Why it’s time to be opportunistic about commercial property

While interest rate rises were an inevitability following the record low cash rates of the COVID-19 pandemic, few predicted the unprecedented speed at which these changes would take place.

However, as is the case with economic cycles and the fiscal policies designed to support them, what comes up eventually comes down – and with inflation re-approaching the RBA’s 2-3% target, the broad consensus is that rate cuts could be back on the cards as early as late 2024.

These shifts will have important implications for commercial property as sentiment – and capital – returns to the market. So, what will this mean for investors looking ahead?

Rate hikes – a significant impact…but not across the board

In order to understand the potential impact of rate cuts, it’s firstly important to understand the impact of recent rate rises.

As interest rates have risen in the past few years, income returns from commercial property have inevitably come under pressure, with the rising cost of debt – at least initially – outpacing growth in rents. This, in turn, has impacted capital values across some sectors as buyers have re-adjusted their price expectations, or opted to sit out of the market altogether.

True to the varied nature of the commercial property market, however, the impact of rising rates has been far from universal.

Take the office market, for example. This sector was already facing structural issues in the lead up to rate rises as it grappled with the move towards work-from-home and the resulting shift in tenant demand.

Combined with an oversupply of office space in certain sub-sectors, these weaker fundamentals left the market more exposed to the economic pressures of rising debt costs.

On the other side of the ledger, it’s been a very different story for the industrial sector.

Rising demand from the growth of online retailing, together with a marketwide shortage of logistics assets, has seen vacancy rates in this sector drop to near-record lows. As a guide, the national vacancy rate for the industrial market stood at just 1.0% at the end of 2023 according to Colliers (Industrial & Logistics Capital Markets Investment Review 2024).

These factors have seen industrial rents soar, rising 13.6% in the first three quarters of 2023 according to JLL.

This growth has played a key role in underpinning the market’s resilience against interest rate rises, with rising rents helping to offset the impact of rate hikes and in turn supporting the buoyancy of capital values.

Looking towards the retail market, the impact has been more mixed.

While CBD retail has struggled under the pressure of rising living costs and the tightening in consuming spending, retail assets focused on non-discretionary services and goods – such as neighbourhood shopping centres – have remained resilient. This has particularly been the case in strong local economies such as Western Australia and Queensland, and where asset rents have been linked to CPI.

The “upside” of declining sentiment

The bottom line is that there have been many factors at play influencing the performance of the various commercial sectors – and because of this, some sectors and assets have kept pace with economic movements better than others.

Of course, the “upside” of declining sentiment in recent years is that investors and fund managers have been able to secure these properties at attractive prices.

The tides are turning: rising confidence, falling rates

While the central bank remains hesitant to give anything away about the future direction of interest rates, the consensus from economists is that the tide is about to turn.

The Commonwealth Bank is predicting that rates will start to head south from November, while NAB economists are forecasting the cash rate to drop to 4.1% by December before falling to 3.1% by the end of 2025.

While these are only predictions, we know from prior experience that expectations can have a powerful impact on sentiment.

This is already starting to happen, with the ANZ reporting a rise in consumer confidence in March , while Roy Morgan says business confidence increased rapidly in February 2024.

So, what implications does this hold for commercial property?

A time for opportunistic buying

As rates begin to trend downwards and investor sentiment returns, we’re going to start to see capital re-enter the market.

For those investors and fund managers who have been buying quality assets at discounted prices, this is going to be a chance to reap the rewards of well-made decisions. These assets will be well-placed to capture the market’s upside potential when interest rates fall and investor demand forges ahead.

For those in a position to enter the market in the shorter term, the time for these strategic acquisitions may not be up yet. Despite rising confidence levels, larger institutional groups and listed property funds are still taking a conservative approach to acquisitions as they continue to divert capital to meet investor redemptions.

This is creating a narrow and valuable window of opportunity for non-institutional investors and unlisted funds to purchase assets at discounted values before this capital and competition re-enters the market.

This window won’t last forever. However, the beauty of commercial property – as we have seen – is its diverse nature. Just as investors in industrial property have benefited from strong growth fundamentals in recent years, we will continue to see opportunities to maximise income and capital returns as sector-specific influencers continue to shift. And as always, we will be monitoring these opportunities closely at Westbridge to identify which assets and sectors will be best placed to ride the tide.

 

Recommended

What is IRR and why does it matter?
Are you a retail or wholesale investor?
How to invest in commercial property in Australia
What’s the difference between listed and unlisted property funds?
Tax-deferred income – a hidden perk of unlisted property funds

Damian Collins Profile photo

Damian Collins

Chairman - Westbridge Funds Management

As our Chairman, Damian provides invaluable guidance for the strategy behind our portfolio at Westbridge Funds Management. Damian is a well-known advocate across Australia’s real estate industry, and served as President of the Real Estate Institute of WA from 2018 to 2022. He has a Bachelor of Business from RMIT University in Melbourne, a Graduate Diploma in Property from Curtin University in Perth and a Graduate Diploma in Applied Finance and Investment, FINSIA.