Jones Lang LaSalle believes the value proposition for secondary grade assets in the Brisbane CBD has changed. Brisbane’s CBD office market has recovered strongly over the past two years and is into the early phases of an upswing with demand underpinned by the resources sector. Despite the strong underlying fundamentals of the Queensland economy, and the positive outlook for Brisbane’s CBD office market, the risk premium for secondary assets is at its widest point on record.
The premium that investors have historically required for moving up the risk curve to secondary grade assets in the Brisbane CBD is around 575 basis points above the real risk-free rate. The risk premium is now at an all-time high of 819 basis points and exceeds the level reached during the early-1990’s recession (664bp) and the GFC (660bp).
A large part of the current spread can be explained by the recent decline in Government bond yields which has occurred as a result of investors directing money into risk-free assets due to the uncertainty surrounding Europe’s sovereign debt crisis. The other part contributing to the historically high spread is the secondary equivalent yield. Despite the strong recovery to Brisbane’s CBD office market and secondary vacancy moving back towards an equilibrium range, secondary yields have remained above their long term average since 2009. At the end of Q2/2012, the yield range for secondary assets was between 8.25% and 9.50%, implying that the mid-point is still 16 basis points above the long term average.
Institutional and offshore investors continue to pursue the relative safety of core prime opportunities, which has partly resulted in modest yield compression at this end of the market. However, a subdued supply pipeline has meant that prime opportunities are limited. Investor risk aversion has meant that demand for secondary assets has been somewhat subdued. Despite the recent risk aversion, which is being driven by economic volatility in offshore markets, we believe that the long term outlook for the Queensland economy is very positive and the fundamentals for the Brisbane CBD office market are solid.
If global economic conditions deteriorate substantially, Queensland remains in a relatively strong position. The fiscal and monetary policy ammunition that is available in Australia relative to other developed nations will support national economic prospects. The now very large volume of resources investment, totaling $48.95 billion, including projects that are either under construction or committed, will also put a floor under local economic conditions.
Strong demand fundamentals led by the resources sector will continue to underpin the Brisbane CBD office market over the short to medium term. The completion of GPT’s 111 Eagle Street and Leighton Properties’ 145 Ann Street will see a lull in supply beyond 2012. Vacancy is expected to reach a cyclical low of 5.2% in 2014, which will support above trend rental growth. In light of this, we believe that risk adjusted returns appear very attractive for secondary assets.
About the author
Luke Prokuda is a Research Analyst for Jones Lang LaSalle, based in Brisbane, Australia.