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Australian office prices to fall?

Sydney office buildings are currently valued at nearly 30% above replacement cost.

  • Melbourne office buildings are currently valued at about 20% above replacement cost.

  • I am guessing that prices are so high as part of the chase for yield - the yield bubble where assets that produce a decent yield tend to me now priced at levels that history suggests are unsustainable ... and at least when bond yields rise (as they have started to do), this will put fairly strong downward pressure on these "long-duration" yield assets.

  • To state the obvious:

  • If an building is trading at a much higher valuation than its replacement cost, people will build more buildings to arbitrage the difference. This suggests that there is substantial risk that Sydney and Melbourne office property values will fall significantly.

  • From slide below, please also observe that if we focus on the Sydney chart of premium to replacement value, on each of the other 2 occasions when we reached this sort of level of premium, this was followed by a significant fall in office prices - in the late 1980s and in the Global Financial Crisis. So that should be a good warning for what is ahead.

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