According to a report released in October 2011 by the ANZ Bank, commercial property investment is set for “strong returns” over the next 10 years.1
While the forecast found that Australian shares are likely to be the strongest performer over the next 10 years, when considered on a risk-adjusted basis, commercial property showed similarly strong forecast returns. Naturally, however, the authors of the report did make the point that any forecasts were very sensitive to a number of assumptions.
Importantly, what set this report apart from many of the simplistic comparative tools that are available when considering how to invest was that it deliberately sought to address the ongoing costs associated with some assets, as well as accounting for a range of tax considerations, gearing and risk.
In this way, the report aimed to create a level playing field for different types of assets to objectively compare them.
Adjusting for risk
Without doubt, risk is one of the most critical elements of any investment decision. One means of thinking about risk is known as ‘Value at Risk’ (VaR). Essentially, this is a model designed to measure the amount of capital you might expect to lose over a given time period.
For example, if the VaR for a particular asset is -15% at one quarter with a 95% confidence level, this would mean there was a 5% chance that this asset might fall more than 15% for a given quarter. For most investment types, the VaR is a negative value. This means that investors must be comfortable with the risk of losing money. For some assets, however, where there is little variation in the positive return profile, then a positive VaR can occur.
A good example of an asset type with a positive VaR is a term deposit. Guaranteed by the Federal Government up to a certain amount, even in the worst case scenario, with a 95% confidence level we can confidently say investors will still make money. Naturally, however, for an asset that has such a low risk profile, the return profile over the long term will also be similarly low.
Due to its high volatility, equities showed the highest VaR. This risk has been highlighted over the past three years as Australian and international investment markets have experienced extreme levels of volatility, falling confidence and dramatic declines in value.
By contrast, at a 95% confidence level, commercial property has a distinctly more modest VaR. And, according to the ANZ report, its value at risk was largely due to the losses experienced in the sector during the early ‘90s recession.
Now and then: a convergent view of the future
Ultimately, the report found that Australian shares would likely be the highest returning asset in the decade ahead, after costs, taxes and accounting for leverage. But, after adjusting for the level of risk across a range of assets, it concluded that commercial property and equities were expected to perform roughly on par.
At Australian Unity Investments, our outlook for commercial property investments is similarly positive. Over the last two years we have observed a steady and gradual recovery in the Australian commercial property market. As a result, commercial property fundamentals, which have been spurred on by a resilient Australian economy and a lack of new supply out of the global financial crisis, are continuing to remain strong. For quality property assets this should result in gradual rent increases, low levels of vacancy, and steady and positive valuation results.
It should not come as any surprise, then, that with a property portfolio of around $1.8 billion (30 September 2011) invested in Australian commercial property, we are looking forward with considerable optimism to the next 10 years of investment.
1 Asset Returns: Past, Present And Future: Australian Property Research, ANZ Research, 6 October 2011
