Commercial real estate sector resilient amid challenging conditions

Commercial property markets remained resilient this year despite higher interest rates hurting demand, according to a new report.

Dexus Research’s Australian Real Estate Quarterly Review Q2 2023 report found that the industrial sector has continued to hold strong, while the retail sector is likely to face some headwinds as interest rate and cost of living pressures begin to bite.

Dexus Head of Research, Peter Studley said while interest rate rises are making for challenging conditions, there are signs they are getting close to their peak.

“Despite volatility in pricing across all asset classes, there are reasons for investors to maintain or increase exposure to real assets, which include a steady defensive income return and a significant diversification benefit,” Mr Studley said.

Tight vacancy rates across the industrial sector

Across the industrial market, record low vacancy continues to lead to significant rent growth, which will mitigate valuation risks.

“While capital values have eased, key industrial markets have now achieved between 20-30 per cent growth in rents over the past nine months, which has been vital for preserving valuations,” the report said.

“Land values in Outer West Sydney and West Melbourne declined 10 per cent, with inner markets proving more resilient.”

The report said the tight vacancy and a strong rental growth outlook continue to attract capital to the Australian industrial market. 

“Investors are becoming more selective in their choice of product due to tightening capital markets,” the report said.

“Transaction volumes eased over the quarter with around $1 billion of investment recorded in the industrial sector. 

“Short WALE (weighted average lease expiry) and value add opportunities were more keenly sought after, as a means of capturing short term rent growth. 

“Foreign backed capital remained strong with acquisitions significantly outweighing disposals.”

Retail sector headwinds

The report also found that while sales growth has been above average over the past year, the retail sector is likely to face some headwinds through 2023. 

“Positives include a decline in shopping centre vacancy rates and an increase in international migration,” the report said.

“Migration has turned positive and is poised to drive sales growth and foot traffic in the retail sector. 

“Visitor arrivals are on track to reach their pre-pandemic levels in the second half of 2023, contributing to increased foot traffic and retail sales, particularly in tourist-centric areas. 

“This resurgence in migration is expected to have a positive impact on the retail market as a whole, providing much-needed support amidst the challenges of rising interest rates and inflation.”

The report said shopping centre vacancy rates, which had been on the rise during the pandemic, have been tightening. 

“After peaking in Q2 2022 at 5.1 per cent, Sydney regional shopping centres saw vacancies decrease to 3.4 per cent in Q4 2022,” the report said.

“Furthermore, vacancy rates in Brisbane for regional, subregional, and neighbourhood centres are now lower than pre-pandemic levels, suggesting a solid recovery across the shopping centre spectrum.”

“Like other sectors, the retail sector remains susceptible to broader economic factors, such as an increasing cost of capital.” 

The report said Sydney regional shopping centre yields have increased 50 basis points since Q2 2022. 

“On a positive note, given the retail sector did not face the same yield tightening as other sectors during the pre-pandemic period, it may experience a milder value cycle going forward,” the report said.

Flight to quality for office sector

Meanwhile, the flight to quality remains a significant factor for the office sector the report said.

“Office demand has been positive in the Melbourne, Brisbane, and Perth markets over the past quarter, while Sydney saw a contraction,” the report said.

“Perth recorded 27,000sq m of net absorption in Q1 2023, its strongest quarterly result since 2012, helped by buoyant conditions in the resources sector. 

“In Sydney CBD small to medium firms have been active in the leasing market, however a few large consolidations in the financial services sector have offset the smaller expansions. 

“A trend towards centralisation, where suburban occupiers have taken CBD space, has supported demand. Flight-to-quality remains a significant factor in the market, as higher quality buildings experience stronger demand. 

“In Sydney, for instance, premium net absorption was up 60,000sq m in the year to Q1 2023, while the total market saw a decrease of 45,000sq m.”

While in healthcare, there was an increase in private health insurance uptake and progress on state and federal government reviews to address rising costs and staffing levels.

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Rowan Crosby

Rowan Crosby is a senior journalist at Elite Agent specialising in finance and real estate.