As we hit the ground running with optimism and gusto in the New Year, our Capital Transactions team conducted a think-tank session analysing Brisbane's commercial real estate economy and what our clients need to know when investing and developing in the current environment. The result was that we needed to investigate the stubbornly high inflation figure better to understand the interest rate cycle we are in.
Increasing rates is a central bank strategy that aims to slow the growth in the economy by reducing demand, but is our economy that strong? If so, why are our households under such budget pressure? Why aren't purchasing managers expanding their inventory? Why is consumer sentiment falling off a cliff?
The answer is that price inflation is not driven by heightened demand and strong economic growth but by a global supply chain in disarray, leaving us fighting over the limited materials, food and fuel that find their way into our market.
This is the real impact of Covid and Russia’s war on Ukraine: The Pandemic and the war has disrupted our supply chains, forcing the central banks to combat the subsequent price inflation when our households and businesses are in no position to endure an aggressive upward cycle. With household saving rates falling off a cliff and further rate raising damaging an already fragile economy, another two or three rate raises could be the catalyst for a hard economic landing later this year.
The narrative that logistical supply chain issues have driven inflation is a more credible scenario than saying underlining demand is robust. The solution the RBA has adopted by pushing up interest rates eight consecutive times is like putting a band-aid on an infected wound; the wound never heals, further adding to the theory that until supply chains are somewhat normalised, central banks have no choice but to pour cold water on an already fragile economy.
We are on the recovery path, but patience is needed. China, our biggest trading partner, is entering the Lunar New Year and suffering a massive wave of COVID. It will likely be another two to three quarters before we see any light at the end of the tunnel and before we see material supply chain improvement in China's factories and ports. In addition, global geo-political headwinds are slowing down the supply chain recovery.
On the ground, the demand for asset class themes we saw during COVID continues to play out. The COVID hangover is pushing investors to allocate capital towards retail, industrial and residential accommodation based investments. Whilst capitalisation rates have adjusted and continue to expand, investors are looking for rental growth and repositioning opportunities to create better efficiencies and higher income. Counter-cyclical investment into prime office is also gathering momentum as institutional investors are calling the bottom of the office market, citing an improvement in leasing activity and a re-energising CBD.
Investors are being enticed with a barrage of in-direct opportunities in the private debt and syndication market. Attractive high-yielding opportunities, which were paying 6% - 7% 12 months ago, are now paying 8% - 9%. No detail is too small when considering these opportunities and valuations are shifting quickly.
On the development front, continued activity in the residential accommodation sector is evident, and rightly so. Essential serviced-themed developments are still in hot demand, although underwriting of the exit yield is unlikely to be sub 5%. Continued pressure on construction prices will further impact land values, with some sectors and locations being adversely affected more than others.
We continue to see a large portion of seller's preferring to treat on an off-market basis. This theme is likely to extend into 2023. While investors and developers navigate the unpredictability of the market's external factors, the physical characteristics of bricks & mortar, tenant lead demand and location are even more important than ever.
For further information contact:
Hugh Menck MRICS
Head of Capital Transactions
hmenck@bne.mcgees.com.au
+61432560589
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