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Regions v cities: Where should investors buy?
While many investors choose to buy in capital cities for steady long-term growth, regional areas are also popular for higher yields, but which offers the better investment: city or region?
Scott O’Neill and Phil Tarrant recently sat down in an episode of Inside Commercial Property to explore the nuances of commercial property investing in regional areas versus capital cities.
O’Neill said that while regions attract investors with strong yields, capital city assets still offer significant growth potential, with investors ultimately needing to weigh their goals to determine the best return for their portfolio.
According to O’Neill, investors need to dispel the idea that regional suburbs do not experience strong capital growth.
“It just goes back to why do people think it grows less? Because commercial’s attached to build costs – yes, the land’s cheaper, but the building and the lease have underpinned more of the valuation story,” he said.
“[All regions are] growing, and some markets would have done a lot better than others, and some a little bit flatter.”
Similarly, O’Neill said that some residential assets in regional markets respond differently across the country, with some regions performing better when the interest rates rise.
“The general rule is the lower the yielding asset, the more it’s going to get affected by an interest rate rise, because people’s cost of money is higher than the interest, as it doesn’t justify the purchase, they don’t buy,” he said.
“If you’re going regional where the yields are 6, 7, 8 per cent, and your interest rate goes from 5 to 6 per cent, who cares? You’re still making a positively geared investment on 100 per cent debt.
“The same goes with commercial, but the equivalent is a higher-yielding investment that gets targeted more.”
O’Neill said that when it comes to capital city investing, lower interest rates can be disadvantageous for commercial property at times.
“When the interest rates are dropping, you’ll see those lower yielding investments like … those ones in the middle of the city warehouses,” he said.
“They’ll get targeted more because they’re viewed as a growth only asset and people are happy to not collect any cash flow on those ones.”
However, he said that given the yields are higher in the capital cities, they are also cheaper to invest in, providing a more budget-friendly option.
“You can get more bang for buck there,” he said.
O’Neill said that ultimately, multiple factors might affect an investor’s decision about where to invest, with interest rates playing a crucial role in the commercial market.
“If you think they’re going up much higher, expect lower growth – so if you have that, then maybe you target higher yielding,” he said.
“We’re going into a falling interest rate environment or at least whatever the terminal rate might be, it might be like 1 per cent lower than what it is today.”
“There’s so many variables happening, but if that goes 1 per cent lower, in a year’s time you’re going to see rapid growth in the next 12, 24 months. So could be a really good market trick is tenant security.”
Additionally, O’Neill pointed out that there are weaknesses in the economy and political factors at play.
“We’ve had a per capita recession. We’ve got a lot of changing consumer behaviour, the work-from-home things still floating around,” he said.
“There’s political risk in places like Victoria, with that you’ve got AI coming into it. How’s that going to change things?”
O’Neill’s final advice to investors is to be strategic and not rely only on one market, nor rule anything out.
“Just like residential and commercial, you don’t go all in one and you don’t rule out an asset class or a location just because of the bias. That’s what a lot of people do,” he concluded.