Sydney & Melbourne commercial property markets remain attractive for investors

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Sydney & Melbourne commercial property markets remain attractive for investors

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The commercial property market, especially in Sydney and Melbourne, remains an attractive opportunity for self-managed super fund (SMSF) trustees in 2020. A record low interest rate environment, a robust demand for office space (CBD and suburban) and strong overseas interest in this market will continue to foster its growth.

It’s not gilt-edged, of course. There are risks with any investment. But for trustees looking for income, capital growth and greater security than equities then the arguments underpinning an investment in this property sector are sound.

Certainly, it’s a market where SMSFs are developing a growing interest; the search for yield is pushing them beyond the familiar turf of cash and fixed deposits. ATO figures show SMSF investment in real property is now around 13.1 per cent of total SMSF assets. Of this total, the split between residential and non-residential is about 35 per cent/65 per cent so the former comprises about 4.6 per cent of total SMSF assets ($747 billion at 30 June 2019) and non-residential property 8.5 per cent. This property investment (especially residential) has been facilitated, in part, by limited recourse borrowing arrangements (LRBAs).

Remember, too, that one of the special attractions of non-residential direct property for SMSFs is the exemption that “business real property” (BRP) enjoys from the broad prohibition of related party transactions imposed under the SIS Act.

This means that real property that is “wholly and exclusively” used in business may be acquired by an SMSF from a member or related party and can be occupied by a member’s business, all of which is out of bounds for residential property.

This exemption is very applicable to small and medium enterprises (SMEs) where business owners can hold and control their business premises in a tax-advantaged structure that simultaneously allows for long-term retirement planning – something many failed to address in the past. With this investment, they can set and (largely) forget.

A long-term superannuation asset coming hand in glove with business advantages; little wonder real property appeals. At the same the positive market outlook for the sector at a time of volatility for other assets (notably equities) simply reinforces its attraction.

Certainly, the property consultancy Knight Frank, in its Outlook 2020, paints a positive picture.  It predicts commercial real estate to achieve double-digit capital growth for the sixth consecutive year in 2020. Although many analysts in 2019 were suggesting the yield compression of the past five years would end in 2020, there is now greater consensus that this pessimism was misplaced, and this market sector will continue to grow.

In hard numbers, Knight Frank expects prime Sydney CBD office property yields to fall 30 basis points to 4.3 per cent in 2020 and by another 20 basis points to 4.1 per cent in 2021. South of the Murray, Melbourne’s prime office property yields are set to drop to 4.5 per cent in 2020 and 4.3 per cent in 2021. With these tighter yields comes the prediction for prime office space to enjoy higher capital growth – 5.8 per cent in 2020 and 6.4 per cent in 2021.

Knight Frank cites two reasons for its bullish outlook. First, the Reserve Bank’s decision to cut rates this year has changed investor perceptions, fuelling increased activity from local wholesale funds, SMSFs, and superannuation groups, as well as international investors.

As Knight Frank notes, this investment, especially from offshore, helped to increase market-wide investment volumes in commercial real estate to a record rolling annual peak of $45.6 billion. In 2019 alone, overseas investors acquired $13.2 billion of commercial property.

Second, the keen demand for commercial property – and this despite the new developments coming onstream. Knight Frank predicts office vacancy rates in Sydney, currently at 3.71 per cent, to rise to four per cent in 2020 before falling to 3.6 per cent in 2021. Supply will be even more pronounced in Melbourne with new projects opening their doors, especially in Docklands and the western CBD, taking the CBD vacancy rate to an expected 7.7 per cent in 2021.

But such vacancy rates are the historic norm – not a cause for investor angst, with Frank Knight noting that much of the new supply is being pre-let.

Whether the investment vehicle is a listed or unlisted vehicle (both have their pluses and minuses), it still requires investors to do their homework. Thoroughly. And, as we always highlight, seek specialist advice if there are any doubts as to whether such an investment dovetails with an SMSF’s investment strategy. If trustees don’t, their auditors will.

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