, plant, stock and location,” Stevens says.