The spread between the yield on bond and core domestic property is at an all-time high, says AMP Capital, but investors are finding it hard to allocate amidst a greater number of international buyers and concerns at office overcapacity.

The recent drop in the Reserve Bank of Australia (RBA) cash rate to 2.25 per cent is intended to stimulate the economy, it is also expected to boost residential house prices, but the impact on quality institutional property is expected to be small.

According to John Dynon, head of separate accounts and specialist funds, real estate at AMP Capital, there was a major boost for quality property in the performance of shopping centres, where the cut in interest rate is boosting the amount shoppers will spend, while he was also seeing growing demand for Melbourne and Sydney offices.

He pointed out that the RBA cut had led the yield spread between bonds and real assets to grow to an historical high. “Quality institutional property is now delivering two-to-three times the yield available on bonds and that is being reflected in asset allocation decisions,” he added.

He noted that the investor focus in the Australian market continues to be on quality assets with strong lease covenants and robust income streams.

David Hartley, chief investment officer of Sunsuper, said he was cautious of office purchases, but more bullish on retail for the reasons Dynon stated. “I don’t think the drop in interest rates is going to be a big catalyst for a lot of improvement in office buildings.”

He noted that from just one view out of Sunsuper’s new investment office in Sydney, he could see five cranes.

“There is some pretty good stock coming on board and there will be pressure from vacancies, so I am not sure they will get the rental income they like. I would be cautious; retail will probably do OK, but offices could have a bit of soft patch,” he added.

For Ian Lundy, chief investment officer at the Retirement Benefits Fund, the biggest problem was being able to allocate to property in a domestic sector that was attracting foreign investors.

“(International buyers) are just generally creating price pressure in the market, the fact that their interest rates and rental rates are so low is part of the reason they are coming to the market,” he said.

He added that compared to other asset classes unlisted property was still reasonable value compared to alternatives such as equities.

Tim Stringer, senior consultant at Frontier Advisors, foresaw the property risk premium as falling in light of lower bond rates.

“That risk premium is too high,” he said. “The internal rate of return for high quality investment property is more like 7.5 rather than 9 per cent.”

He is concerned at investors going up the risk curve to achieve higher returns in a low yield environment.

“It would be better to accept that the IRR on good quality property has actually fallen, prices have gone, and accept they are going to get a lower return, but in a risk adjusted sense a better quality return,” he said.

“You have got to be experienced in that space or else you are taking more risks than you understand.”