Sydney office yields to compress to 4.25%-4.75% by end-2022

The Sydney CBD prime equivalent yield range currently sits between 4.38% and 5%. 

The Australian economy received significant fiscal and monetary policy support over 2020, providing a level of downside protection from the impact of COVID-19. It is estimated that Australia’s GDP only contracted by 2.8% in 2020. According to JLL, while the full-year GDP result is expected to be negative, the Australian economy exited technical recession in 3Q20 with quarterly GDP growth of 3.3%. Oxford Economics project the Australian economic recovery will gather momentum with GDP growth of 2.9% in 2021 and 3.2% in 2022. 

The Australian Bureau of Statistics (ABS) reported that total employment was 12.91 million people in December 2020 – only 0.7% below the pre-COVID peak recorded in February 2020. The lead indicators for the Australian labour market have started to firm. ANZ’s Job Advertisement Series (January 2021) revealed that job advertisements increased for an eighth successive month and are now 5.3% higher than the pre-pandemic level. 

Here’s more from JLL:

The Reserve Bank of Australia (RBA) eased monetary policy to an all-time low through COVID-19 with the official cash rate falling to 0.10%. The RBA has implemented a range of policy measures for the Australian economy – bond purchases, the Term Funding Facility, the 3 year bond yield target, the record low cash rate for all borrowers and helped ensure that the banking system is able to provide the credit that is needed for the recovery. The RBA expects the official cash rate to remain unchanged through 2024. 

The RBA stated that very significant monetary policy support will be required in Australia for a few years and that inflation should be within the 2% to 3% target range before they would consider raising the official cash rate. To meet this inflation target, the Australian economy would need to experience a tighter labour market and stronger wages growth. Australian Government bond yields have traded in the 0.60% to 1.40% range over the past 12 months. Over the next 3-4 years, bond yields are forecast to remain low with Oxford Economics projecting they move out to 1.50% by 2024 and 2.80% by 2030.

Financing Costs for Investors

Bank lending criteria has remained disciplined with conservative Loan-to-Value (LTV) and Interest Coverage Ratios (ICRs). Offshore banks and non-bank lenders’ are looking to increase their exposure to the Australian commercial property sector and typically compete on loan tenor. Australian banks will normally provide loan facilities for up to five years, but a number of offshore banks and non-bank lenders’ will provide 7-10 years (at an additional margin). 

Publicly available information on debt market pricing is limited in Australia, so we have historically adopted corporate bond market pricing as a proxy for the cost of debt. The BBB-rated corporate bond yield moved out by 100 basis points from 1.81% in February 2020 to 2.89% in April 2020 reflecting the potential economic impact of COVID-19. The resilience of the Australian economy and expectations of a low interest rate and inflation environment has led to a sharp reduction in the BBB-rated corporate bond yield to 1.49% in January 2021.

What could happen to Sydney office yields?

Australian prime office yields were largely unchanged in 2020 as the prime grade office sector displayed its defensive characteristics. The price discovery journey was relatively short with liquidity returning to the office sector in 3Q20. A number of benchmark sales were recorded across different geographies highlighting that prime grade assets with strong covenants and long WALEs were proving resilient.

The Sydney CBD prime equivalent yield range sits between 4.38% and 5.00%. The spread between office yields and the real risk-free rate (implied risk premium) is wider than historical benchmarks. However, the softer leasing market conditions and potential for higher vacancy is expected to see yield decompression for assets with income risk in the short-term. JLL projects the Sydney office market will start to recover in late 2021 and prime equivalent yields are forecast to compress to 4.25% to 4.75% by the end of 2022.