Australian Commercial Property Investment Market: Styles, Performance and Funding

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Australian commercial property is a physical asset class that forms an important part of the capital market universe. On available data, the extent and composition of investment grade commercial property and associated property investment products can be measured and compared to the wider Australian investment market. As at December 2012, the estimated Australian institutional grade commercial property stock was AU$681 billion. The size of the core property investment market  (office, retail and industrial)  is  AU$280 billion of which approximately AU$195 billion (70%) is owned by Australian Institutions.

Due to illiquidity and high value thresholds, a range of  securitised  property investment products exist which offer investors exposure to local and overseas commercial property. The largest is public equity with Real Estate Investment Trusts  capitalised at AU$89 billion representing close to  4% of the Australian Stockmarket. Next is private equity, comprising wholesale property trusts and property syndicates at a combined value of AU$84 billion. Debt securities offer an alternative return stream linked to property in the form of the AU$165 billion whole commercial property mortgage sector and the AU$16 billion traded  debt securities sector.
Typically, data about the performance of investment asset classes is sourced from transaction based indices. With no central trading place and low transactions, commercial property investment  performance data  are based on  valuation  indices which  exhibit artificially low volatility. Using accepted statistical  techniques,  the valuation based  PCA/IPD composite property data can be desmoothed, which  increases volatility by 31%. Over  the 1985-2012 period, with inflation removed, desmoothed property is shown to  have  one of the best risk adjusted performance  profiles (joint second)  of  the  eight leading  investment asset classes.
However, future performance depends on economic conditions and how levels of new supply affect rentals and prices. A high value threshold means that direct property investment requires considerable capital. This can be achieved by increased equity leading to higher specific property risk or debt financing part of the property investment. Whilst debt funding can improve property investment returns, it substantially increases the risk levels.  Using the same 28 year desmoothed property data series, a 80% gearing level can lead to a 30% improvement  to the property total returns, although the risk (volatility) is increased five-fold.