Does Building Or Buying Provide The Best Risk Adjusted Returns?

Building is become an increasingly attractive option relative to buying for a growing band of commercial property investors, according to a new CBRE Viewpoint.

The report examines recent yield compression and subsequent capital value growth in Australia, which has exceeded growth in construction costs and improved development economics.

This in turn has supported a growing pipeline of both new construction projects and expansion/redevelopment projects according to CBRE Research Analyst Alexander Salman.

“A number of significant investors have indicated that development is currently providing the best risk-adjusted returns at this point in the cycle,” Mr Salman said.

“As a result, we have seen a pick-up in development activity, aligned to the theme of building rather than buying.”

CBRE’s Viewpoint examines the recent shift in the distribution of returns across the property spectrum.

It highlights a broad-based yield compression cycle in Australia that has been fuelled by falling borrowing costs and risk premiums.

However, with yields approaching a cyclical low - and with a relatively soft outlook for rental growth - owners are now facing the prospect of total returns being driven largely by rental yields.

Mr Salman said investors were also finding it increasingly difficult to meet hurdle return rates on new acquisitions given the competition for assets in the major capital city markets.

“As a result, we are seeing some owners look to reinvest capital into their existing portfolio, as executing a development is more likely to meet hurdle rates of return,” Mr Salman said.

“Higher potential returns associated with larger scale developments can effectively replace yield compression as the main driver of capital value uplift. Moreover, expansion can engender yield compression if it facilitates an asset moving risk-return style from core-plus to core.”

CBRE’s Viewpoint also points to owners capitalising on opportunities to cater to changes in tenant demand, mix and requirements, to position their assets for the future.

This has been particularly evident in the retail sector, as highlighted by groups such as Scentre, which has $500 million of projects under construction and a further $3 billion of development opportunities.

In the office sector, it has allowed owners to consider capex items such as end-of-trip facilities, to modernise and enhance their assets in what remains a highly competitive leasing market.