Commercial property wrap Q2 2022

• Full impact of interest rates yet to be seen
• Anecdotes of renegotiations following rate rises have been seen
• Industrial likely to continue being significantly undersupplied for some time

As another quarter elapses, we look back at the months that were.

So far it has been characterised by many of the same issues, with “record low” continuing to precede various metrics and keywords including tight supply, low-interest rates, rising rents, construction blow-outs, and more.

Events throughout the quarter did add some caprice to what initially sounded like a broken record, but the full impact of which is yet to be seen.

Interest rates have been moving upwards, however, the cash rate remains low in the broader scheme of things. Construction timelines have been shifted around meaning stock to come online this year looks much thinner, but may be to the relief of some that buildings will come online at all given the concerns surrounding construction more broadly.

Of course, there is still a strong desire to bring office demand back in droves, and it seems that goal is getting closer – occupancy data from the Property Council showed some encouraging signs in June, however more recently that recovery seems to have stalled.

Finally, the search for solid investments in an uncertain world continues to drive the commercial property sector.

This wrap includes information from the Raine and Horne Commercial Insights Q2 2022 (RH), Dexus Australian Real Estate Quarterly Review Q3 2022, and Herron Todd White Month in Review July 2022 (HTW).

Interest rates

Cash rate increases didn’t seem to dampen the spirit of buyers – particularly owner-occupiers, according to Raine and Horne.

The report said that while interest rates normalise, businesses are looking to purchase more than they are leasing. This is because in many cases, it is still cheaper to buy than rent.

“This is driving intense demand from owner occupiers, especially in the industrial property market.”

Raine and Horne Commercial Insight Q2 2022

The Dexus report wrote that: “… rising interest rates have fueled conjecture about real estate pricing going forward given a narrowing of yield spreads.” The report also noted that, historically, interest rate rises over the last four tightening cycles have been just 2.25%.

Aside from the cash rate, the report also took note of the rise in the 10-year bond yield to 3.5% in the latest quarter, stating it “… has implications for confidence and investment markets.”

Herron Todd White’s report said its agents are already seeing sales activity slump as a result of the interest rate rises. The report also noted that over the next few months, “… the market is likely heading into a phase where there will be a noticeable disconnect between vendor expectation and market value.”

Undersupplied

In an attempted smooth segue into the topic of supply, the Dexus report noted under the headline of interest rates, that periods of uncertainty “… may unlock development sites that were previously unavailable.

There will be stiff competition for space though, the Raine and Horne report noted that the boom in residential values has seen some developers going from industrial to industrial chic.

The significant undersupply is also expected to continue, with the Raine and Horne report noting limited development of new industrial estates, and both the Herron Todd White and Dexus reports noting the continued cost of construction concerns.

HTW’s said four key factors have been responsible for the reduced appetite to create new industrial stock: land cost, construction cost, rents, and yields.

To put numbers to construction woes, HTW’s David Walsh wrote that the price of construction has increased by circa 30%-40% over the past year or so.

The cost of land has also ballooned, with Mr Walsh stated “Demand is simply outstripping supply, so premiums are being paid to secure land suitable for development.”

Rents haven’t moved much for about a decade, according to the HTW report. While rents have started to rise, Mr Walsh noted this was principally around prime space in prime locations. The upshot was that rents will have to rise much further before “… development feasibilities stack up.”

Finally, the report said yields are at record lows due to industrial investments being snapped up like hotcakes throughout the pandemic. Mr Walsh noted that tight yields “… translated to premium purchase prices which has been helping mitigate feasibility risks because of increased land values and construction costs.” The next few months will be interesting, Mr Walsh said yields have now peaked in this cycle and are beginning to soften.

“We’ve already seen situations where acquisitions that were agreed in principal prior to interest rate rises are now beginning to be renegotiated.”

David Walsh, Director, Herron Todd White

For full details, please see the reports listed in the introduction.