Capital crunch

New Zealand’s commercial property market in the first half of 2022 has been marked by a cautiousness not seen since the 2007 credit crunch.

That has played out in the widening of bid-ask spreads and a circa-65 percent drop in high-value transactions from the last year, according to Bayleys market experts.

The cautiousness is not surprising given rapid rises in inflation and the cost of debt, and puts the country on par with what is happening in almost every developed economy in the world, says Bayleys national director commercial and industrial Ryan Johnson.

The key difference is that the Reserve Bank of New Zealand’s (RBNZ) aggressive approach to moving interest rates in March of this year, puts New Zealand about three months ahead of most other key economies.

“Other countries have been watching what happens here, particularly Australia which has been watching to see what happens in both the residential and commercial markets in New Zealand.

“The Reserve Bank of Australia moved their rates in June, and are following the same pattern we experienced, just later,” Johnson says.

The recent Rising Capital in Uncertain Times; Active Capital Asia-Pacific Perspective report for June-July 2022, by Bayleys’ global real estate partner Knight Frank outlined the key issues for investors as:

● increasing caution and risk aversion as a result of geopolitical and economic uncertainty
● limited stock for investment
● widening bid-ask spreads
● a downturn in activity due to inflation and cost of debt.

Those are playing out in conjunction with other, related trends such as a flight to quality, high demand for distribution and logistics warehousing, softening yields against higher interest rates, and the ongoing rise of construction costs.

In response to those issues and trends, Asia-Pacific countries are seeing increasing allocations from cross-border investors towards prime grade offices and sustainable assets, alongside diversification and inflation hedging strategies.

The US is expected to be the largest capital source in APAC at 66 percent, with Singapore (16%), Hong Kong SAR (6%), Germany (4%) and the UK (3%) rounding out the top five.

Most of those trends and issues can be found in the New Zealand market with some subtle local differences in the level of impact, particularly cross-border flows from Australia, Johnson says.

Bid-ask spreads and transaction volumes

“Bid-ask spreads are particularly large at the moment. That clearly illustrates that vendors and investors are in different places with very different expectations which is largely down to the higher refinancing costs and re-rating of asset risks at a sector and sub-sector level,” says Johnson.

With vendors and investors struggling to agree on price, there is an obvious and fairly immediate hand-brake effect on transaction volumes, which is what has been seen in the New Zealand market over the past quarter.

“We’ve seen a drop of about 30 percent in transaction volume since mid-March,” Johnson says, adding that the next question is just how long this phase of the cycle, with its higher refinancing costs, will last and what impact that will have on capitalisation rates.

“What we have seen towards the end of June was quite a material pull-back in the two-year swap rates,” he says. “So that is signalling we could be getting near the top end of the interest rate cycle. The cost of debt moved so aggressively over the past two quarters; it could be that the end is not too far away. That is progress in the sense that the RBNZ’s efforts around taming inflation are having the desired impact, which is pretty much the same story for every developed economy around the world.

“Two or three months ago, no one knew just where the end was and how high interest rates would go.”

One area most noticeably impacted by the rapid change into an inflationary environment is the area of large or high-value transactions. Johnson estimates there has been a 60-70 percent drop in the number of transactions of over $20 million compared to last year.

“That really shows how cautious investors have been over the first half of the year as they assess pricing across different asset classes,” he says.

That cautiousness has been absent from the market for more than 10 years. “We’re getting to that point of inflexion that happened in 2007, when refinancing costs start to exceed cap’ rates which just doesn’t add up. A further example of this imbalance is the current yield spread to the 10-year government bond of +250 basis points versus the last five-year average of +390 basis points.”

The stock paradox

While the Knight Frank report found a shortage of investment stock was a key roadblock for many of the APAC markets, Johnson says there is plenty of stock in New Zealand, it is just stalled by the bid-ask stalemate.

“We actually have the same number of commercial listings as we had last year and that was at a record high. That is really interesting given we’re seeing transaction volumes are down circa-30 percent against the prior year.

“That’s a demonstration of that bid-ask gap because clearly there is plenty of stock available, but vendors aren’t prepared to take what the market is offering,” Johnson says, adding that with little transactional evidence to suggest the current market conditions favour vendors over bidders or vice versa, sales are stalled with neither side prepared to move.

A small group of purchasers acquiring on an all-equity basis is having the added impact of keeping commercial cap rates tight, by squeezing out the majority of the market.

“The majority of offers are pricing with a levered return, which is now significantly higher. But then there’s the odd exception – a small number of bidders - which are all-equity offers paying vendors’ expectations in some cases, because it allows them to secure good quality stock.

“It’s an interesting situation where those all-equity buyers are actually keeping prices higher across the board, however, once their mandates are complete there just isn’t the depth of bidders below.”

Industrial boom and flight to quality

With prime industrial vacancy rates below 1.5 percent and huge demand from the logistics and warehousing sector for properties in the 20,000sqm and over category, New Zealand is on par with its APAC colleagues in trying to offset a shortage in industrial property.

The trend has been driven by the pandemic-fuelled boom in e-commerce paired with global supply chain disruption that is seeing more and more businesses trying to hold more and more stock at any one time.

“When it comes to that requirement for 20,000sqm or more, it’s very challenging. That means more companies look to build, but then they come up against surging construction costs which means they’re seeking significantly higher rents,” says Johnson.

With that demand for warehouse sites not likely to change anytime soon, it does mean more investors are prepared to live with the firmer yields, because they’re achieving significantly higher rents with pre-determined growth, he says.

The next six months

Johnson expects to see far more activity in the market over the second half of 2022 than the first, as everyone gets more visibility of the impacts of the recent fast and sharp inflationary period.

“We are starting to get to that point in the economic transition where things are starting to get a bit clearer.

“Ultimately, the capital has to move. There’s been a lack of transactions in the first half of the year but decisions still have to be made, balance sheets still have to be adjusted or re-positioned.

“The December end of the calendar year is coming up, and that will be an important balance date for a lot of corporates.”

“We do expect there to be significantly more activity into this second half of the year, particularly in off-market transactions where vendors look to test the waters.”

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