Welcome to the September 2022 edition of Banner Asset Management’s Quarterly Property Report. Rising interest rates and higher living costs have reversed the strong nationwide gains in residential housing prices over the past three months with the major Sydney, Melbourne and Brisbane markets experiencing price declines. However, the rental market continues to remain tight as low supply levels cause national vacancy rates to dive and rents to rise across all capital cities and property types.
Economic activity is expected to gradually slow over the remainder of 2022 as household spending eases, and export growth slows, offset by more activity in travel and educational services.
Australia’s economy continued to grow 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 0.9% in the June quarter, 2022, and by 3.6% over the year to June due mainly to strong household spending, higher commodity prices and a growth in investment. The unemployment rate was steady at 3.5 per cent in September, its lowest rate in almost 50 years.
Economic activity is expected to gradually slow over the remainder of 2022 as household spending eases, and export growth slows, offset by more activity in travel and educational services. Overall, the coming months will start to see the rising headwinds of higher interest rates and falling house prices starting to hit household spending.
The new Labor Government has announced plans to help boost the residential property market including a Housing Accord with the states, territories and private investors to build one million new homes over the five years from 2024. The Accord calls on the $3.3 trillion superannuation sector to provide capital for construction and has been backed by three of the biggest Funds: Australian Super, Aware Super and Australian Retirement Trust. Federal Treasurer Jim Chalmers also announced another $350 million in additional funding for 10,000 new affordable homes on top of the government’s existing commitments.
Across the whole market, shortages of materials and labour remain a major challenge construction and infrastructure projects, with recent flooding across the eastern states putting more demands on the building industry workforce. Dwelling investment fell by 2.9 per cent in the June quarter to be 4.6 per cent lower over the year. This was seen as a surprisingly weak outcome given the large pipeline of work, with some businesses under considerable financial strain from high inflation in input costs.
The decline in national housing prices has continued over recent months with CoreLogic’s national HVI index dropping 4.1% in the three months to the end of September led by Sydney with a 6.1% drop, Brisbane with a fall of 4.3% and Melbourne which declined by 3.7%.
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 disruptions to economic activity.
In our Spotlight section, we look at the outlook for the real estate market following the recent series of sharp rate hikes by the Reserve Bank and the efforts by the Government to improve supply and access to the housing market.
We hope you find these insights useful.
The Reserve Bank of Australia (RBA) said the Australian economy continues to grow solidly and national income is being boosted by booming export markets. However, it noted the shortages in the labour market, with many firms having difficulty hiring workers. The RBA noted the unemployment rate of 3.5% was the lowest rate in almost 50 years. Job vacancies and job ads, it said, were both at very high levels, suggesting a further decline in the unemployment rate over the months ahead.
Inflation reached a 32-year high of 7.3% in the September quarter and the RBA expects it to peak at 8% by year end before falling back to be a little above its 2-3 percent target range by 2024. It aims to reduce inflation through a series of interest rate hikes without sending the economy into a deep recession. Governor Philip Lowe said the RBA’s priority is to return inflation to the 2–3 per cent range over time, while keeping the economy on an even keel. He admitted the path to achieving this balance is a narrow one and is clouded in uncertainty. In November the RBA increased the cash rate by 25 basis points to 2.85%, the seventh straight month of increases and the second consecutive 25 basis point rise after a run of 50 basis point increases from June through to September.
One source of uncertainty is the outlook for the global economy, which has deteriorated recently. About a third of the world economy faces two consecutive quarters of negative growth, according to International Monetary Fund forecasts. In its latest World Economic Outlook, the IMF said global inflation is forecast to rise from 4.7 percent in 2021 to 8.8 percent in 2022 but to decline to 6.5 percent in 2023 and to 4.1 percent by 2024. Upside inflation surprises have been most widespread among advanced economies, with greater variability in emerging market and developing economies.
It expects global growth to slow to 3.2% in 2022 from 6.0% in 2021 and to 2.7% in 2023. This is the weakest growth profile since 2001 – except for the global financial crisis and the acute phase of the COVID-19 pandemic – and reflects significant slowdowns for the largest economies. US GDP is expected to contract in the first half of 2022, the euro area in the second half of 2022, while China is experiencing its weakest growth in decades thanks to repeated lockdowns as part of COVID-zero policy and a growing property sector crisis.
The global economy’s future health rests critically on the successful calibration of monetary policy, the course of the war in Ukraine, and the possibility of further pandemic-related supply-side disruptions such as those caused by China’s lockdowns.
Across the world many central banks continue to tighten monetary policy settings in the hope of taming inflation that is now at multi-decade highs without tipping their economies into severe recessions.
The US Federal Reserve has led the way, increasing the target rate by 300 basis points in the seven months to October. Rates are expected to hit 4.25-4.5% by the end of 2022 as the Consumer Price Index edges higher from the 8.2% level posted in September.
In the UK, where political turmoil has gripped the financial markets causing bond rates to jump and the currency to weaken, the inflation rate has hit double figures, posting a 10.1% rate in September when the Bank of England raised its key interest rate to 2.25%.
At its latest meeting in October, the European Central Bank decided to raise interest rates by 75 basis points. The ECB’s deposit rate is expected to reach 2.5% by next March, as the bank acts much more forcefully than previously expected to rein in record inflation despite the threat of a region-wide recession.
New Zealand’s central bank delivered its eighth rate hike in 12 months when the RBNZ policy committee raised its official cash rate by 50 basis points to 3.5% in October.
China’s central bank has kept its main policy rate unchanged at 2.85%, but analysts say the People’s Bank of China faces pressure to lower interest costs and reserve requirements for banks to prop up the cooling economy and a troubled property sector.
The RBA lifted the cash rate for the seventh straight month at its November meeting with a second successive 25 basis point hike following a series of 50 basis point increases. The cumulative hike since it started tightening policy in May now stands at a 9-year high of 2.85%. It also increased the interest rate on Exchange Settlement balances by 25 basis points to 2.75 per cent. The Bank’s official rate is currently within its preferred 2.5-3.5 percent range. The rate hikes have had an impact on residential housing prices across the country with CoreLogic’s national measure of housing values, the Home Value Index (HVI), showing dwelling values across the combined national capitals falling 1.2% in October, following a 4.3% decline over the September quarter and fall of 0.8% in the June quarter.
All of the suburbs tracked by the HVI in Sydney, Melbourne and Canberra experienced a decline in values over Q3. Darwin, Perth and Adelaide had the lowest quarterly declines, as those cities reached their peak a little later in the cycle than the larger capitals.
Unsurprisingly, Sydney and Melbourne had the highest share of house and unit markets recording an annual decline in values. Sydney’s home values are down by 10.2%, equivalent to approximately $116,500, since the city hit its peak value in February 2022, CoreLogic’s daily HVI showed.
As part of its 2022-23 Budget, the NSW government will trial a property tax to replace stamp duty, which is seen as a disincentive to property buyers. First home buyers purchasing properties up to $1.5 million will be provided the option to pay an annual property tax instead of stamp duty, which is expected to ease the cost pressures buyers face. Victoria is considering a similar plan. The moves follow developments in Queensland where the state government pulled proposed land tax changes which would have penalised landowners who also owned property interstate.
Sales volumes are continuing to trend lower across the nation as buyer demand slows. CoreLogic estimates that in the year to the end of September, there were 566,609 sales nationally, down 5.2% compared to the previous year. Sales estimates over the year to date were 11.4% lower than the same period of 2021.
Properties are taking longer to sell. In the three months to September 30, the median days on the market was 35, up from a recent low of 20 days over the three months to November 2021. The flow of new listings is 14.3% lower than the five year average.
Similarly, vendor discounting has also increased from the recent low of -2.9% recorded in the three months to November last year. In the three months to September, the median vendor discount at the national level was -4.2%.
Unlike changes in dwelling purchase values, rental value growth remains high across Australian dwellings. But the annual growth in house rents has shown signs of moderating. It was 9.4% in the 12 months to September.
Unit rent values have seen increased momentum, rising 11.8% over the past year. This saw annual rental growth across national dwellings hold steady at 10.0%.
Through September, Australian gross rent yields rose to 3.57%, from a low of 3.21% in February this year. Since the end of 2021, gross rent yields in Sydney have lifted 51 basis points, and 35 basis points in Melbourne.
The ongoing remaking of industrial supply chains to meet demand for e-commerce kept industrial and logistics property riding high. The national vacancy rate held at a record low of 0.8% (1) at the end of the September quarter and spurred rents sharply higher.
With Australia already holding the lowest industrial vacancy rate among developed markets and limited scope for major new supply or speculative activity, conditions are expected to remain tight. Almost a third of the development supply of 654,000 sqm was delivered in the September quarter, but the annual total has been downgraded from 2.7 million sqm estimated in the second quarter to 2.1 million sqm. While still more than a third above the 10-year average, it is 20% below demand.
Construction delays because of bad weather, material shortages from supply chain disruptions and decisions to postpone several projects because of rising construction costs have pushed any additions to supply into the 2023 and 2024 forecasts. Colliers estimated more than one million sqm of new capacity could be developed by the likes of Goodman Group and Charter Hall as multi-story facilities in the next five years, emulating established practices in land-constrained markets such as Hong Kong.
Leasing activity slowed over the quarter because of the record low vacancy rates, with deal activity dominated by pre-leasing in Sydney and Melbourne, where there is more new supply in the pipeline. Gross take-up totalled 950,766 sqm for the quarter, putting the year-to-date total at 2.5 million sqm and on track to eclipse the long-term average of 2.6 million sqm by year end.
Rents increased again in the September quarter, up 6.7% to $134/sqm for national super prime property. That is up 19.2% year-on-year and in markets where conditions are particularly tight rents have jumped even faster: up 29.6% in Sydney and 24.3% in Perth.
Sales volumes have slowed in the middle of the year thanks to a lack of stock and rising bond yields and the increasing cost of debt, which deter some buyers. Demand remains strong however, with many local and overseas investors under-exposed to the sector at a time when e-commerce growth and broad economic conditions are strong. Yields were estimated to have edged 25 basis points higher to 4.7% and are expected to expand by as much as 100 basis points.
Rents and land values continued to grow strongly through the September quarter thanks to record low vacancy rates of 1.1% and continued strong demand. Gross take-up totaled 450,603 sqm, almost double the previous quarter, thanks to increased floorspace from new development activity1, with pre-lease transactions making up 50% of activity. While a deal for 74,200 sqm at Melbourne Airport in the North precinct was the highlight of the quarter, activity was concentrated in the west, with 53% of floorspace take-up. New floorspace added in the quarter totaled 261,785sqm – about half of the 2022 total – but the pipeline falls away sharply after that. Weighted average super prime rents rose by 7.7% in the quarter while land values for quarter hectare and 1.6 hectare lots rose 34.4% and 28.6% year on year.
Melbourne’s rents and land values continued to grow strongly through the September quarter thanks to record low vacancy rates of 1.1% and continued strong demand.
The Sydney market set itself apart from national trends with retail trade accounting for the largest share of leasing activity in the September quarter. Of 310,291sqm taken up over the quarter, retail trade accounted for 46%1, reflecting a boom in retail spending. This was nearly double the national average of 25%, well ahead of Melbourne’s retail share (13%) and reduced transport, postal and warehousing industries, long the dominant players in industrial property, to 44%. At just 0.3%, Sydney has the lowest vacancy rate in Australia and in the world and rents along with land values moved sharply. New supply of 227,276 sqm was more than double the previous quarter and brings the running total to more than 40% above the long-term average but it was not enough to bring the market back to equilibrium.
At just 0.3%, Sydney has the lowest vacancy rate in Australia and in the world and rents along with land values moved sharply.
Brisbane is considered to have returned to growth after better-than-expected leasing in speculative stock during the September quarter. Vacancy levels remain around 1.4%, with a lack of available space pushing incentives down by an average 233 basis points and year-on-year growth in net face rents up as much as 9.1 per cent for super prime, prime and secondary properties. Gross take-up was 161,971 sqm, less than half the record June quarter total, but still 42% above the 10-year average. Just 64,036sqm was added to supply, down by two thirds on the prior quarter but on track to a revised annual total of 536,00sqm, which is comfortably above the 10-year average of 322,300 sqm. A lack of available space and construction delays, combined with solid population growth, mean upward pressure on rents and land values is likely to continue through to 2026. Large occupiers looking to expand their presence beyond Melbourne and Sydney are expected to continue to drive demand.
Brisbane vacancy levels remain around 1.4%, with a lack of available space pushing incentives down by an average 233 basis points and year-on-year growth in net face rents up as much as 9.1 per cent for super prime, prime and secondary properties.
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A split is emerging in office occupancy levels between the cities most and least affected by pandemic lockdowns. Workers returned to their office in large numbers in cities that experienced relatively fewer pandemic lockdowns - Brisbane, Perth and Adelaide lifting occupancy levels to 70%-plus.
But in Sydney occupancy was stuck at 52% and in Melbourne it edged from 39% to 41%, according to a September survey by the Property Council of Australia1. A preference for working from home, or a hybrid of three days in the office has become entrenched in the workplace and continues to cast a shadow over CBD office property. Share prices for many listed office real estate investment trusts (REITS) reflected deep discounts to the net tangible assets amid investor concerns about the outlook for occupancy and rents and the rising cost of debt. In its Financial Stability Review, the RBA warned of a risk of decline in commercial property values2.
The national vacancy rate was 14% at the end of the June quarter, up from 13.5% in March and above the 10-year average of 11.2%. Net absorption came in at minus 3700 sqm, the first negative quarter since March 20213. Demand was positive in Sydney, Perth and Brisbane, but consolidation activity by larger organisations in finance, utilities, education and the public sector drove negative results in Melbourne, Adelaide and Canberra.
Against some of these negatives, anecdotal evidence suggests people returning to the CBDs in big numbers, buoying hospitality venues that traditionally serve office workers. As well, prime gross effective rents rose for a second straight quarter – by 1% – indicating they are in a recovery phase after turning down from the first quarter of 2020. Hopes remain that a strong labour market – with unemployment holding near record lows at 3.5% in September – will fuel further recovery in demand.
Investment activity totaled $1.72 billion in the June quarter, the weakest since the March quarter of 2012, according to JLL. Higher interest rates have affected the cost of debt with the added uncertainty over future rises contributing to a slowing in deal flows. Knight Frank estimated yields for prime and secondary CBD office properties moved 12.5 basis points higher to 4.5% and 5.2% by June4.
Demand for prime grade stock remained resilient in the June quarter in what is being seen as a flight to quality in the Melbourne CBD. The broader market continues to suffer indigestion from big additions to supply in the pandemic lockdown years of 2020 and, to a lesser extent, 2021. June was the second straight quarter of negative net absorption – minus 10,650 sqm – as large tenants continued to retrench surplus space via the sublease market. The headline vacancy rate edged up from 14.8% to 15% in the June quarter, well ahead of the 10- year average of 8.7%. However, vacancies eased in the prime category. There was not significant movement in net face rents and incentives remained stable at an average of 38.6%. After adding nearly 400,000 sqm in 2020 and 2021, the first new additions to Melbourne’s CBD supply are expected in the December quarter when two towers totaling 28,911 sqm are delivered. Another 230,000 of supply in new and refurbished buildings are expected to be completed by the end of 2024.
Vacancy rate for Melbourne CBD
Sydney’s CBD office market passed a big test with the first quarter of positive demand in 2022 and a rise in prime gross effective rents in the June quarter. There was 2400sqm of net absorption following the opening of the 88,000 sqm Quay Quarter Tower. The withdrawal of buildings at 33 Alfred Street and 333 Kent Street for refurbishment removed 41,800 sqm from the market. Demand remains patchy, however, with the vacancy rate climbing to 13% and the prime vacancy rate up from 11.6% to 12.9%. A total of 256,700 sqm of new developments representing 4.9% of existing stock are due to come to market through the end of 2022 to 2024. JLL noted those nine projects are concentrated in the core precinct and had achieved aggregate pre-commitments for 37% of the space. Investment activity over the June quarter was $410 million, bringing the half year total to $2.78 billion, their highest since 2019. Even so, the uncertain economic environment and rising interest rates have slowed activity, with the largest sale a $210 million property at 4-6 Bligh Street.
Vacancy rate for Sydney CBD
A mismatch between landlords and occupiers has emerged in the Brisbane market, with vacancies and rents both moving higher in the June quarter amid strong net absorption. Brisbane absorbed 27,718 sqm, with higher primary figure dragged lower by a minus 1,666 sqm in the secondary market. After recovering in March, the vacancy rate increased from 13.5% to 15.4%, thanks in part to the practical completion of the 80 Ann Street building reaching practical completion. Its 60,243 sqm are 94.7% leased. Both prime gross effective rents and secondary rents rose – up 1.7% and 1.8% – while incentives remain at elevated levels above 40% for both prime and secondary properties. Yields have been steady at 5.63% since the middle of 2019. Tenant and investor interest is expected to be subdued in the face of uncertain economic conditions, including rising inflation and interest rates.
Vacancy rate for Brisbane CBD
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The overall outlook is certainly weaker than it has been for some time with the Federal Government forecasting that the economy will slow from a 3.5% expansion this financial year to 1.5% in 2023-24.
Rising interest rates and higher consumer prices for food and utilities are having a major impact on the economic outlook and in particular the prospects for the whole property market, but new government policies and shifting patterns of behaviour post-Covid means the impact across sectors may vary.
The overall outlook is certainly weaker than it has been for some time with the Federal Government forecasting that the economy will slow from a 3.5% expansion this financial year to 1.5% in 2023-24, in part due to weaker consumer spending and falling house prices.
Inflation is forecast to peak at around 8.0% later this year and RBA cash rate is now expected by some forecasters to peak at 3.85%. Meanwhile households and businesses face a shocking rise in electricity prices, estimated to grow by 20% in late 2022 and a further 30% in 2023-24. Retail gas prices are expected to increase by up to 20% in both 2022-23 and 2023-24.
According to the Federal Government’s recent budget announcement, unemployment is on course to go up by a percentage point to 4.5%, while wages will grow faster than they have been but still won’t catch up with inflation until at least 2024.
The projections in the interim Federal Budget in October come amid an already sharp slowdown in the private real estate market where six consecutive months of interest rate hikes by the RBA have already taken a heavy toll. According to the CoreLogic Home Value Index (HVI), median house values in Sydney have dropped more than 10% since the market peaked in mid-February, and by more than 6% in both Melbourne and Brisbane.
The RBA’s own internal forecasting has found that prices nationally could fall 20% if people become more pessimistic about the market outlook. An RBA economist said the fall in inflation-adjusted terms could be the largest to hit the Australian property market since the early 1980s. However, in its October Financial Stability Review, the RBA noted that while interest costs had risen sharply, most borrowers had built up substantial buffers in the form of savings and early repay of principal while rates were at record low, limiting prospects for forced sales. A small percentage of borrowers who had bought recently, had lower income and low or no buffers were considered to be the most vulnerable to further rises in interest rates.
Meanwhile a tightness in supply in the rental market has been worsened by the return of domestic and international travel, foreign students and immigration. The Domain rental report for September found that Sydney’s house rents had risen to a new high in the quarter and unit rents were back at a record high for the first time since 2018. It is a significant milestone for house and unit rents to be sitting at a price peak.
Melbourne’s house rents increased 2.2% over the quarter to a new record high while Brisbane’s record-breaking streak continued over the September quarter with house and unit rents both hitting new highs.
Federal Government policies announced in the October Budget are likely to have conflicting effects on the market. Permanent migration will lift from 160,000 to 195,000 in 2022-23 and net overseas migration is set to recover from 150,000 in 2020-21, to pre-pandemic levels of 235,000 a year from next financial year.
However, the government has also announced a range of measures to address the high cost and low availability of housing, including a focus on affordable housing for lower income households.
A centerpiece of the new Labor Government’s first budget was to tackle the supply side of the market with a new Housing Accord agreed with the states, territories and major private investors which aims to build one million new homes over five years from 2024.
Under the Accord, state and territory governments will have to meet supply targets by freeing up land and re-zoning properties to enable the homes to be built, with construction costs backed by capital from the $3.3 trillion superannuation sector. Separately the Government will also provide $350 million over 5 years from 2024–25 to help fund an additional 10,000 affordable homes.
The Future Fund will be handed an extra $10 billion for a Housing Future Fund to be invested toward the delivery of 30,000 social and affordable homes over five years. Other measures include $350 million to be spent on acute housing needs, measures to encourage older Australians to downsize their housing and support for 10,000 people a year in regional areas to buy homes with a smaller deposit.
In the commercial, industrial and logistics markets, the split that emerged at the start of the pandemic in early 2020 has continued through the first months of the interest rate tightening cycle.
Vacancy rates for office properties are at or near record highs as companies face a continuing preference for working from home. Share price discounts to the net tangible asset value of office properties widened to as much as 30% in the middle of 2022 amid concerns about the longer-term implications for property income and valuations of an entrenched work-from-home culture in traditionally office-based industries.
Industrial and logistics vacancy rates, meanwhile, are at record lows and rents are booming as retail, postal, warehousing and logistics business scramble to remake their supply chains for the boom in e-commerce sparked by pandemic induced WFH. New developments cannot keep pace with demand, spreading some businesses to the regions, where increasing numbers of workers have moved in search of lifestyle and more affordable housing than is available in the capital cities.
Across both asset classes, agents report that the worsening global economic outlook and the rising cost of debt has slowed buyer interest, even if the strong performance of the economy and compelling industry growth rates remain a key attraction for offshore investors. While there is little transaction data to back it, anecdotal evidence is that yields may be moving a little higher.
In east coast office markets, the high vacancy rates and incentives have seen a flight to quality and upgrades for some large tenants. Others have been resizing their property footprint to take account of reduced in-office workforces and sending surplus property to the sublease market. Rents have held steady, with landlords and investors supported by long-term lease arrangements, often with inbuilt annual CPI+ rent escalators built in.
In all, as Australia heads towards a projected economic slowdown and almost certainly lower residential house prices when higher mortgage rates take effect, low rental vacancy rates, structural changes in the economy and efforts by the government to tackle the housing crisis look set to ensure the market will still offer many opportunities.
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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.
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