The commercial property market has always been more difficult to track and analyse than the housing market. Whereas the latter has a wealth of data available from REINZ, CoreLogic, and other sources, much of our non-residential work relies on collecting piecemeal data from several different commercial real estate companies and trying to construct a consistent narrative to inform our non-residential forecasts.

Recently, the Reserve Bank published a paper examining New Zealand’s commercial property market in the context of the Bank’s financial stability objectives. This article highlights some of the key pieces of data from the paper that provide us with a better picture of the market’s historical performance than we’ve ever had previously.

One of the most astounding graphs in the Reserve Bank’s paper provides data on the Auckland prime office market back to 1986. The price data shown in Chart 1 highlights the property market’s collapse during the late 1980s and early 1990s, due to the domestic and global recession following the 1987 stock market crash. Other downturns occurred in the wake of the late-1990s Asian Financial Crisis (AFC) and 2008’s Global Financial Crisis (GFC), as well as the current post-pandemic downturn.

The extent of the market’s decline between 1988 and 1991 was phenomenal, with prices plunging 62% over a 3½-year period. As bleak as conditions were in the late-1990s and late-2000s, those downturns were mild compared with the late-1980s collapse (see Chart 2).

The trends in prices are mirrored in vacancy rates, which got up to 33% in Auckland in 1991 (see Chart 3), because the prolonged downturn in the economy had been preceded by a commercial construction boom that created a massive oversupply of office space. The increases in vacancies were much less acute following the AFC and the COVID-19 pandemic (although lower-grade office space has been hit much harder in the last few years than the prime market, with vacancy rates for secondary office space in Auckland reaching 20% in the latest data). Even following the GFC, prime vacancy rates only rose by eight percentage points to 14%.

It would be impossible to overstate the catastrophic effect that the 1987 stock market crash, resulting business failures, and declining employment had on the commercial construction industry. The annual nationwide value of office consents fell from $1.22b in 1988 to just $146m by 1992, an 89% decline in real terms (see Chart 4), and the volume of work put in place also slumped by 84%. Many planned projects did not go ahead, meaning that sites where buildings had been demolished were repurposed as car parks for a decade or longer. The highest volume of office consents since then, in 2014, only got to 63% of the 1980s record.

Auckland prime office property prices did not surpass their 1988 high until 2007 (and then promptly fell again, taking until 2014 to reattain that level). In real terms, the Reserve Bank’s data shows that Auckland office prices are still 37% below their 1988 peak (see Chart 5).

Other data published by the Reserve Bank provides a broader perspective, beyond the Auckland prime office market, on non-residential property in New Zealand. Chart 6 shows that the trend in overall non-residential property prices across the country generally moves in line with the Auckland office market, with deviations from time to time when other regions or other property types perform differently. For example, industrial property was a stronger performer than commercial during 2021, while the Auckland CBD office market was also negatively affected by the region’s extended COVID-19 lockdown during this time.

It’s also notable that the effects of ultra-low interest rates on the housing market during the pandemic are repeated in the non-residential market. Chart 6 shows a 17% lift in non-residential property prices during 2021 when interest rates were at their lowest, and a 9.4% reversal in prices in the March 2023 year as potential buyers responded to much higher interest rates than had previously been expected. The market’s fluctuations were not as extreme as in the housing market, perhaps reflecting a more sophisticated level of investor, or greater barriers to entry for potential buyers. Essentially the non-residential market didn’t experience the “fear of missing out” demand to the same degree as the housing market during the COVID-19 boom.

The fortunes of industrial, office, and retail property have generally moved together – reflecting broader influences such as interest rates and economic growth. However, Chart 7 shows that there has been more of a divergence in rental performance in recent years. Although the COVID-19 pandemic is not the only factor, the effects of the pandemic and the policy responses have been felt unequally across different property types.

For example, restrictions on people’s movement hit the retail sector particularly hard, while supply chain disruptions and increased online shopping boosted demand for industrial (warehousing and logistics) space.

Chart 8 shows that rental yields for non-residential property trended downwards throughout the 2010s, reaching a record low during the pandemic – as was the case for residential property. Significant upward pressure on yields developed during 2022 and 2023 as interest rates rose, which was manifest in rising rents (where possible) and falling property prices.

With the overvaluation of property during the pandemic, coupled with the deterioration in economic conditions since early 2023, it is unsurprising to see bank lending on commercial property declining. The fall is not as large as in the wake of the GFC, reflecting that there has been less of a credit crunch for businesses during the current recession than in 2008/09, when very tight funding conditions proved to be a real constraint on business operations.

Chart 9 shows that the biggest downturn in lending has occurred, unsurprisingly, for development activity. Low rental yields, higher construction costs, and rising interest rates have made it increasingly difficult for developers to construct new buildings and achieve a viable return – particularly when rising vacancy rates are also taken into account. The uncertainty associated with the weaker economic environment has also undermined investment intentions and is dragging private sector construction activity lower.

These trends show through in Chart 10, which reveals that the volume of private sector non-residential consents has declined 11% over the last year and is 14% below 2018’s record high. This fall to date compares favourably with the drops in private sector consents of 31% following the GFC, 24% in the late 1990s, and 72% after the 1987 stock market crash. However, it also hints at downside risks to our non-residential construction forecasts. Although commercial property markets are currently in a better position than during previous downturns, vacancies are likely to increase further over the next year as tough economic conditions and weak demand weigh on sales activity, profitability, and employment. Even higher vacancies will further undermine the business case for new buildings going ahead.

We will continue to monitor trends in the non-residential property market over coming quarters. The downturn to date is nowhere near as bad as the three previous major episodes highlighted in the data (thankfully!). Even though interest rates are starting to track lower, it is too soon to start thinking about the next upturn in consents and activity yet – particularly given the tendency of non-residential construction to lag the rest of the economic cycle.