Darwin August 2017

The month in review: Darwin

By Herron Todd White
August 2017

Following the extensively reported contraction in the residential market over the past 18 months, levels of market demand have waned across all buyer profiles, including the investor market segment. This follows a strong period of growth where high rents were driving investor demand which presented yields of up to 7% or 8%. However investors have recently seen a contraction in annual returns and dramatically reduced prospect of capital growth, particularly within the CBD unit market, where they have traditionally been most active (particularly interstate investors).

Despite this and whilst we acknowledge the reduction in demand, we have not experienced a mass exodus from this market segment which could have been expected and there are some investors still actively seeking new residential units with reasonable lease terms. Just this week, this office has seen a contract of sale for the purchase of a new residential CBD unit by an interstate investor which, on analysis, showed a yield of 7.4%, being an oil and gas industry related lease. Is this the exception rather than the rule? Certainly the oil and gas industry operates on another level compared to the balance of the market players, preferring to retain efficiencies in personnel logistics over and above seeking the best deal from across the city which typically sees above market rents being paid. Investors are being sold a guaranteed return typically higher than the market, however there is almost no prospect of capital or rental growth and certainly that return will diminish at the expiry of the lease with rents reduced to market levels.

In regard to lease terms, probably the most distinct difference in the market we are currently in compared to the market 18 months ago is that lease terms are significantly shorter. Previously we have seen lease periods of up to three or four years at an annual fixed percentage increase, however as we move down the construction time line for some of Darwin’s major projects and the closer we get to completion, those lease terms are naturally becoming shorter, now negotiated on multiple lots of six month periods for up to 18 months or so.

The other major player in the investor market outside of the oil and gas industry is Defence. Defence Housing Australia (DHA) is still very active in the market place in seeking properties to rent, sale and lease back agreements and off loading ageing assets that no longer meet current requirements. There are major differences between a Defence related lease agreement and one which is associated with the oil and gas industry. With higher risk, you expect a greater return. This rule also applies when comparing the two types of investor properties. A lease with DHA will typically give you a lower return. You could expect as much as 5% to 5.5% (gross) property dependent, down a couple of percent from the example above in the oil and gas industry. However, leases are typically for extended periods of time up to nine to twelve years plus options. Rents are reviewed annually and adjusted to be in line with the market, however depending on the nature of the agreement, some leases include ratchet clauses maintaining the original rent as a minimum, incentives and make good requirements which see that minimal maintenance is required by the owner and is more of a set and forget type arrangement – a management fee is detracted from the annual return and can be up to as much as 16.5% including GST.

Returns in the private sector are not too dissimilar to that of DHA, typically hovering around the 5% mark, although leases are more subject to market movements and susceptible to the particular circumstances of the tenant and landlord. These types of leases are typically for periods of one year, with management fees of around 8% to 12% per annum.

So, is Darwin an attractive place for investors? If looking solely at the returns on offer it would appear so, being a couple of percent stronger than some other capital cities. However, capital growth in the short to medium term cannot be expected given the over supply of properties for sale and rent and if market conditions continue to weaken, particularly in the CBD unit market, capital values and annual rents will be adversely impacted. Traditionally Darwin investors chase yield, whilst eastern state investors chase capital growth. While the eastern state capitals of Sydney and Melbourne continue to explode it is likely that we will have continued limited investment.

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