- The full impact of interest rates is not yet visible
- Anecdotes of renegotiations following rate hikes have been seen
- The industry is expected to continue to be significantly undersupplied for some time
As another quarter goes by, we look back on the past months.
So far it has been characterized by many of the same issues, with “record low” continuing to precede various metrics and keywords including tight supply, low interest rates, rising rents, blowouts building, etc
Events throughout the quarter added a bit of whimsy to what initially looked like a broken record, but the full impact of which remains to be seen.
Interest rates have risen, but the cash rate remains low overall. Construction timelines have been changed, meaning the stock to go live this year looks a lot thinner, but it may be to the relief of some that buildings will go live at all given concerns surrounding construction more broadly.
Of course, there’s still a strong desire to bring back office demand en masse, and it looks like the goal is getting closer – Property Council occupancy data showed encouraging signs in June, but more recently , the recovery seems to have stalled.
Finally, the search for solid investments in an uncertain world continues to drive the commercial real estate sector.
This summary includes information from 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).
According to Raine and Horne, increases in spot rates haven’t seemed to deter buyers, particularly homeowners.
According to the report, as interest rates normalize, businesses are looking to buy more than they rent. Indeed, in many cases, it is always cheaper to buy than to rent.
“This is driving strong demand from owner occupiers, especially in the industrial real estate market.”
Raine and Horne Q2 2022 Business Overview
The Dexus Report wrote that: “…rising interest rates have fueled speculation about house prices going forward given narrowing yield spreads.” The report also noted that, historically, interest rate hikes over the past four tightening cycles have been just 2.25%.
In addition to the cash rate, the report also noted the rise in the 10-year bond yield to 3.5% over the past quarter, stating that it “…has implications for confidence and markets. investment”.
Herron Todd White’s report says his agents are already seeing a drop in sales due to rising interest rates. The report also notes that over the next few months, “…the market is likely heading for a phase where there will be a noticeable disconnect between vendor expectations and market value.”
In an attempt to segue smoothly into the subject of supply, the Dexus report noted under the interest rate heading, that periods of uncertainty “…can unlock development sites that were previously not available.
There will be fierce competition for space though, the Raine and Horne report noted that the boom in residential values has seen some developers shift from industrial to industrial chic.
Significant undersupply is also expected to continue, with the Raine and Horne report noting limited development of new industrial areas, and the Herron Todd White and Dexus reports noting continuing construction cost issues.
HTW said four key factors have been responsible for reducing the appetite to create new industrial stock: cost of land, cost of construction, rents and yields.
To quantify the construction problems, David Walsh of HTW wrote that the price of construction has increased by around 30-40% in the last year.
The cost of land has also skyrocketed, with Mr Walsh saying ‘demand just outstrips supply, so premiums are being paid to get land suitable for development’.
Rents haven’t budged much in about a decade, according to the HTW report. As rents began to rise, Mr. Walsh noted that it was mostly prime space in prime locations. The result has been that rents will have to rise much further before “…development opportunities pile up”.
Finally, the report says yields are at record highs due to industrial investments that have been snapped up like hotcakes throughout the pandemic. Mr. Walsh noted that the tight yields “…translated into high purchase prices, which helped to mitigate feasibility risks due to rising land values and construction costs. “. The next few months will be interesting, Walsh said, yields have now peaked in this cycle and are beginning to soften.
“We have already seen situations where acquisitions agreed in principal before interest rates rose are now starting to be renegotiated.”
David Walsh, Director, Herron Todd White
For more details, please see the reports listed in the introduction.