The Australian commercial real estate market will see further growth in capital values and strong returns, as the impact of lower interest rates flows through and creates the conditions for yield compression, according to the latest research from Knight Frank.
Knight Frank’s Chief Economist, Ben Burston, forecast the Australian economy would gradually regain momentum in 2020 as a result of lower interest rates and the recovery in the housing market.
“However, despite an extended cycle, we are yet to see the re-emergence of inflationary pressures and stronger wage growth. In fact, there is a high chance that interest rates will move even lower in 2020, and the RBA may even undertake quantitative easing,” Mr Burston said.
“As a result of a sharp downward shift in interest rates, and the prospect of further RBA action, we expect the investment market will drive to new highs in 2020, prolonging the property price cycle.
“In a sense, the Australian market is continuing to play catch-up to the unprecedented lowering of global interest rates.
“Based on the historic lagged relationship between bond yields and prime office yields, we expect significant further yield compression during 2020 and 2021, with Sydney prime CBD office property yields to decline by 50 basis points over the next two years to 4.1 per cent.”
Head of Institutional Sales, Paul Roberts, noted the shift in interest rates had changed investor perception of pricing and outlook.
“We now see major investor groups, both local and offshore, gearing up for the next phase of investment in the Australian office market.
“Groups from Hong Kong, Singapore and Europe continue to seek core assets with fundamental stability, and Australia is an extremely attractive proposition for them, while local wholesale funds and superannuation groups remain just as competitive.
“The challenge is accessing sufficient stock to satisfy the demand for core product, and this competitive tension is likely to drive yields lower over the period ahead.”
The strong outlook is reflected in the extent of capital raisings in recent months for office and industrial property and ongoing confidence in market fundamentals.
Mr Burston said the recent run of capital raisings pointed to strong prospective demand from institutional investors to allocate to office and industrial property assets, notwithstanding slower economic growth.
“As the economic outlook gradually improves, the major office and industrial markets are also expected to enjoy continual rental growth, but at a more even pace across cities.”
Associate Director, Research & Consulting for Knight Frank, Chris Naughtin, said capital growth in both the office and industrial sectors should pick up in 2020 and 2021, resulting in total returns remaining in double digital territory for the sixth consecutive year.
“We expect capital growth of office property to pick up by 5.8 per cent in 2020 and 6.4 per cent in 2021 from an estimated 5.4 per cent this year.”
Mr Naughtin also believes industrial property will perform relatively well as demand for warehousing space continues to grow as a result of the rapid growth of e-commerce and logistics.
“The growth of e-commerce continues to drive demand for industrial property. Even as capital growth slowed from 7.7 per cent in 2018 to an estimated 6 per cent in 2019, we expect it to pick up to 6.4 per cent in 2020 and 7 per cent in 2021.
“Sydney and Melbourne have dominated occupational market performance in both the office and industrial sectors over the past five years, substantially outstripping Brisbane, Adelaide and Perth in terms of rental growth, capital growth and overall returns,” Mr Naughtin said.
“In 2020, we expect to see the start of a shift to a more even pattern of growth moving forward.”
The Brisbane, Perth and Adelaide office markets have each benefited from a sustained run of positive absorption which has lowered vacancy and exposed a shortage of prime stock even though overall vacancy remains elevated.
However, office vacancy in Melbourne is set to increase as a large wave of new office supply is coming to the CBD.
“Melbourne office market conditions have been very tight for the past two years, as the market has benefited from a sustained run of high net absorption which has driven the vacancy rate to a low 3.3 per cent,” Mr Naughtin said.
“In 2020 and 2021 there will be around 590,000 sq m of supply to be delivered to the Melbourne’s CBD, with a big focus around around the Docklands & Western core.
“This new supply will see the vacancy rates rise from historically low levels and will be the largest increase in supply since the early 1990s.
“While strong tenant demand is expected to continue, and the new schemes are substantially pre-committed, the sheer volume of new development set to be completed over the next few years will push the prime CBD office vacancy rate from 3.3 per cent to 7.7 per cent in 2021.”
Meanwhile, occupiers are increasingly putting pressure on real estate to respond with innovative solutions to ensure work environments deliver a positive workplace experience for their staff.
Mr Burston noted after a recent focus on improving the physical amenity provided by buildings and surrounding precincts, the next few years would see a shift toward greater focus on mental well-being and the integration of educational facilities in office environments to enrich the occupier experience.
“Occupier needs are changing, and forward thinking owners will continue to want to get ahead of the curve.”
For a full copy of the report head to Knight Frank