- The forecast for 2024 is a slightly rosier one.
- Sustainability reporting is expected to begin being phased in.
- Industrial rents still have room to grow.
The Australian real estate market has endured a tempestuous few years following the onset of Covid, witnessing incredible lows and exceptional highs across the board.
Interest rates dipped to 0.1% and stayed there for a while. In May 2022, interest rates began to rise, subsequently soaring month after month. Along with a few pauses, the official cash rate now stands at 4.35%.
Sectors such as retail and office suffered, with WFH impacts and foot traffic falling. Industrial, however, was a standout.
As inflation and interest rate rises slow and the market regains its confidence, what’s in store for 2024?
Seven property market predictions for 2024
According to Knight Frank’s Australian Horizon 2024 report, next year is set to be better for investors, with a focus on assets such as build-to-rent (BTR), student accommodation, and more, along with new requirements on the horizon.
- A better year to acquire assets,
- Tilt to core strategies to drive living sectors expansion,
- End of the NICE era has important implications for investment strategy,
- Wide divergence in yield impact depending on perception of risk and rental growth prospects,
- New sustainability reporting requirements will raise the bar for real estate,
- Slowdown in office development to create conditions for future shortages of new supply, and
- Global comparisons show that industrial rents have further to rise.
1. A better year to buy
Next year is looking a bit more promising than the tumultuous past few years. Knight Frank chief economist and report author, Ben Burston, believes the commercial property market can look forward to consolidation and the prospect of recovery in 2024.
“The sustained pressure of higher rates has, naturally, put pressure on asset values and this is still playing out to varying degrees,” he said.
“Part of the uncertainty has been a disconnect between formal valuation metrics and market sentiment. However, with more deal evidence now coming through and formal valuations likely to be adjusted further in the December cycle, we expect the gap between sentiment and formal valuations to erode substantially over the next six months so that by mid-2024 the picture will be clearer for buyers and sellers alike, helping to restore confidence and liquidity.”
Burston added that, “Higher yields act to reset the market and provide a more attractive entry point for investors, generating the prospect of higher returns.”
“This is clearly illustrated when we assess historic market cycles and the performance achieved after pricing is reset in the aftermath of interest rate hiking cycles. \
“The period immediately after the conclusion of the rate hike cycle ending in 1994, 2000 and 2010 was in each case a very attractive time to buy, achieving above average returns over the following five years.”
Ben Burston, Knight Frank
“This is not to say that history will repeat, and investors cannot take for granted that interest rates will fall exactly as anticipated. But careful asset selection will maximise the chances of strong performance whether it is achieved through income growth or boosted by a return to yield compression as interest rates revert in 2024-26.”
2. Living sectors to expand
The report also foresees that 2024 will see a greater investor focus on alternative sectors, particularly, residential living sectors; this includes BTR, student accommodation, and retirement living.
“The shift to living sectors is part of a wider shift from major institutions globally to focus predominantly on core investment strategies as they seek more exposure to the relative stability of the living sectors in response to a more uncertain global economic outlook,” said Knight Frank head of alternatives, Tim Holtsbaum.
“Related to this, investors are also gravitating toward living sectors because they offer the ability to adjust rental income streams more quickly than other sectors in response to high inflation.
“These drivers will remain in place in 2024, and we expect a further expansion of interest in BTR and other living sectors to be reflected in continued growth of the pipeline and additional capital partnerships being formed.
“However, we expect to see more variation in the strategies of different investors, with groups seeking large scale defensive investments favouring BTR while groups with a higher return target will gravitate to other assets types such as co-living and student accommodation.”
3. Inflation grows as a concern
The acronym NICE was coined by central banker, Mervyn King, when referring to the end of global macroeconomic conditions that have driven a ‘non-inflationary consistent expansion’.
According to the report, those conditions have prevailed in Australia for many years, with inflation hardly being an investor concern since the early 1990s.
Burston said there is evidence that expectations are shifting, with higher bond yields, globally, signalling the expectation that rates will not swiftly return to the low levels that prevailed in 2016-21.
Some of the factors behind this, according to the report, include Australia’s strong fundamentals, with a strong long-term growth outlook once the nation makes it through the current hiking cycle.
However, this growth may come alongside a more variable outlook for inflation and interest rates over the next decade.
“Lower rates may return, but they are unlikely to return to the lows of 2016 to 2021 and investors will need to strategise for multiple scenarios,” said Burston.
4. Perception to play a role
According to the report, pricing will vary in the commercial property market, depending on the ways in which higher return targets will be achieved by different property types.
“Core assets that are perceived to offer better income security will trade at tighter internal rates of return (IRR), and for those that also come with strong income growth prospects this will imply that a given return target can be achieved with a lower yield,” said Burston.
“On the other hand, weaker quality stock is likely to be perceived as higher risk and offering less income growth potential, so yields will need to be significantly higher to achieve a given return target.
“This plays relatively well for industrial assets, which are benefitting from strong rental growth and tight supply that is starting to appear structural rather than purely cyclical.
“For office and retail assets, there will be a sharp divergence depending on asset quality and perceived growth potential. Prime assets that are the demonstrated preference of tenants and consumers within their local market and are experiencing rental growth associated with the recognised flight to quality will also see a reduced shift in required return targets and hence reduced yield shift.
“However, assets facing heightened vacancy risk and without the prospect of seeing effective rents rise in the near term will suffer a larger shift as investors demand a higher premium for risk. In these cases, the yield shift experienced will also be larger because investors will perceive that a higher proportion of the return over the medium term will need to be achieved via income as opposed to future growth.”
5. Sustainability reporting to be phased in
Mandatory sustainability reporting is expected to be phased in from financial year 2024-2025.
The changes will see businesses required to report audit-ready data.
6. Office shortage ahead, as development slows down
Multiple factors are putting the breaks on Australian office development, with the report highlighting the challenge of meeting feasibility thresholds as construction and lending costs rise; this is all against a backdrop of higher yields, impacting asset values.
In addition, higher vacancy rates and elevated incentives are traditional signals pointing to a need for caution.
“However, a slowdown in commencements will impact the pipeline in 2027 and beyond, and even at this early stage it is possible to identify a risk of a shortage of prime space later in the decade,” said Burston.
“While overall market vacancy rates may remain elevated for some time, the demonstrated strength of tenant demand for newly built space will mean a potential shortage of new buildings at this time.”
7. Industrial rents have room to rise
The report found that industrial rents are expected to continue growing, with two reasons behind the 2024 prediction.
Firstly, the report noted that an assessment of rental costs as a proportion of total operational costs suggests that rents are not presenting an unmanageable burden, representing even less than five per cent to up to 10% for most occupiers.
The second reason is that Australian rents are not out of line with the level of rents in comparable cities globally, most of which have also seen a sharp rise in recent years.
Comparing Australia’s current prime industrial rents to other major economies, the report found that Australian rent levels were middle of the pack when compared on a like-for-like basis and the growth experienced has been in keeping with, rather than running substantially ahead of, the rise experienced in other major markets over the past five years.
Population growth and supply shortages are also expected to continue driving rental growth, albeit at a more modest pace than 2022-2023. The report also highlighted a more marked difference between the pace of growth for prime and secondary assets.
