_Capital Markets: Back to the Future
Inflation peak and greater certainty on rates outlook will restore liquidity
Compounding inflationary pressures have resulted in the sharpest tightening of financial conditions globally since at least 1994, leading to a rapid shift in the macrofinancial context underpinning property investment. Consequently, property markets globally are going through a period of reduced liquidity on the path to price discovery. Higher rates are now embedded in expectations, but there remains significant uncertainty as to exactly how high they will go and for what duration. As 2023 progresses we can expect clearer answers, with a turning point on inflation likely to coincide with greater clarity on the outlook for interest rates. This is expected to restore confidence and liquidity.
Back to the future as yields rise to reflect the higher cost of funding, but the impact will be mild compared to past episodes
With bond yield and swap rates touching ten-year highs right along the maturity spectrum, the cost of debt rose by well over 200 basis points during 2022. This begs the question as to how far property yields will rise. On the basis that bond yields settle at around 3.5% over the next 12 months and rental growth is maintained, we expect to see a 50 to 75-basis point yield shift in the Sydney and Melbourne prime office markets, and a 100-basis point rise in industrial markets, which are coming off a much lower base. To end Q3 2022 we had already seen a 20 to 40-basis point rise in major office markets and a 50 to75-basis point shift in industrial markets.
The new investment climate requires renewed focus on income growth
Over the past decade the market has seen significant yield compression across nearly all locations and property types, and so high investment returns could be achieved even in the absence of strong rental growth. In the current climate, however, the income growth equation has become more urgent. This will drive demand for emerging sectors such as life sciences. In traditional sectors, it will accentuate the evolution of new product types, such as multi-level logistics facilities and the next generation of new office towers. It will also cast a spotlight on lease structures, and the ability to ratchet up rents relatively quickly in line with higher inflation. Finally, it will add to the focus on aligning with more demanding ESG criteria to safeguard long-term asset value.
Keen to learn more? You can check out the Top Ten Insights from our Outlook Report 2023 or read the report in full via the links below:
For more information, please reach out to the team:
Ben Burston
Chief Economist
+61 2 9036 6756
ben.burston@au.knightfrank.com
Michelle Ciesielski
Partner, Head of Residential Research
+61 2 9036 6659
michelle.ciesielski@au.knightfrank.com
Jennelle Wilson
Partner, Research
+61 7 3246 8830
jennelle.wilson@au.knightfrank.com
Lawson Katiza