Australian real estate: Our view for the long term

All four major banks increased interest rates during October, citing their reason for the rate hike due to increased pressure from the Australian Prudential Regulation Authority (APRA) for financial institutions to adhere to the 10% cap on property investor lending growth. Given that we are set to be operating in a low-growth environment for the foreseeable future, investors should  ensure that any downside risk is eliminated or mitigated.

The Australian commercial real estate market is benefiting greatly from the current low interest rate environment, with strong investment demand from both Australian and international investors. Leasing and consumer spending are improving in Sydney and Melbourne – where the largest concentration of property resides – but momentum is slower in the mining states as the commodities boom recedes.

An overview of our outlook for the sector is below:

A low growth environment encourages a chase for yield, with lukewarm economic momentum and capital market volatility underpinning this trend. Real estate remains good value compared to bonds and equities.

We expect that cap rates will continue to decrease in the short term while interest rates stay low, but they are likely to start to increase later in the decade once interest rates start to rise. The cap rate is the rate of return on a real estate asset based on the income the property is expected to generate.

Evolving technology, shifting demographics, increasingly flexible workforces, ongoing business margin pressures, competition from Asian financial hubs and globalisation are all likely to affect the demand for office space. These changes present opportunities for investors.

The latest real-world data is starting to verify our key views of the future of retail research that consumers will shop where most convenient, or somewhere offering a retail and non-retail ‘experience’ such as a major regional shopping centre, CBD, market, or high street.

While office vacancy rates have risen and rents fallen, large shopping centres have provided the strongest risk adjusted returns in the resources states (Western Australia and Queensland) in the past and this is set to continue despite generally weaker momentum in the mining states.

Industrial has benefited greatly from the chase for yield, prompting capitalisation rates to compress. But it’s now close to the top of the cycle and likely to be most impacted when the music stops because of its historically lacklustre rental growth to back up pricing. Investors should remain patient – there will be an opportunity to get exposure to the sector later in the decade when interest rates start rise. Industrial is likely to benefit from some of the negative structural headwinds facing the retail and office sectors.

Michael Kingcott, Head of Property Investment Strategy and Research, AMP Capital

Michael is the Manager of the Property Investment Strategy and Research Team, responsible for leading a team of property investment analysts who monitor and forecast the domestic and international property markets. Michael joined AMP Capital in 2005 but has been at the coalface of the commercial property markets for more than 20 years, previously working with Knight Frank, Jones Lang Wootton and the University of Western Sydney property research houses. Michael’s experience lies in researching and forecasting the performance of property markets, property/investment analysis and benchmarking. He has substantial exposure to and familiarity with the major property markets across Australia and the Asia Pacific region.

 

Source: AMP Capital

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