Are we at the bottom of the commercial property market?

From 2019 to 2024, Western Australia’s commercial property market, particularly in Perth, underwent significant changes. Initially driven by pandemic-era low interest rates, the market attracted both local and interstate investors due to its high population growth and strong GSP results. This led to rapid yield compression across various asset classes, with industrial properties performing exceptionally well due to low vacancy rates and strong rental growth.

The spread between cash rates and yields remained attractive, reaching 500 to 600 basis points, resulting in record-breaking commercial property investment in Perth during 2021/22. As interest rates began rising from mid-2022, Perth’s higher yields continued to draw interstate buyers, further compressing yields. Added to this has been a vibrant owner occupier market, often competing at above market values to secure accommodation and shelter from rental increase, particularly in an environment where new supply for some asset types have been limited given the difficulties in the construction sector. The industrial sector was most affected, with spreads to finance rates narrowing to as low as 100 basis points, while office and retail markets maintained gaps of 180 to 200 basis points, lows unseen since the GFC period.

By June 2024, WA’s prime yields stood at 5.5% for industrial, 6.1% for CBD office, and 6.5% for retail properties. These rates increased only marginally compared to East Coast markets, resulting in limited capital value corrections. Despite nationwide negative capital growth, Perth’s high demand saw it outperformed in total returns. Western Australia’s industrial sector saw a 3.1% increase in total returns, surpassing New South Wales (2.0%) and Victoria (-3.2%). Similarly, Perth CBD office market showed a 0.9% total return, contrasting sharply with Sydney (-10.2%) and Melbourne (-11.3%) CBDs.

The growing income returns have helped maintain these positive total returns, boosting confidence in Western Australian commercial investment. Looking ahead, expected interest rate improvements in late 2024 and 2025 may help restore spreads to more acceptable levels. However, the market bottom remains uncertain. High-quality assets with strong returns or development potential continue to exert downward pressure on yields. This period presents both challenges and opportunities for astute investors who can identify long-term prospects or untapped potential in existing assets.