Why the end of a rate hiking cycle is an attractive time for this asset class

There are more than a few of us awaiting the end of the Australian rate hiking cycle. The rapid pace of hikes has been a source of pressure for both individuals and businesses alike. One asset where rates are a constant source of concern is property – there’s nothing like rising mortgage repayments to keep you up at night.

While residential property may be at the forefront of many people's minds, rates are equally a concern when it comes to commercial property. You could even say they are more of a concern given factors like a housing shortage and rising immigration, which have only served to boost residential prices despite interest rate hikes.

It's been a tougher period for commercial property, with headwinds such as supply shortages in construction, developers going bust, and the impact of work-from-home on the office sector.

Could it all be about to change now that we are approaching the end of the rate hiking cycle?

Linda Rudd and Mark Vonic from Realside Property believe so, pointing out this would traditionally signal an attractive time to invest.

“We’re seeing some private capital come back into the market. Institutional capital is still not coming back in, but that will at some point,” says Vonic.

In this episode of The Pitch, Rudd and Vonic discuss the trends across the commercial property market and the growing interest in the space. They also share where they are seeing opportunities towards the end of the rate hiking cycle.

This interview was filmed on Tuesday, 2 April 2024.

Edited transcript

Can you talk me through some of the trends you are seeing across commercial property at the moment?

Rudd: Commercial property provides investors with an attractive income stream as well as access to capital growth. Now we're coming off a rate hiking cycle and historically this has been a very attractive time to invest.

What we're seeing in relation to industrial property is that this is attracting investor interest, as is retail, which is evidenced by the recent transactions office of course, as a sector has had more headwinds.

But that sentiment seems to be changing a little bit and with the headwinds across the interest rate hiking cycle, that has provided opportunities to buy. There’s also a story around flight to quality that's been playing out as well. We’re asset selective in the opportunities we look at and they have to have a quality bias for us to review them.

There have been quite a few challenges in the construction industry. How has that affected the sector as a whole?

Vonic: Supply chain issues have been very challenging coming out of COVID, but we're seeing that stabilise right now.

Labour retention has also been a challenge and that is an ongoing challenge. We have a very tight labour market and maintaining access to good labour is really quite challenging across the whole sector.

There are regulatory challenges. Planning approvals take a long time and managing through these continues to cause issues in some jurisdictions. We’re found we’ve been able to manage that well with our vertically integrated industrial development business Realside Invest. It’s an experienced team that has produced good outcomes for us. We’ve now got 15 projects on-the-go around the country. From starting in 2021, we now have a portfolio of $350 million worth of developments in the pipeline.

Where are you seeing value across the sector?

Vonic: We see value in all sectors really; it just comes down to your perspective.

Office does have some headwinds, as Linda has mentioned, but for the right asset at the right price in the right location and the right quality of asset, there is still appetite. We're seeing some private capital come back into the market. Institutional capital is still not coming back in, but that will come at some point. We see some really exciting opportunities in retail and we have a project we're launching shortly in a Perth sub-regional shopping centre. The play for us around retail is very much about the landholding and very much an under-utilisation of valuable metropolitan land, which has higher and better uses in some instances.

In industrial, we continue to be optimistic. There is still demand from an occupier perspective and capital is still very interested in the space.

Turning to office, what has the work-from-home trend meant for this sector?

Rudd: The work-from-home trend is becoming more of a norm as it relates to flexibility. We had flexibility prior to the pandemic and we have flexibility post-pandemic, but what it has really done is drive negative sentiment across the office sector. This has probably led to the heavy discounting we’ve seen within the office sector.

However, for counter-cyclical groups such as us, that has actually represented an opportunity. In December 2022, we transacted on 108 St Georges Terrace in Perth, which is a 44,000 square metre office asset. It represented great buying for us at the time and back to my earlier point about a flight to quality.

We have a program of work we’re undertaking at 108 St Georges Terrace to ensure we deliver a quality office product that attracts tenants back to the office. We’re seeing a lot of organisations really look at the space they occupy and make sure it is quality space to attract their employees back to the office.

Similarly, with 45 Pirie St, which we acquired in May last year, again that was an 80% vacant building in Adelaide. An A-grade building with fantastic features, but we acquired it at a significant discount and are now spending $17 million to reposition and refurbish to make sure we attract business occupiers, and redesign the building so that businesses and employees want to be there.

This also relates to retail, because we look at doing this across all sectors so that customers or visitors want to come to visit and spend money.

There has been talk about increasing vacancies for warehouses on the industrial side. What has your experience with this been?

Vonic: The vacancy rate is still at historically low levels, so it's not something that we've been overly concerned about. There's been very strong rental growth in the sector in some markets, 30-40% rental growth. We see a concern around that. The capacity of tenants to continue to pay ever-increasing rents must come into the equation. And so we're a little bit more circumspect about rental growth in that market.

In our industrial development business, we have a particular niche that focuses on workshop and fabrication uses and those tenants and so we're getting pre-commitments. As I said before, we have 15 separate projects on the go that are largely pre-committed to workshop and fabrication-type tenants who take very long leases. On average, they're 10, 12, 15-year lease terms. We feel like our business is insulated from short-term vacancy concerns. But again, those concerns are very mild. They're coming off a very, very low base at 1% vacancy rate.

Are there any areas that you are avoiding or focusing on in the current environment?

Vonic: No, we're not really avoiding any particular sub-sectors. We keep an open mind. We're opportunistic, so we're looking across office, retail and industrial.

Industrial does continue to have tailwinds and that's a market we are very active in. Office does have some headwinds, but again, for the right asset in the right location, we'll continue to look at opportunities. Retail is a very interesting asset class with yields at almost historically high levels. There's some opportunity there, but we are very circumspect. To give you an example, we sat out of the office market between mid-2020 and late 2022. We’re happy to be patient and wait for the correct opportunity to come along.