Welcome to the Q3 2023 edition of Banner Asset Management’s Quarterly Property Report.

Australia’s property markets continue to respond to the uncertain conditions which have dictated the local economy in recent years.

Residential values are nearing record levels after continuing a rebound from their COVID-19 lows, and a housing shortage exacerbated by post-pandemic immigration is keeping the rental market tight. The office market is showing some signs of stabilisation in vacancy rates after suffering the impact of the working from home phenomenon, though demand remains heavily weighted towards prime space.

The industrial and logistics sector remains characterised by strong demand and rising rents, even if some heat has come out of the market in recent months.

In our Spotlight section, we take a deep dive into whether the “fixed rate cliff” that was forecast to cause mortgage stress for residential borrowers has played out as expected. Interestingly, it appears that other property owners – such as those with high loan to value ratios or first home buyers – are more impacted by higher interest rates than those who took out cheap fixed loans during COVID-19.

We hope you find these insights useful.

Australia’s economy grew by a modest 0.4% in the June quarter as annual growth in real gross domestic product decelerated to 2.1%, according to the latest official figures¹.

It was the seventh straight quarter of economic growth but increased migration since Australia reopened its borders meant GDP per capita actually fell 0.3% in the three month period, repeating a similar fall of 0.3% in March.

Higher interest rates squeezed consumption as the mortgage interest paid by Australians doubled to $82.8 billion during the year and discretionary household spending fell by 0.5% in the quarter. Wages rose in response to tight labour market conditions but the high cost of living meant the household saving rate continued to fall, according to the Australian Bureau of Statistics (ABS)².

The Reserve Bank of Australia (RBA) kept official interest rates steady at 4.1% throughout the quarter, though it continues to indicate its willingness to raise rates again if inflation proves stubborn.

“Inflation in Australia has passed its peak but is still too high and will remain so for some time yet. Timely indicators on inflation suggest that goods price inflation has eased further, but the prices of many services are continuing to rise briskly and fuel prices have risen noticeably of late,” new RBA Governor Michele Bullock said in a statement accompanying the central bank’s October monetary policy decision³.

“Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will continue to depend upon the data and the evolving assessment of risks,” Bullock said.

The Consumer Price Index (CPI) rose 1.2% in the third quarter as petrol prices, rent and electricity costs increased. Over the 12 months to September, the CPI rose 5.4% compared to the RBA’s 2%-3% target range⁴.

The day before these figures were released Governor Bullock said in her maiden speech that it was possible inflation could be brought down, and employment kept growing, with the cash rate at its current level. But she also reiterated the RBA board’s low tolerance for allowing inflation to return to target more slowly than expected.

“Accepting this would risk eroding public credibility in our commitment to low and stable inflation … the long-term costs to the economy if that were to happen would be considerable,” she said⁵.

CoreLogic’s national Home Value Index shows capital cities led the gains, with Adelaide (4.3%) and Brisbane (3.9%) recording the biggest quarterly rise. Sydney dwelling values registered a 2.5% jump, while Melbourne values rose 1.3% for the three month period¹.

The annual rate of growth in national dwelling values was 3.9% at September 30.

The slowdown in quarterly growth, from 3% in June, was due to higher advertised stock levels which relieved pressure on the market, according to CoreLogic.

These higher stock levels were the result of twin factors: a rise in new listings and a reduction in the number of homes sold (most likely due to housing affordability issues).

In a positive for supply, the Cordell Construction Cost Index – which tracks the cost to build a typical new dwelling – recorded a quarterly growth rate of just 0.5%. This is the smallest increase since June 2019 and suggests growth in construction costs has normalised after the spike recorded during the pandemic².

The pace of rental growth in capital cities also eased to 1.9% versus 2.7% per cent in the June quarter, even though vacancy rates tightened further³.

The counterintuitive slowdown in rental growth as vacancies decline is a potential outcome of a shift in living arrangements as more renters move to shared accommodation to defray housing costs.

This rethink in traditional households is extending to property purchases too – as housing undersupply encourages young people to pool their resources with friends and family members to get onto the property ladder.

NAB research earlier this year found that 40% of young Australians are considering buying a home with someone other than a romantic partner.  Among 18 to 29 year olds, buying with a friend was among the first compromises people would make to get into the property market, the research found⁶.

A mid-year expansion of the Federal Government’s First Home Guarantee (FHBG) is providing extra support for this trend. This initiative is part of the government’s Home Guarantee Scheme (HGS) and aims to help eligible people buy a home sooner. It has 35,000 places available in the 2023-24 financial year⁷.

Under the FHBG, part of a home buyer’s loan from a participating lender is guaranteed by the National Housing Finance and Investment Corporation. Eligible buyers can purchase a home with as little as a 5% deposit without paying lenders’ mortgage insurance and up to 15% of the value will be guaranteed⁸.

And, under expanded criteria for the HGS for the 2023-24 financial year, friends, siblings and other family members are now eligible to make joint applications.

The concept of “rentvesting” – buying in one location and renting in another – is also gaining popularity among property owners. NAB’s research showed almost one third of potential first time buyers were considering buying a property to initially rent out if it would help them overcome barriers to home ownership.

Read more about residential property in our Spotlight section – which takes a close look at how the so-called “fixed rate cliff” has played out since COVID-19.

Strong demand and tight vacancy rates are ongoing themes in industrial and logistics property, but while rents continue to grow some of the heat has come out of the market in recent months.

Effective rents for super prime assets increased 2.6% in the three months to September 30¹, down from 5% quarter-on-quarter growth in June, CBRE data shows². Annual rental growth rates are still above 20% in Sydney, Brisbane and Perth, according to Knight Frank, but the forecast is for rental growth to slow to an annualised rate of 5%-8% over the coming year³.

Several factors are behind the easing in conditions. The slowing economy and cost-of-living pressures are now flowing through to lower retail sales. High rental prices are encouraging tenant businesses to carefully consider their needs. And extra supply is increasing.

More than one third of the 2023 calendar year’s floorspace will be delivered in the fourth quarter, CBRE forecasts. Total floorspace supply for 2023 is expected to be 75% higher than the long-term average, while an even larger supply forecast for delivery in 2024 – at just over 4 million square metres⁴. Still, with 46% of the 2024 pipeline already pre-committed⁵, supply is unlikely to fully cover demand, providing support for continuing rent growth.

Transaction volumes in the sector have also slowed, and were 38% lower in the September quarter than the corresponding period last year, according to JLL⁶. This was largely attributed to a reduction in foreign investment, with offshore buyers hesitating due to fast-changing funding costs and rising bond yields, coupled with limited stock on market.

Investment is likely to ramp up again into 2024 with industrial becoming an even higher conviction strategy for many investors.

Melbourne
Leasing activity picked up in the September quarter compared with the previous period, but was still 20% lower than a year earlier, CBRE reports¹. Limited availability of floorspace continues as a feature of the market, with pre-lease accounting for much of the activity.

By the end of the 2023 calendar year, almost 900,000 square metres will have been added to the industrial and logistics supply but most of that has been pre-committed.

Vacancy rates remain at a record low 1.1%, consistent with the first half of the year². Rents for prime assets rose by 6.9% in the quarter, the strongest increase of the capital cities³.

Leasing activity picked up this quarter. Vacancy rates remain at a record low of 1.1%. Rents for prime assets rose by 6.9%, the strongest increase for all capital cities.

Sydney
The picture in Sydney industrial property is remarkably similar to previous quarters, being characterised by record-low vacancy rates at 0.2%, rising rents, and new supply largely absorbed by pre-lease activity.

Overall, lease transactions are lower than average due to the limited supply of space – leasing volumes in the second quarter were 9% below the 5-year average, according to Knight Frank⁴. Of the lease transactions that did take place, 66% were in the outer north west, with the outer south west a distant second in activity levels at 14%⁵.

Rents are rising more slowly than in previous quarters, but were still up by 6.7% over the September quarter for super prime properties – with the strongest growth in the inner south west at 11.1%⁶.

Land values appear to have reached their peak with smaller lots in Sydney’s south west declining around 20% year-on-year in the second quarter, Savills reported⁷.

Lease transactions sit at 9% below the 5 year average, due to record-low vacancy rates of 0.2%. Rents were up 6.7%, with the strongest growth in the inner south west at 11.1%.

Brisbane
As is the case elsewhere, Brisbane is experiencing tight vacancy rates, putting upwards pressure on rents.

On average, prime net face rents rose 2.1% over the quarter, with assets along the M1 corridor recording the strongest rental growth⁸.

Developers are working through pipelines, clearing backlogs of supply caused by poor weather and construction constraints over the past few years. Around 705,000 square metres of space is expected to be added in calendar 2023, and a similar amount in 2024⁹.

The increase in development may lift vacancy rates in the short term, according to Savills Research¹⁰, but in the longer term – out to 2027 – commentators are forecasting population growth and limited land availability will keep Brisbane rents rising.

Vacancy rates are anticipated to lift, as developers continue to resolve the supply backlog. Around 705,000 square metres is expected to be added this year, with a similar amount in 2024.

Prime net effective rents rose 0.2% for the three month period on a nationwide basis and 2% year-on-year, according to CBRE¹. Its analysts noted incentives have risen to an average 39.4% across the nation’s CBDs, partly due to higher vacancy rates in some cities and higher costs for fit outs.

Vacancy rates are recovering better than many pundits expected, with 62% of properties in the national CBD market reporting vacancy rates of more than 90% in the second quarter of the year².

Still, a flight to quality persists in major capital cities as tenants continue to seek out prime space with facilities that may attract staff in a tight labour market.

This weaker activity in the secondary market is now encouraging debate about the potential conversion of office space to either residential property or hotels.

A study by architecture firm Hassell on behalf of the Property Council of Australia found, for example, that around 86 office buildings in Melbourne could be transformed into 12,000 new homes³. Some developers are also looking to vacant buildings as a potential source of residential projects in sought-after middle ring suburbs.

In the hotel space, a recent example of an office conversion is JLL’s sale of 39 York Street, Sydney for $52.58 million. The purchaser, Singaporean group Invictus Developments, plans to convert it into a hotel, with the potential to open by 2025⁴.

Melbourne CBD
Office occupancy in the Victorian capital continues to lag other cities, even though it registered an improvement in vacancy rates in the past year, according to CBRE¹.

Stronger demand for quality office space persists at the expense of the secondary market. Premium grade stock recorded 12,000 square metres of net absorption in the first half of 2023 versus -60,100 of negative net absorption for the A-grade market, says Cushman and Wakefield².

Premium grade net face rents have increased to an average $762 square metres per annum year-on-year. However, the still large volume of vacant stock means net incentives for premium grade and A-grade properties are at an indicative level of 41.5%³.

Sydney CBD
The flight to quality shows no sign of abating with the city’s core precinct recording net absorption of 33,500 square metres in the six months to July versus -73,500 square metres in other areas of the CBD, according to Cushman & Wakefield⁴.

Prime gross effective rents grew 0.8% in the September quarter to average $1520 per square metre per annum⁵.

CBRE reports that no new office developments were completed over the first nine months of the year and that only one new project is scheduled for delivery in the final quarter. This lack of supply is one reason why CBD vacancy rates have stabilised over 2023 even as leasing activity remained subdued⁶.

Brisbane CBD
Queensland’s capital remains a standout performer in the national office market due to economic conditions, interstate immigration and a tight labour market.

Lack of supply has pushed up gross face rents across all grades of CBD property in 2023, with premium gross rents up 13.7% year-on-year to an average $1035 per square metre per annum, according to Cushman & Wakefield⁷. Gross incentives also decreased in the September quarter.

Sectors such as professional services, government and real estate are driving demand and a flight to quality office space⁸.

Limited new supply is expected to come onto the market in the next three years, which is likely to ensure vacancy rates remain tight and put upward pressure on rents⁹.