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What’s next for local commercial real estate?


While performance has been strong in the past couple of years, there are a number of expected medium term headwinds in the commercial real estate market that need to be managed.


 

Trump win highlights need to position for rising interest rates

While performance has been strong in the past couple of years, there are a number of expected medium term headwinds in the commercial real estate market that need to be managed. These include the eventual rise in the interest rate cycle, and the impact on tenant demand for accommodation due to digital disruption, technological change, demographic change and globalisation.

Navigating the eventual rise in the interest rate curve is a medium-term issue all investors need to be considering in their portfolio construction across all asset classes. The shift in US politics has the markets believing inflation is coming back, so an adjustment in return expectations is underway across many asset classes in the wake of the election.

For real estate, rental and occupancy growth at or in excess of the rise in the discount rate can negate the impact on value. If it can’t, then there is the potential for a fall in property value.

Rental growth has lagged the rise in values, but this will start to redress

Australian commercial real estate values have risen sharply since 2012, but net income growth has lagged due to patchy economic growth, higher vacancies, and some structural adjustments. An example is the retail sector from growing online competition.

Many of those structural and cyclical adjustments are now bottoming. Occupancy cost ratios have adjusted in shopping centres and landlords are repositioning malls to combat the online threat, vacancy rates are falling in the main office markets and economic growth is strengthening. So the fundamentals for rental growth are improving.

Regional shopping centres that can expand to capture market share in areas of strong population and income growth are expected to generate the strongest rental growth in Australia over the next 10 years.

The Sydney and Melbourne office markets are considered to be the next strongest in terms of rental growth outlook, both benefiting from a rise in tenant demand as economic fundamentals improve. The Sydney CBD market is on track for undersupply of office space in 2018/19, and this market is expected to record the strongest rental growth in the country over the next five years because of that undersupply of accommodation.

Non-CBD office markets are expected to see above average rental growth in this window. Melbourne should experience similar conditions, but the market is not as cyclical, which complements Sydney’s volatility in portfolio construction models.

Brisbane is also starting to stabilise with a slow recovery in rents expected over the latter few years of the decade now that construction is slowing in that city.

Industrial assets in central metropolitan areas experiencing gentrification pressure and growth in demand from e-commerce-related business are also expected to be resilient, outperforming greenfield industrial areas in rent and land values.

 

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