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Outlook: Commercial

Effects of the Global Financial Crisis and the Christchurch Earthquakes on Nelson Commercial Property

The Nelson commercial property market has changed significantly in the past several years because of two significant events: the Global Financial Crisis of 2007/08 and the Christchurch earthquakes of 2010/11.

Global Financial Crisis Effect on Nelson Property

Before the Global Financial Crisis, Nelson’s overall commercial property market had been buoyant.  Investors experienced above-average growth in rentals and market values.  Many inexperienced investors entered the property market and business conditions were buoyant.  Everyone appeared to be on the gain!

Historically, the New Zealand property market is significantly influenced by overseas economic conditions.  Following the Global Financial Crisis, lead by the collapse of the US sub-prime mortgage market, high-risk property investments started defaulting. In turn, financial institutions started collapsing through their exposure to these investments.  Capital dried up and, in the blink of an eye, the market turned on its head. 

Following the onset of such financial chaos, property owners typically enter a state of denial.  No one likes facing losses.  Consequently, sales dried up as vendors refused either to reduce their pricing expectations or to take their properties off the market to wait for a “recovery”.  Few new leasings occurred, and there was little evidence of rental reductions due to standard lease review ratchet clauses preventing rentals from declining.  Over time, claims of a two-tier market emerged.  Landlords and tenants often agreed to maintain rental levels on existing leases.  New leasings clearly evidenced deals being struck at reduced rates or inclusive of sweeteners such as rent free periods and landlord fitout contributions.

Ultimately, market forces do prevail and are accepted by key market players; i.e. investors, estate agents and valuers.

Christchurch Earthquakes Effect on Nelson Property

Normally, the market would have entered a recovery phase after two or three years from such a financial crises.  However, before a recovery occurred, the destructive Christchurch earthquakes in late 2010 and early 2011 dealt a blow to the commercial property market.  Words like liquefaction, seismic risk and sum insured entered our vocabulary.  Insurance premiums commonly doubled and even trebled in some instances.  These increases affected cashflows for both tenants and property owners.

Furthermore, local authorities around the country began reviewing commercial buildings in their jurisdiction using their Earthquake Prone Buildings policies.  Buildings having a seismic rating of less than 34% New Building Standard (NBS) were classified as “earthquake prone” and would require strengthening to above 34%.  High-level public-use buildings fell victims first; e.g. the Trafalgar Centre and Nelson School of Music.   Older buildings using masonry brick construction were also prioritised for strengthening where required.

Simultaneously, many government, bank and institutional tenants insisted that the premises they occupied meet at least 67% NBS and, where failing to do so, the tenants vacated until the building was appropriately strengthened.  This situation created a sub-market for short-term tenancy relocations.

Additionally, some banks would not lend against commercial property with less than a 67% NBS seismic rating.  From a valuation perspective, it has therefore become imperative to know a building’s seismic rating as a part of the valuation process. The cost of strengthening a non-complying building, inclusive of a profit-and-risk allowance, needs to be reflected in a building’s market value.

Commercial Property Investment Yields

Property investment yields is another interesting change during this period.  For properties perceived by the market to be low risk with features such as good location, long-term tenancies, rents at market, and a seismic rating of greater than 67% NBS, yields have remained firm and typically in the range of 6.25% up to 7.5%.  Sales of lesser-quality properties have seen analysed yields of as much as 10% to 12%.

Since 2012, the market has been maintaining a steady level of sales activity.  Rental rates for modern, well-located premises now appear to be under pressure and increasing as demand edges ahead of supply and developers seek a fair return on their development costs.  Second-tier and older accommodation types remain difficult to lease, and rental rates have shown little change over the last three years.

Nelson Commercial Properties Sold in 2014

Key benchmark sales and yields over the last 12 months include:

  • 50 Achilles Avenue - sold in April 2014 for $4,870,000 at a yield of 7.26%
  • 200 Trafalgar Street - sold in June 2014 for $4,960,000 at a yield of 6.39%
  • 108-112 Bridge Street - sold in June 2014 for $750,000 at a yield of 7.87%
  • 7 Forests Road - sold in July 2014 for $3,905,000 at a yield of 8.36%
  • 31 Bridge Street - sold in September 2014 for $1,250,000 at a yield of 7.73%
  • 675C Main Road Stoke - sold in October 2014 for $733,500 at a yield of 8.41%
  • 30 McPherson Street - sold in October 2014 for $1,300,000 at a yield of 8.69%

Nelson Commercial Property Rental Market

Within the industrial markets of Nelson and Tasman, new open-market leasings are indicating a more stable market with some small recovery evident in some sectors. The majority of industrial lease agreements are on a net basis with tenants responsible for all property outgoings.  Increases in rates and insurance passed on from landlords to tenants therefore increase the total occupancy cost of leasing space by these tenants.

Our research and anecdotal evidence suggests there is increasing demand for industrial space. This increase is having a positive effect on previous vacant space with vacancy rates falling in some locations.

The retail and office sectors were hardest hit by the effect of increased insurance premiums, especially for buildings erected pre-1934 when New Zealand’s first seismic standards were introduced following the Napier earthquake.  For the first time in many years, sustained vacancies of CBD retail and office premises occurred and rentals were under pressure.

In the years immediately following the Global Financial Crisis, tenants were apprehensive, and lease terms of just one or two years were common.  Recent new leases have indicated that tenants are now more willing to agree to longer lease terms such as three or four years with rights of renewal.

Future of the Nelson Commercial Property Market

We anticipate a long, slow recovery of the commercial property market, but things are certainly starting to head in the right direction with improved business confidence a fundamental economic driver.  We believe the mixed market between modern and older-type premises will continue until older building stock with a low seismic rating is brought up to a higher standard.  Investors will continue to chase high quality commercial properties.