Welcome to the June 2022 edition of Banner Asset Management’s Quarterly Property Report.
Rising interest rates and higher living costs have slowed the strong nationwide gains in residential housing prices over the past three months with some markets experiencing price declines. However, the rental market continues to tighten as low supply levels cause national vacancy rates to dive and rents to rise across all capital cities and residential property types.
Australia’s economy remains resilient in the face of recent monetary policy tightening by the Reserve Bank aimed at tackling a surging inflation rate, while the labour market remains strong. The national economy grew by 0.8% during the March quarter 2022, and by 3.3% over the past year due mainly to strong household spending, supported by higher commodity prices and a growth in investment. The unemployment rate fell to 3.5 per cent in June, its lowest rate in almost 50 years.
Nevertheless, there remain several sources of uncertainty over the outlook, including the response of consumers to rising prices, the impact of further expected rises in interest rates and the decline in housing prices in some cities.
The new Labour Government, elected in May, has announced plans for a ‘Help to Buy’ scheme designed to enable more low to middle income earners gain a foothold in the property market, while ending the previous government’s plan to allow buyers to access their superannuation to purchase homes. Up to 10,000 households are expected to be able to access the new scheme, although the price of properties available to be purchased will be capped.
Across the whole market, shortages of materials and labour are emerging as a major challenge for residential construction and infrastructure projects. Dwelling investment declined in the March quarter as the Omicron outbreak and weather-related disruptions exacerbated ongoing supply constraints, although there remains a strong pipeline of construction work. Business investment increased in the March quarter, but supply constraints and cost overruns slowed the rollout of public investment plans.
The decline in national housing prices over recent months has been concentrated in Sydney, Melbourne, and Canberra, while in other capital cities and most regional areas the price growth has moderated. National home values fell by 0.2% in the three months to June, the first quarterly drop since October 2020.
In the commercial real estate market, there is strong demand for industrial and logistics real estate with occupancy rates at near record highs driven by the remaking of supply chains and a lack of speculative supply. Office markets have remained resilient in the face of serial disruption to economic activity.
In our Spotlight section this quarter, we look at the outlook for the residential rental market, where vacancy rates stand at near-record low of 1.0%, pushing up rents. We explore what is behind the shortage and the potential solutions.
We hope you find these insights useful.
Founder and CEO
Australia’s economy maintained its post-pandemic recovery in the March quarter, although quarterly growth slowed to 0.8% from the strong 3.6% rise in the December period. The annual growth rate remained a healthy 3.3% to the end of March, according to the latest figures from the Australian Bureau of Statistics. Household spending rose 1.5% during the quarter, with spending on discretionary goods and services up 4.3%, exceeding pre-pandemic levels for the first time.
The Reserve Bank of Australia (RBA) said it believes the economy does have significant underlying momentum and would post a pick-up in GDP growth in the June quarter, driven by further strong household consumption and an upswing in both private and public investment. GDP is forecast to expand by 4.25% during 2022 after which it is expected to moderate to 2.0% in 2023.
The underlying economic momentum enabled the RBA to begin raising the cash rate, announcing two consecutive rises of 0.5% during May and June to bring the target to 1.35%. RBA governor Philip Lowe said inflation was expected to peak at around 7.0% in the December quarter before falling back towards the 2-3% range next year. However, Lowe added much will depend on household spending and how consumers respond to both higher prices and the increase in interest rates. The RBA is widely tipped to announce a third 0.5 percentage point increase in the cash rate to 1.85% in August in its most aggressive tightening cycle in almost 30 years.
The new Labour Government is expected to focus on the rising cost of living when it brings down its first budget in October. Labor’s five-point Economic Plan, announced during the election campaign in May, aims to reduce the costs of living; drive productivity growth; alleviate supply side pressures; get wages growing; and invest public money in a way that delivers genuine economic value for Australians.
With budget deficits forecast to reach $261.4 billion over the four years to 2025, and national public debt headed towards the $1.0 trillion mark, Prime Minister Anthony Albanese has said the government’s first budget would initially prioritise getting spending under control. But with the government under pressure to deliver on its election promises to improve spending on healthcare, education and childcare, new Treasurer Jim Chalmers will need to find a lot of savings or increase taxes in some form.
Across Australia, state governments have been delivering their budgets for the coming fiscal year. The NSW government unveiled plans to replace land transfer duty with an annual property tax. Victoria put the health sector at the centerpiece of its plans with $4.2 billion being set aside to increase hospital capacity. In Queensland increased support for the health system also featured along with disaster recovery assistance and spending on childcare.
Healthcare has been growing as a concern over the June quarter with the re-opening of state borders, the relaxation of mask wearing rules and the arrival of new Omicron variants producing a sharp growth in the numbers of people succumbing to COVID-19. Australia’s death rate from the virus passed the 10,000 mark in June with more than 70% of the total being recorded in the past six months.
Central banks tighten monetary policy
Across the world many central banks have begun to withdraw some of the substantial stimulus implemented during the pandemic, while in general fiscal policy settings remain supportive of growth, at least in advanced economies. The central bank action has been mainly prompted by the surging inflationary pressures caused mainly by disrupted supply chains and the impact on food and energy costs of the war in Ukraine. Inflation in many developed nations increased in March and is now expected to reach 6–9 per cent in 2022, around 1–2 percentage points higher than forecast earlier in the year.
The economic impact of Russia’s invasion of Ukraine continues to resonate around the world, largely manifested in higher commodity prices. The prices of thermal coal and European gas have risen by 30–40 per cent since the start of February, while the price for oil is around 20 per cent higher. These higher commodity prices are adding to upstream price pressures seen in most nations but, in commodity-exporting economies such as Australia, they are also boosting national income. As a result, Australia’s terms of trade have reached a new peak in the first half of 2022 and are expected to remain generally higher than previously envisaged throughout the year.
The US Federal Reserve has been leading the way on tightening monetary policy, aggressively lifting interest rates this year as its works to tame the highest inflation in over 40 years, a move it has acknowledged could slow US economic growth and weaken the labor market. At its June meeting the Federal Open Market Committee (FOMC) decided to raise its benchmark funds rate by 75 basis points to a 1.5-1.75% target range, effective June 16, 2022. It was the Fed’s biggest rate increase since 1994. After an unexpected surge in inflation to 9.1% in June, some expect a one percentage point rise is the likely next step.
The rise in rates is stoking fears of a recession though data to date has shown the U.S. economy was set for a moderate rate of increase in the second quarter after having declined in the first quarter, and the labor market remains very tight. Fed officials, nevertheless, significantly cut their outlook for 2022 economic growth to forecast a 1.7% gain in GDP, down from 2.8% forecast in March.
The inflation projection was lifted to 5.2% for this year from 4.3%, though core inflation, which excludes rapidly rising food and energy costs, is forecast to be 4.3%, up just 0.2 percentage point from the previous projection with price pressures expected to ease in coming months.
In the UK, where political turmoil has seen Prime Minister Boris Johnson resign, the Bank of England raised its key interest rate 0.25 percentage points to 1.25% in June. The move came after the 12-month CPI inflation rate rose to 9.0% in April despite weaker than expected GDP growth in the month. The BoE expects inflation to be over 9% during the next few months and to rise to slightly above 11% in October before heading back towards its 2-3% range next year.
At its meeting on 9 June, the European Central Bank decided to leave rates unchanged but announced plans to start hiking in July with an initial 25 basis
point rise and a further hike likely at its September meeting. The move followed data showing annual consumer price inflation across the 19-member euro area hit a fresh record high of 8.1% in May. Inflation is now expected to hit 6.8% in 2022, declining to 3.5% in 2023 and 2.1% in 2024, which are all substantial increases from the Bank’s March projections.
New Zealand’s central bank delivered its sixth straight interest rate hike in July, hiking its official cash rate by 50 basis points to 2.5%, the highest level since March 2016. The RBNZ signaled it remained comfortable with its planned aggressive tightening path as it seeks to reduce the second-round effects of runaway inflation and said it expects cash rates to peak near 4.0% in 2023.
Meanwhile in China, the central bank has kept its main policy rate unchanged at 2.85% with most analysts expecting the People’s Bank of China to lower borrowing costs and reserve requirements for banks or lower interest rates to pump cash into the economy to prop up the cooling economy.
The RBA lifted the cash rate a further 50 basis points in July, taking the cumulative hike since it started tightening policy in May to 125 basis points. As a result, the second quarter of the year has seen CoreLogic’s national measure of housing values, the Home Value Index (HVI), ease to an 11.2% gain in June across all the capital cities, down from a peak of 22.4% for the year to the end of January 2022.
Conditions are diversified, but every capital city has moved from a peak rate of growth to a lower level with housing values in Sydney falling 2.8% while Melbourne saw a fall of 1.8% over the quarter but Brisbane recorded a 2.7% gain. Sydney’s dwelling values are 3.1% below the record high recorded in January 2022 while Brisbane dwelling values are currently at a record high.
In the three months to June, the change in capital city dwelling values dropped by 0.8% compared to regional markets which increased 2.0% for the period. Australian Bureau of Statistics (ABS) regional population growth figures for FY 2020-21 help explain the strong housing conditions outside of the capitals. The number of people living in regional areas of Australia increased by almost 71,000 residents, while residents living in the capitals fell by approximately 26,000, due mainly to a sharp drop in Melbourne and, to a lesser extent, Sydney.
Sales volumes are starting to ease from recent highs. CoreLogic has estimated that in the 12 months to June, there were 584,917 sales nationally, up 3.2% compared to the previous year. However, initial sales estimates over the June quarter were 15.9% lower than the same quarter of the previous year.
At the national level, properties are taking longer to sell. In the June quarter, the median days on market was recorded at 30, up from a recent low of 20 days in the three months to November. While new listings have steadied, they are now 5.9% higher than the five-year average for the equivalent period.
Similarly, vendor discounting has also increased from the recent low of 2.8% recorded in the three months to April last year. In the three months to June, the median vendor discount at the national level was 3.5%.
Unlike changes in dwelling purchase values, rental value growth remains high across Australian dwellings. Rent values increased a further 0.9% in June, taking rents 9.5% higher over the year. The divergence between capital city and regional markets was also apparent for rental properties. Over the year
to end of June, capital city rental rates rose by 9.1 % compared to regional markets which saw rents increase 10.8%.
Around the country demand continues to outstrip new supply for industrial and logistics property with Sydney one of the tightest held markets and Melbourne getting tighter by the month.
The national vacancy rate continues to fall and stood at a record low of 0.8% at the end of the first half of 2022. Australia has the lowest national vacancy rate globally, according to CBRE Research and Sydney has the lowest vacancy rate of any major city in the world. Strong demand throughout the pandemic has compressed commercial property yields to record lows, particularly for industrial properties, which in turn has increased values to record highs. For the first time, the Australian average weighted Prime Industrial Yield of 3.71% has moved clearly below Prime CBD Office Yield of 4.53%, as at the end of 2021. However, rising funding costs may impact the market in several ways, challenging these high prices and values. First, it may reduce the amount investors can borrow and therefore bid for properties. A reduced number of bidders and the lower competition this creates may be enough to ease trading activity and price growth (1).
Property income is expected to start to increase in the short- to medium-term, as the economy rapidly rebounds from the impacts of COVID. Driving this will be a reduction in vacancy rates as well as a more general lift in inflation. Projections for increasing inflation should feed through to rents linked to the CPI over the next couple of years. So softening yields or cap rates may, at least in part, be compensated for by this potential rise in property income over the next 1-2 years, as the driver of price and value switches from cap rate compression to income.
There has been limited leasing activity in the first quarter though the leasing market has continued to tighten across all precincts compared to the already exceptionally low rates in the second half of 2021, with vacancy levels currently at an all-time low. As a result, rental growth of around 10% has been recorded in the first half of 2022 with some transactions up 15% on 2021 levels. The supply pipeline is expected to be relatively low in all precincts going forward with weather delays pushing many projects into 2023. Although the 2022 supply pipeline is at a record high, totaling 874,880sqm, 73% of this new floorspace is already pre-committed. There will be increased upward pressure on rents especially as the Christmas period approaches with vacancy levels at close to zero.
Vacancy rates have stabilised at record low levels after the sharp rise in demand from occupiers throughout the final quarter of 2021. Rising construction costs and delays in the arrival of materials are slowing the speculative development pipeline which is reducing the supply of more space. Transport, Postal and Warehousing occupiers make up most of the leasing transactions in the past six months although manufacturing is picking up its space requirements and retail trade is closely following. Like the Sydney market, the record low availability of vacant floorspace has led to strong rental growth in super prime and prime grade stock. Super prime and price face rents have grown significantly by 13.9% and 11.1% respectively.
Brisbane has recorded its largest decline in vacancy levels between the last six months of 2021 and the end of the first half of this year. The vacancy rate now averages around 1.4%. Occupier demand over the past six months has been driven by the retail trade and manufacturing sectors which together account for 70% of the total. The low availability of floorspace is driving up rental rates, while the increase in construction costs is putting many speculative developments on hold. As a result, prime net face rentals have recorded a 5.2% year-on-year growth and now average around $118 psm. It is expected rental growth will continue for at least the next 12 months in line with the trend seen nationally. However, there is a good supply of new stock expected on the market from the second quarter of 2023.
The latest results from the Property Council of Australia’s office occupancy survey – a series which began two years ago as the Pandemic took hold – shows the uptake of CBD desks around the country barely increased in June over the previous month and remains at levels well below pre-pandemic levels.
There has been limited demand recovery in the national CBD office market over the first quarter of 2022 with positive net absorption recorded for a fourth consecutive quarter. However, this recovery has been patchy on a CBD basis, with Sydney, Melbourne and Brisbane affected by some larger corporates rationalising their space footprint. Positive net absorption was only recorded in Adelaide, Perth and Canberra over Q1 2022 (1).
Australian CBD prime gross effective rents (PGER) increased by 0.4% over the quarter. This was the first increase in effective rents since the first quarter of 2020 and is an indication that weighted national CBD effective rents have bottomed out and are currently in the recovery phase of the cycle. However, job advertisements remain strong, an indication that businesses are looking to increase headcount growth in the near term, which is a positive for office demand.
Demand recovery has been patchy for the Sydney office leasing markets during the first half of 2022. The prime vacancy rate has increased to 11.6% over the quarter while the secondary vacancy rate fell to 13.5%. Overall, the headline vacancy rate has declined to 12.3%.
Net absorption totaled 8,900 sqm over first three months of 2022, which is the first quarter of negative demand since the same period in 2021. This was largely due to poorer demand for prime stock, with 5,300 sqm of prime net absorption over the quarter. The withdrawal of 270 Pitt Street in Q1 removed 24,400 sqm of space from the market. No new completions were recorded this quarter.
Investment activity over the March quarter totaled $2.27 billion, which is a 60% increase over the first quarter 2021 sales volumes and the strongest Q1 for many years. In terms of new supply there are currently nine projects under construction across the CBD, totaling 326,800 sqm and equivalent to 6.3% of current total stock. These developments are expected to be delivered between 2022 and 2024 and have achieved an aggregated pre-commitment rate of 52%. The majority of the developments are in the Core precinct.
Positive net absorption Sydney CBD
The Melbourne office leasing market tightened over the March quarter to have a headline vacancy rate of 14.8%, still well above the 10-year quarterly average of 8.5%. Comparatively, the vacancy rate in the CBD in 1Q20 was recorded at a low of 3.4%. Prime vacancies held steady at 15.26% as the secondary market recorded a vacancy increase to 14.8%.
No projects reached practical completion in the CBD in the March quarter. Two projects are set to be completed in the final quarter of 2022, bringing around 28,911 sqm of space to the market. Five new projects (153,690 sqm) and three whole building refurbishments (75,659 sqm) are currently under construction and expected to be completed by mid-2024.
Prime gross effective rents marginally increased as face rents rose 1.0%. Incentives continued to hold steady to an average of 38.5%, with prime net face rents increasing 1.0% to $636 per sqm pa. As a result, prime gross effective rents continued to stabilise for a third consecutive quarter, rising 0.5% to $518.8 per sqm pa.
Headline vacancy rate for Melbourne CBD
Vacancies for premium offices in the Brisbane CBD fell by 1.4% in the March quarter compared with the previous quarter, while vacancies have risen for A-grade buildings, jumping up from 13.2%to 19.7%. Even with the sharp increase for A-grade space, total vacancy remains stable at 13.5% and is expected to stay that way through 2022 with limited new stock becoming available. Brisbane recorded its first increase in prime gross effective rents during the March quarter since the first quarter of 2020, in a sign that landlords have regained some confidence. Headline vacancy rates edged lower over the quarter, decreasing by 0.5% to 14.9%. This is the third consecutive quarter to record a declining vacancy rate since the third quarter of 2019. Despite this decline, vacancies remain above the 10-year quarterly average rate of 14.3%. Prime gross effective rents (PGER) have increased by 1.4% to $392 psm over Q1 while secondary gross effective rents (SGER) increased by 1.0% to $292 psm.
The supply pipeline for Brisbane CBD remains large, with 149,555 sqm under construction. 360 Queen Street began construction in Q1 and is set to deliver 45,000 sqm of commercial space to the market. The completion of 80 Ann Street has been pushed out for another quarter and is now expected to be completed in May 2022.
Headline vacancy rate for Brisbane CBD
Rents in the June quarter of 2022 experienced the largest jump in 14 years, Domain’s research found (1). Unit rents reached higher levels than at the start of the pandemic for the first time in Domain’s June 2022 Quarterly Rental Report, and this was closing in on the 2018 record high of
$550 a week.
According to community service group Anglicare, which conducts an annual survey of over 45,000 rental listings across Australia, it has never been harder for tenants to find an affordable rental property, and there is now a real crisis in rental affordability. In the past year, Anglicare found the number of advertisements for rental homes had plummeted by over a third, which was unprecedented.
At the other end of the spectrum, the results of the 2021 national census revealed that, of the 10.8 million dwellings counted in the 2021 survey, there were just over one million unoccupied homes on census night – almost 10% of the national housing stock. Of the housing stock that was occupied on census night, 30.6% was rented, down from 32% at the census in 2016. The remaining properties were either owned outright (31%) or being purchased with a mortgage (35%) (2).
With the rise in population over the period between the two census estimates, tenant advocacy group Better Renting estimates that the number of rental households increased by 280,000 from the 2016 census to 2.8 million at the latest count. Within this number there has also been a big change in the type of landlord, with private landlords increasing their share of the market to 26% from 20% and the percentage of state and territory government landlords declining sharply to 3% from 6%.
The average expenditure on housing by rental households has also risen relative to owners. Renters currently spend an average of 20% of their income on housing costs, while owners with a mortgage pay around 16% (1).
In Australia, this shift towards greater numbers of people renting, increased rental costs and a lack of supply, has been driven by a range of factors.
Chief Lending Officer
Finding solutions to the rental crisis will require the combined efforts of government and industry over a long period of time and dramatic actions may be required.
Australia’s housing tax concessions may need to be reformed – including negative gearing and capital gains tax exemptions, which tend to favour wealthier Australians and encourage property investors, sometimes at the expense of people trying to buy or rent a home. Anglicare estimate negative gearing and capital gains tax concessions cost the Federal budget a staggering $14.85 billion a year, and overwhelmingly favour the wealthiest 20% of Australians.
Better targeting negative gearing and capital gains tax exemptions may provide greater funding for social housing and more affordable rental homes for people on low incomes.
Housing supply is the other side of the equation. Building more affordable housing requires greater action by state and federal governments. As with many other areas of policy, whether it’s building and maintaining roads, or funding hospitals, there is a role for Government to play in addressing market failure in housing supply and ensuring everyone has a decent place to live.
With rising inflation and interest rates continuing to put pressure on households, it is likely that political pressure will build on the new Labour Federal Government and on the state and territory governments to tackle the affordable housing crisis and we should expect to see some action in the not-too-distant future.
We provide an opportunity for investors to gain exposure to the real estate debt market through lending to established and proven developers for development projects, or for strategic acquisition of sites earmarked for development in the future.
At Banner Asset Management we provide opportunities to invest in secured debt products and other property through funds alongside other project partners.
In the residential space, our focus is on medium density development (apartments and town-houses) in the bigger population centres of Sydney, Melbourne, and Southeast Queensland, which provide greater liquidity and depth than other markets in Australia. This includes mixed-use residential projects that incorporate uses such as office space or retail. We also invest in non-discretionary retail and the industrial sectors, as growth in e-commerce drives demand for warehousing and logistics.