The Real Estate Institute of Australia (REIA) expects to see interest rates remain at elevated levels, which will continue to drive commercial capitalisation rates higher over 2023.
REIA’s Commercial Agency Engagement Program found that the impact of high inflation and interest rates on the commercial property sector has been significant, with investment volumes down 58 per cent year on year.
REIA President, Hayden Groves said markets remained unsure on how long interest rates would need to remain restrictive in order to get inflation down to target levels.
“Indeed, the RBA has been clear that getting inflation back down to the target range of 2 to 3 per cent is their ultimate goal,” Mr Groves said.
“The impact of high inflation and interest rates to the commercial property sector has been profound.”
The report said it is more likely the RBA will let the current higher interest rates sit a little longer, as this allows them the best chance to keep a lid on unemployment and manage inflation.
Mr Groves said that while consumer confidence had been near record lows for some time now, business conditions for some sections remained strong.
“Unemployment remains near record lows, and while business confidence is flat, it is nowhere near the recessionary levels of consumer confidence,” he said.
“While office vacancy rates remain high across the country, particularly in the Sydney and Melbourne CBDs, occupancy across most asset classes have held up well considering the pace of interest rate hikes are yet to fully impact.”
In positive news for the commercial sector, the record high level of immigration is likely to see business conditions improve.
“One key driver of demand for commercial real estate is overseas migration,” Mr Groves said.
“Both the March and September 2022 quarters were record years for net overseas migration, which is extraordinary given how strong migration intake was prior to the pandemic.
“Small-scale commercial assets are often a target for new arrivals keen to start a business and with reasonable supply, high-street stock is finding new occupants.”
Meanwhile, build-to-rent will also encourage more investment in the sector he said.
“The emergence of the build-to-rent (BTR) commercial property investment category in more recent years is beginning to play an important role in providing additional housing stock where tenants are demanding it, opening additional investment channels for institutions,” he said.
The report also found that there are a number of potential disruptions to the industry ahead.
It said that the current economic climate, combined with the lingering societal effects of COVID-19, have created a set of economic challenges that will continue to impact the commercial property industry over the next year.
This will contribute to a downtrend in spending which will impact smaller businesses and retail assets.
While longer term, office and retail spaces will continue to be fundamental but will change in nature.
The report said that the work-from-home trend is something that will likely continue and put pressure on office and retail assets.
Technology is also one of the greatest disruptors to the office sector, with improvements in the ability to connect people, further reducing the need for office space.
A key long term economic impact to consider is just where interest rates are likely to settle once inflation is under control.
The report said that a 0.2 per cent cash rate is far too low to remain in the long term, and this setting was all about inducing demand.
A higher equilibrium cash rate may put pressure on highly leveraged properties in the short term.
In the medium term, higher interest rates may lead investors to seek higher yielding assets, potentially leading to adjustments in the low yields of some Australian commercial assets.