The central theme of our 2024 Horizons report released in November was that the new year would bring better times for prospective investors after a prolonged pause in the market and falling valuations during 2022-23. With the first quarter now completed, three key developments have shown this to be firmly on track.

Closer to the turn

Firstly, the macroeconomic backdrop has become more favourable. Since October, inflation has continued to fall in most advanced economies, most notably in Europe where the headline rate has dropped to 2.4% in Europe off the back of rapidly decelerating inflation in the cost of goods. Australia has also benefited, with the Q4 CPI print declining to 4.1% and the latest monthly inflation indicator showing an annual rate of 3.4%. The US has experienced a recent uptick back to 3.5%, which serves as a reminder the battle is not yet won, but steady progress is being made.  

Off the back of declining inflation, as each month passes we are getting closer to the point at which the interest rate cycle will turn. Europe has already started the path down, with Switzerland the first advanced economy to shift to rate cuts in March and the ECB expected to follow in June. The US is now expected to take longer to cut given the strength of its economy and signs of persistent inflation, but forward rate expectations still imply around a 100 basis point reduction in the US Fed Funds rate by end 2025 and a 140 basis point reduction in Europe.

In Australia, the cash rate was not raised as high as in many comparable economies, and so the RBA is likely to wait longer than other central banks. But alongside the drop in inflation, the cooling pace of growth and protracted weakness of consumer spending have still acted to shift expectations, and the RBA has altered the guidance provided in its recent March statement to reflect a more balanced outlook rather than the explicit rate hiking bias that prevailed until February. Forward rates currently imply that the cash rate will drop by around 50 basis points by end 2025 and many forecasters are tipping much larger reductions.

Bid-ask spreads narrowing

Secondly, substantial progress has been made to narrow the first of two wide gaps that have prevailed since early 2022 – that between buyer and seller price expectations. Valuations fell by a further 2.5% on average in Q4 according to the MSCI All Property index, while valuations in the office sector, where the impasse has been most pronounced, dropped by a further 3.2%.

The Q4 reductions mean that average asset values have declined by 7.7% since peaking in Q3 2022, with the office sector most impacted with an average 12% reduction and retail with 4.9%. The industrial sector has been more resilient with average values rising over the past two years despite the pressures of higher interest rates, with strong rental growth able to offset cap rate expansion.

It’s all relative

Finally, the outlook for relative returns across asset classes has shifted. Falling inflation and the shifting tone from central banks has triggered a substantial rally in equity markets, with the ASX up by over 10% since its October lows, the US S&P 500 price index up by over 20% and equity indices all around the world recording strong gains.

Amidst the equity market rally, Australian REITs have mounted a strong comeback, with the A-REIT index not far off the highs reached at end 2021 following a rise of 30% since late October.

This has effectively closed the second gap that has impacted sentiment over the past two years – the gap between pricing in public markets and slower moving private markets.

More broadly, as prices in fixed income and equity markets have surged, while property values have continued to correct, the relative risk-return equation offered by different asset classes looking forward is changing. During 2023, few were willing to deploy additional capital to real estate, but as pricing adjusts the outlook is looking more favourable on both an absolute and relative basis.

Turning a new leaf

All of this will start to entice investors back. After an extended period of inactivity, major domestic institutions and cross border investors will be reappraising the outlook and some will choose to flick the switch back to acquisition mode. In addition, pent up demand from both investors and vendors to trade and reposition their portfolios continues to build and as the level of uncertainty around the outlook eases and downside risks dissipate, a deeper pool of assets will come to market.

This is not to say that it will all be smooth sailing. The adjustment of formal valuations has still not entirely played out and will remain a brake on activity for a little longer. And the macro outlook, while much more favourable than a year ago, is still uncertain and the ‘last mile’ of the inflation fight may prove stubborn, impacting the willingness of the RBA to deliver rate cuts in line with current expectations.

But as time goes on, it will become apparent that the risks are two-way. Buyers waiting for the full suite of economic and pricing indicators to switch from red to green may end up waiting too long. History suggests that property markets can move quickly, and that the best buying often comes hot on the heels of a downturn, as evidenced by the returns generated by the early movers who shifted into acquisition mode in late 2009.

The storm has not yet passed, but the worst is over and investors should be gearing up for the next chapter.