Interest rate rises have affected different sectors of capital markets in different ways, but the anticipated slowdown in increases during 2023 will likely stir investor activity.

According to Fitzroys’ 2023 Capital Markets Outlook, the first few interest rate rises of 2022 had a relatively immediate impact on value-add and development property; anything that was up the risk curve, or had modest or insecure cashflow was less attractive to financiers, thus purchasers.

Subsequently, when the Reserve Bank of Australia persisted with interest rate increases, securely leased property was impacted with a softening of capitalisation rates, Fitzroys Director Paul Burns said.

“The fall in value has been modest as there is still capital looking for a home in quality, securely leased commercial property. However, the queue of buyers shortened,” he said.

“Whilst we are still entering a period of price discovery, securely leased property remains keenly sought, albeit higher yields are expected.

“When interest rate rises look like easing, astute buyers will re-emerge with a broader mandate, and attractive countercyclical opportunities will be secured.”

Inflation hit 7.8% over the year to December, according to the Australian Bureau of Statistics. Many economists are expecting further early-year interest rate rises in response - the Reserve Bank has just lifted the official rate to 3.35% at its February meeting - before inflation eases and interest rates hold or come down throughout the second half of 2023 and into 2024.

“Investments with a long lease and fixed annual rental increases are seen as less attractive when inflation is at a very high rate, as buyers see themselves going backwards relative to CPI, but the high-inflation environment should be short-lived and this should be a short- term phenomenon. Assets purchased now at historically high yields will prove to be very prudent investments,” Burns said.

Burns said borrowers are clearly affected by lending criteria imposed by lenders, the obvious consequence being a reduced purchasing power for many would-be buyers.

“However, we anticipate a levelling-off of the Reserve Bank’s recent strategy,” he said.

Burns said sentiment is an important driver of a market, “however it almost always overreacts”.

“When the mood is negative - as it is now - people struggle to believe it will improve, and vice-versa. However, change is the only constant, and we hope that a softening of the Reserve Bank’s monetary policy will see sentiment improve and more investors will re- engage.”

Burns said on the sell side, there is the possibility of an increase in stock coming to the market as the year progresses.

“Vendors may be holding off bringing their assets to the market until they see a glimmer of stability, which could come over the next few months as inflation eases and the Reserve Bank finishes this cycle of interest rate hikes,” he said.

Industrial highly sought-after, Suburban offices a “sleeper”

Industrial remains a highly-sought asset class, having experienced an unprecedented boom during COVID on the back of e-commerce and online shopping, and will remain keenly sought. Ongoing rental growth is offsetting softening yield and so capital values are holding firm.

The return of office rental growth, particular for prime CBD assets, is supporting values. All office markets have been affected by higher interest rates but Burns maintains “the office will come back into its own with the passage of time”. Following three COVID-interrupted years that saw businesses re-evaluate their real estate requirements, many leaned towards more office space per person, and increasingly are showing a preference for suburban locations which are close to workers’ homes.

“Suburban offices remain a sleeper,” Burns said.

“Logic says people will want more space per employee and to be close to their homes. As yet, there has not been the expected uptake in office leasing in the suburbs, however I still believe it will come. This will bode well for rental growth.”

As a result of the higher interest rates, many planned developments will now be delayed or just not proceed, and others that are underway will be far less profitable as the cost of debt from secondary lenders is much higher, Burns said.

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