Yield, Risk and Inflationary Tales

This edition’s article covers a few topics which will hopefully be of use to you. Within Tauranga we have seen a significant fall in yields. This has led to several sales with passing yields of between 5% and 6%, as well as some below 5%. Whilst this is not yet the new norm for most property, it is pertinent to ask what has caused yield structures to be where they are. I consider this is due to factors such as extremely stimulatory mortgage interest rates, a healthy local economy and good levels of confidence. This confidence is based largely on the steady and continuous growth of our region in population, physical size and economic development (with this latter factor being admittedly more volatile than the first two). As well as the perceived capital gains available here through investment in property.  The following graph from the Reserve Bank shows the path of mortgage rates since 1990.

graph 1

The above graph details the significant fall in mortgage interest rates that occurred from the early 1990s. According to official statistics, mortgage rates peaked at 20.5% in June 1987. This seems inconceivable in our low rate environment. But many will remember those days and we must be cognisant that it has happened in the past and could happen again. Interest rates like other aspects of an economy tend to travel in cycles and we would be sticking our heads in the sand if we thought we weren’t in one now. But this low rate environment is also becoming embedded in our consciousness and is driving investment in property from those investors able leverage off such rates.  Further, the international environment suggests little pressure from overseas for a marked upward shift in the short term. The next graph details inflation since 1970 and gives a flavour of why mortgage rates reached such giddy heights. 

graph 2

We note that the Reserve Bank now regularly predicts that inflation will shortly return to the target band of 1% to 3%.  Much like the boy who cried wolf, there seems to be little reason to have confidence that the Reserve Bank’s latest prediction will come to pass. But just for the record they are stating their expectation that CPI inflation will return well within the target band in early 2016 - echoes of the movie Groundhog Day perhaps.

I recently read an article by Sir Bob Jones in which he espoused his view that the existing lease terms and conditions (and tenant quality) within a commercial/industrial property were less important than the property’s other attributes such as location, size, design etc. If these factors were present then the leases were less important. When I read that article it got me thinking about our local market. In the period of 2004 to 2007 decreasing attention was given to the lease terms and conditions of a property and little discount for these factors seemed to be paid.  This is one part of what Sir Bob was writing about. However, too often purchasers seemed to ignore the rest of his advice. That is, to consider instead the location, build quality etc. Then in the period of 2008 until the first half of 2014, far more attention was paid to the leases at a property and we saw an increasing discount for deficiencies in these factors. But since the first half of 2014 we have once again seen an attention decrease.  

If you wish to follow Bob’s advice, then considering the whole picture is a more balanced view. Another of Bob’s points was the need to take a long term view of the likely income and expenses associated with a property. At TelferYoung we will often undertake a discounted cash flow assessment of a property which will consider known or expected cash flow and expenses over what is usually a ten year time period. However, as the time horizon stretches out towards ten years, the certainty of such predictions inevitably decreases. 

As a final note, TelferYoung have sourced information on generic yield structures across the entire country. The following table shows these yield structures for Tauranga and some selected areas elsewhere in New Zealand.  

Tauranga      

5.5% to 7.5%

Rotorua

7.5% to 9%

Hamilton

6.5% to 8.25%

Please note that these ranges take out the extreme highs and lows. The table does though illustrate that Tauranga is a region where the income return on property investment is squeezed tighter than in other areas. The relationship between our yield structures and those of our provincial neighbours has remained similar to this since well before I came here in the late 1990s.  Given the profile of this area, I would suggest that it won’t diminish soon either.

By Paul Higson


Location: Tauranga | Posted 3 years ago