_2020 Outlook: Capital markets foresight

The sharp shift to lower interest rates in 2019 increases the attractiveness of commercial property assets through higher relative value, and lower funding and hedging costs. Lower interest rates will underpin strong demand for property assets and drive further yield compression, prolonging the property price cycle. This represents a significant change in the outlook compared to 12 months ago, when many had thought, including us, that the current cycle of broad-based yield compression was coming to an end. The impact of lower interest rates will be significant. We estimate that Sydney prime CBD office property yields will decline by 50 basis points over the next two years to 4.1%.      

Lower yields will drive stronger capital growth in 2020 following a slowdown this year. For office property, capital growth is expected to pick up from an estimated 5.4% in 2019 to 5.8% and 6.4% in 2020 and 2021 respectively. Total returns have been in the double digits for five consecutive years now and we expect a continuation of this strong performance over the next few years.  

Industrial property should perform relatively well driven by strong demand for warehousing space partly reflecting the rapid growth of e-commerce and logistics. Capital growth is expected to slow from 7.7% last year to 6% in 2019, before picking up to 6.4% in 2020 and 7% in 2021.               

Office property investment volumes have remained strong in 2019 after reaching a record high level in 2018. Looking ahead, lower interest rates and the prospect of further yield compression will continue to support commercial property investment, as investors search for yield in a low interest rate environment. Large institutional investors have been particularly responsive to the shift to lower interest rates, driving a historically high concentration of investment activity in relatively large deals. 

Another sign of the impact of lower interest rates is the spate of capital raisings this year among listed REITs and unlisted funds. Equity issuance among real estate companies is running at the highest level in a decade. The strong level of interest from investors reflects confidence in the return outlook for office and industrial property and more defensive positioning in a slowing economy. The recent run of capital raisings points to strong prospective demand on the part of institutional investors to allocate to office and industrial property assets.