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News release


Yields firm as prime office real estate begins looking ‘cheap’ to investors

SYDNEY, 11 JUNE 2010 – Based on an assessment of historical yields compared with long-term benchmarks such as government bond rates, prime CBD office assets are in ‘cheap’ territory, according to Jones Lang LaSalle.
John Talbot, Australian Head of Capital Markets for Jones Lang LaSalle, said, “Many astute investors have formed a view that prime real estate assets are beginning to look cheap relative to risk free hurdle rates of return. The ten year Government bond rate is around 5.40% and prime internal rates of return (IRR’s) of over 9% are ahead by a nearly 400 basis point margin.
“Prime CBD office markets yields peaked around the end of 2009 and in some cases are starting to firm in response to improving market fundamentals, more competition for limited stock and increased investor interest,” he said.
Mr Talbot said the flurry of deals at the end of 2009 and early 2010 suggest prime yields have re-rated in the core markets of Sydney and Melbourne. They included:
Property, Price, Yield
Aurora place, NSW $685m 6.62%
20 Hunter Street, NSW $77m 7.90%
55 Hunter Street, NSW $106m 7.00%
Atrium, Pyrmont, NSW $137m 7.33%
Myer Docklands, VIC $77m (50%) 7.70%
“With Melbourne forecast to record a period of above trend rental growth and demand for assets in the core markets increasing, investment yields are likely to compress further in 2011.
“Average prime equivalent yields are forecast to tighten from 7% in 2009 to around 6.25% by 2013 in Sydney and from 7.75% in 2009 to 6.75% in 2012 in Melbourne. Secondary yields will also benefit from a positive correction but the trend will be less pronounced because vacancy rates will be slower to decline in this market sector.
“Evidence is accumulating that as in previous cycles, Sydney and Melbourne CBD office markets will be the first to recover,” he said.
In the first quarter of 2010, indicative prime equivalent yields were recorded as stable for Sydney (6.50% to 7.75%) and Melbourne (7.00% to 8.75%).
“With leasing activity improving in the past quarter, landlords are becoming more confident in lease negotiations,” said Mr Talbot. “This is likely to be followed by a narrowing of incentives  and upward pressure on rents.
“The scope for sustained yield compression will occur as market fundamentals improve and as rental growth starts to emerge,” said Mr Talbot.
According to Jones Lang LaSalle’s Australian Office Investment Market Review, Jan 2009 – March 2010, prime office capital values fell by  20% to 30% between the market peak in December 2007 and December 2009.
The market review predicted the increased competition for assets, risk premiums above historical benchmarks, the stabilisation of debt markets and the prospect of a return to rental growth would lead to tightening yields by late-2010. 
Speaking on the depth of overseas buyers, Simon Storry,
Director of International Investments for Jones Lang LaSalle, said, “Investors with a previous track record in Australia, together with Sovereign Wealth Funds, continue to be the dominant off-shore players. However, hedging costs continue to be a challenge for some off-shore investors.
“Proposed changes to legislation governing German open-ended real estate funds, together with the proposed amendment of a Managed Investment Trust, continue to impact on investor pricing for some groups.”
Mr Talbot concluded, “While the outlook is for a period of positive yield compression, we are unlikely to see a return to the “boom time” of 2005-2007 when yields fell below their long-term average and investors were failing to price in appropriate risk factors.”