Investment yields may fall below 5 per cent on prime CBD office towers as more international buyers, including Korean and Japanese institutions, crowd into the Australian market in 2017.
While some individual assets have traded more sharply, investment yields on prime property are averaging 5.76 per cent in Sydney and 5.5 per cent in Melbourne toward the end of 2016.
"We believe we'll go below 5 per cent this year," said Colliers International's managing director for capital markets, John Marasco.
"We believe the premium end of the market hasn't really been tested yet. If it is tested in 2017, we will break 5 per cent."
Investment yields – or the capitalisation rates on which properties are held – have been steadily tightening as the commercial market slowly recovers from the financial crisis almost a decade ago.
There have been strong tailwinds pushing prices higher, as institutional investors competed to secure returns in property while cash yields dropped around the world.
In the last few years, Australia's falling currency, its low rates, and its relatively strong leasing markets have all combined to woo local and offshore buyers.
Bond bears yet to bite
Rising bond yields knocked some of the gloss off that scenario for listed property in the second half of 2016, in anticipation of a US rate rise while the election of Donald Trump to be the next president added more pain to the listed real investment trusts.
But the bond bears are yet to bite in Australia's direct market.
"The competition is deep. We saw it it in 2016 with new entrants and we expect more in 2017, particularly with relatively new sources of capital from Korea and Japan," said Mr Marasco.
Just before New Year, Japan's Mitsubishi Estate Asia joined Chinese insurer Ping An to invest in the construction of Sydney's tallest office building, Lendlease's $1.5 billion Circular Quay Tower project.
Korean money is already taking big positions in the Australia market, through deals such as ARA Asset Management's $578 million purchase of the Southgate complex in Melbourne.
That transaction was partly backed by Korean sovereign wealth.
Transaction volumes are expected to pick up in 2017 as offshore investors begin to sell out their local exposures, creating further opportunity for yield compression.
Last year's biggest single office property deal took place when US giant Brookfield Office Properties sold out of One Shelley Street in Sydney for $525 million on a 5.1 per cent yield.
One half was bought by Charter Hall's Core Plus Office Fund, the other was acquired as a seed asset for a new fund on the Morgan Stanley Real Estate Investing platform, the Prime Property Fund Asia.
Big infrastructure brings boost
Along with the potential uncertainty in offshore markets created by both Brexit and even the Trump election, big infrastructure projects are expected to boost the commercial property market locally.
Over the next four years state governments in NSW and Victoria plan $110 billion investment in infrastructure.
Major leasing pre-commitments will enable fund-through deals on new office developments, such as the $430 million Lendlease project for ANZ in Melbourne's Docklands, which Challenger and US-based Invesco are backing.
And there are more big tenant requirements yet to be met that will drive the development and investment cycle in 2017, including from Japanese advertising and media relations firm Dentsu, which has issued major requests in Sydney and Melbourne.
The leasing markets are expected to remain tight in both Sydney and Melbourne in 2017, according to Investa's research chief David Cannington.
But it will become a tale of two cities within three years, as an overhang of supply from new office developments hits the Melbourne market.
"Consequently, the Sydney and Melbourne office development outlook will diverge, breaking the recent tight correlation in leasing market conditions between the two major capitals," Mr Cannington wrote in his December outlook.
"While Sydney vacancy rates are expected to drive further to new cyclical lows, Melbourne is likely to drift out and hit double digit vacancy rates by 2020."
