Opinion: A bullish investor market to return to the Central region

Across the board, there are obvious impacts of interest rates on the property market both affecting developers and investors. The most resistance to this is seen in the industrial market. That being said it is not without its challenges. There is an enduring lack of supply across the central region and some forces in play that will likely see a correction in supply struggle to meet current demand in the medium term.

Three forces, or components that I find myself talking about more than most are Land, Construction Costs and Yields. In discussing these components, I am shining a light on industrial property. Throughout, there is no intent to discount other influential market forces seen in this sector that also have an impact on activity.

Popular opinion is that we have a sighter on the bottom of the investment market. An indicator of this that will have a ripple effect on the Waikato/BOP are recent signs out of Auckland, of strong participation from investors that have been absent for 18 months or more. Syndicators are getting off their hands, there is cash around and potentially, some may have been encouraged to move prior to the upcoming election. The yields seen across these sales could be considered bullish compared to the general sentiment that previously existed. No doubt there is a smart play or two amongst these recent sales – with industrial rents increasing in Auckland by 15% or more across prime and B-grade stock in the last 12 months some yields at sale will look a lot healthier at rent review.

So, do we see this activity filtering down to our region? The short answer is yes. When? Well, we may see a flurry of activity post-election but more likely as 2024 gets underway. The three components mentioned above will have an impact so let’s touch on them as they relate to the industrial sector.

Land 

Both Hamilton and Tauranga have seen considerable uplift in industrial land values. Not considering some smaller site sales that tipped over values of $1,000/m², in Hamilton, values generally peaked in the high $600/m² range, and around Tauriko we have seen transactions tipping $800/m². These levels are now being tested. Rising interest rates and softening yields have seen developers struggle to make the equation work which has seen a separation in vendor expectations vs. those of the active market. Supply remains tight, however, in the key strategic locations around Hamilton and Tauranga, there is added caution being seen at present as most developers will need to see their exit from a project to assist with funding and mitigate risk in this current lending environment. This simply means the ability and appetite to acquire land is easier if there is a lease commitment in place and an investor to take out the completed project if it isn’t the developer.

We have seen a small number of sales that indicate a discount off the market peaks, but it seems the bulk of those who appear to be testing the market for vacant industrial land at present are not in a hurry to sell and whilst supply remains tight, may await the re-emergence of the market where land would be seen to carry less risk. Across the board I think we can say the industrial land market has flattened off and probably come off the peaks slightly; however, I’d be hesitant to suggest there has been any material fall in value at this point largely due to a robust occupier market and land constraints. It will be interesting to see what any added supply does over the next year or two whilst interest rates are expected to remain at levels above what we have become used to.

Construction Costs  

In keeping with rising land values, the construction sector has been exposed to rapid cost increases albeit over a much shorter timeframe. The housing index shows a cumulative increase in costs of over 33% in the past 3 years which resonates with the commercial market. Recently, with inflation slowly reigned in and an evident slowdown in construction, some relief has been seen.

After rapid price increases and large work pipelines sitting in front of sub-trades, it appears that some of ‘the fat’ is coming out of construction pricing. Bigger ticket items including structural steel and pre-cast panels are seeing price decline and there are some reports linked to labour costs stabilising. Whilst this is welcome news across the board, will it have longevity? Or is what we are seeing a symptom of a temporarily quieter market and oversupply of materials given the number of delays large-scale projects have seen? Most likely, we will see a long-standing but moderate correction in construction costs, as it is hard to see a return to the level of activity witnessed over the past few years and immigration levels will make the employment market more competitive.

Yields 

We generally see a strong correlation between yields and the cost of money. This has been the case again with prime industrial stock in Hamilton coming off the heights of mid-4 % yields to yields that are more likely 6% or slightly over from the limited sales evidence available. Tauriko and Tauranga in general, have achieved slightly tighter yield outcomes comparatively. But general sentiment suggests these have seen a similar softening to the Hamilton market. Of interest will be where things head from here.

If recent results in Auckland are anything to go by, we will see a bullish investor market return to the central region next year (and possibly post-election). A growing number of investors are less location-specific, which is nothing new but, with the improving level of infrastructure around the Golden Triangle, there has been an increasing presence from Auckland investors in the central region.

At this point, I see the industrial market solidifying a little over the next couple of years. A return to recent resultant yields is hard to see happening, even with the lending environment tipped to improve slowly albeit toward the end of next year. We expect that investors are generally in a better cash position than in previous property cycles and, depending on their reliance on lending, probably have the opportunity to be more selective for a period of time. It is also less likely participants will feel the urgency that previously existed; however, we might need to see more supply added before that holds water. 

Despite the headwinds seen, rental levels have played their part in propping up the market and mitigating the softening in yields. We’ve seen rental increases occur when we thought the market might be tapping out so it’s inappropriate to suggest there is no further room for upside now. Whilst supply is tight there is every chance further increases occur as this will play a large part in new stock coming out of the ground. In light of the three components discussed above, design-build rentals have to work hard in order for development to proceed.

Where the industrial market goes will be interesting to see. Given the strategic advantages the central region has, demand from tenants and investors will endure. With interest rates staying higher for longer, construction costs likely to only show slight relief and the low supply of industrial stock, the pick is that whilst land values may take a bit of a hit, ultimately it will be the tenant who will need to continue paying higher rents to get new builds out of the ground.