Property

In general, 2002 was a year of solid gains in the property market, with a continuation of the recovery that started in the late 1990s.

Real estate activity was strong in its own right and, after two years of disappointing share returns, investors turned their focus once again to direct property investment. The tangible nature of the asset, its defensive characteristics and attractive running yield are particularly appealing in the current uncertain economic environment.

No room at the inn

In respect of the Auckland office market, despite the completion of the new PWC Tower, the CBD area finished 2002 with a vacancy level of 9.9%. This is the lowest vacancy rate seen for over five years. Gross office absorption (according to property research by CB Richard Ellis for the 12 months to December 2002) was 45,700m2, which far exceeds the 10-year annual average of 19,500m2.

The education sector has been the major driver in reducing Auckland’s office vacancy level. According to Jones Lang LaSalle (JLL) research, the education sector has grown massively to represent 12.5% of the CBD office stock, compared with 4.6% in 1998. It is also now the single-largest tenant category in the city. The recovery in occupancy rates has also been assisted by the conversion of some older office buildings into apartments and residential units.

Although the number of apartment completions in 2002 was not as high as in the mid-1990s, the level of building consents issued for new apartments over the last six months suggests there will be a massive surge in completions in the coming year.

By sector, vacancy levels reduced in most grades, with the lowest vacancy in fringe Grade A at 5.2%, and the highest in core Grade A at 14.1%. Vacancy levels are a useful indicator for rental growth prospects. As vacancy levels decline and tenants have fewer options to choose from, landlords find themselves in a good position to negotiate stronger lease arrangements.

With no new office towers due for completion in Auckland over 2003, the expectation is for vacancy levels to continue declining. As a consequence, we expect to see the level of tenancy incentives reduce and rental growth re-emerge.

Looking further out, ING believes there is likely to be a short period of office market weakness (caused by oversupply), when at least one new office tower is completed. During this period, supply will outstrip demand before the market catches up in 2005. The eventual redevelopment of the Britomart site in downtown Auckland also has the potential to provide some short-term weakness.

The Wellington office market is in a healthy state, with overall office vacancy at just under 8.0%, according to JLL. Rental growth has been evident since early 2002 and there continues to be a shortage of prime office accommodation, especially high-quality buildings with large floor plates. While tenant growth in Wellington is modest, we expect rental growth to continue over 2003.

A new office tower is likely to be completed in Wellington over the next 2-3 years, but until this occurs, landlords will continue to enjoy favourable rental conditions and capital growth.

Overseas investors showed confidence in New Zealand assets during 2002, paying more than $130 million for two prime Wellington properties towards the end of the year. Foreign investment has provided significant liquidity to the market and, over 2003, we expect offshore investors will remain the dominant purchasers of property assets above $20 million.

Retail therapy working

The performance of the retail sector is closely tied to the performance of the domestic economy. In this respect, retailers enjoyed a good year with increased sales and turnover. Consumer confidence was buoyant and the positive retailing environment lead to expansion by emerging convenience centre retailers, such as Bakers Delight, The Mad Butcher and Nandos Chicken.

The momentum of a tight labour market, higher wages, strong house price appreciation and immigration are likely to help keep retail sales buoyant over 2003. The main risk for 2003/04 will be the extent of new building and shopping centre expansion, particularly in Christchurch. Too much additional space will adversely affect rental prospects.

Industrial-strength performance

Over the last 3-4 years, the industrial sector has provided the most stable returns of the three main property sectors. Industrial vacancy rates in 2002 were benign at around 6% for Auckland.

Favourable returns, a lower level of volatility and accessible price range all point to industrial investments continuing to be keenly sought. Industrial property yields firmed over 2002 and we expect this trend to continue in 2003.

Further strengthening of the New Zealand dollar, together with any increase in interest rates, present the largest risks to the industrial market going forward.

Listed property

Listed property securities (LPS) also performed strongly over 2002, supported by earnings uncertainty in the broader sharemarket and continued low interest rates. LPS performance increased in the second half of the year, as the global economy failed to show signs of the expected recovery and bond yields fell, reflecting stimulatory monetary policy.

For the year, listed property securities produced an after-tax return of 10.45% (New Zealand Stock Exchange Property Index), comparing more than favourably with the New Zealand sharemarket’s modest return of 0.9% (NZSE40 Gross Index).

Outlook: fine

Looking at the next 12 months, ING’s view is there will be continued improvement in the base fundamentals. Overall, the local economy should continue to support business expansion and growth.

At the property-specific level, each of the main cities has its own distinct set of conditions. However, as a general comment, each sector is in a better position than 12 months ago, thanks to a better balance of supply and demand. With limited evidence of oversupply, ING expects to see continued improvement across all sectors over the next 12 months.

Andy Evans is General Manager Property at ING New Zealand.

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