Yields likely to head south

A significant proportion of Melbourne's property transactions in 2012 were to offshore investors, JLL investments director James Kaufman said.

They included offices at 850 Collins, 661 Bourke and 477 Collins streets, which sold to Malaysian, German and Singapore interests.

That level of foreign investment was "a big change from last year", said John Kim, the head of property research at investment bank CLSA.

"There is a lot of UK, European and US capital coming to Australia, both directly and through property fund managers based in Asia," Mr Kim said.

The influx was the result of foreign capital seeking stable, risk-adjusted returns, JLL said.

Offshore investors recognised Australia's commercial property was outperforming similar assets in the US and Britain, Mr Kaufman said.

At the same time, local investors such as wholesale funds, super funds and REITs were also more active.

Some were also getting backing from offshore investors. GPT Wholesale Office Fund, which brought 150 Collins Street this year, has 26 per cent from foreign funds.

Several factors were behind the activity.

Melbourne has the lowest volatility compared with other Australian markets, making it the "pick of the bunch" for steady returns.

Yields were averaging 7.5 per cent, a much more favourable rate than world markets.

The falling price of debt was making commercial investments more attractive to both domestic and international buyers.

Investors were able to secure debt for around 5.25 per cent to 5.5 per cent, substantially less than current yields on commercial property.

"All of these groups are all going to want to buy, all at the same time," Mr Kaufman said. "When that happens and you've got limited supply of investment-grade assets for sale, it will drive yields down."

Investors had overadjusted in reaction to the global economic crisis and local concerns about rising vacancy rates leaving the market "mispriced", he said.

Foreign investors see the potential for yield compression, particularly given the high spread to the 10-year yield and local borrowing costs, Mr Kim said.

"Australia stands out within Asia as being a large market, very liquid, with high transparency and stable fundamentals. In China the capital flows are difficult to predict and it's not as transparent," he said.