[+] Investors Seek Inflation Refuge in Commercial Assets

Inflationary headwinds are buffeting the sails of Australia’s property market and the central bank is trying to put the handbrake on the runaway cost of living. Australia’s consumer price index increased 5.1 per cent over 12 months to April 2022, led by construction and fuel prices. But the ripple effect of inflation is far-reaching in the economy, as New Zealand grapples with 7.5 per cent inflation, and the US has surpassed 9 per cent. Investors are increasingly looking to hedge against inflation and are moving their money to commercial markets for safe harbour, according to PGIM Real Estate head of Asia Pacific investment research Cuong Nguyen. Real estate has always been a “compelling inflation hedge for investors”, but Nguyen says there are some key markets that will perform better than others in the current economic climate. “The ability for asset owners to set rents to keep pace with inflation depends on the fundamental balance of supply and demand for space in each specific market,” Nguyen says. “So there are a few markets that offer more favourable conditions to support positive rental reversions.” ▲ Industrial and logistics assets are in high demand, recording a national vacancy rate of 0.8 per cent, the lowest in the world, driving up rents and providing opportunity for investors. Cuong says industrial and logistics assets are a standout as demand continues to soar and supply is stretched amid the rise of ecommerce. Office assets are also benefiting from improved leasing fundamentals with rising occupier demand against low supply. Cuong says near-term inflation shock could affect real rental growth initially but rents should grow over the longer term. After the reopening of borders there has been a consistently strong demand for better quality A-grade office space across Asia Pacific, and Cuong says there is capacity for pushing rents up in line with inflation “Good quality, well-located grade B assets will continue to attract strong demand from [small to medium enterprises],” Cuong says. “The biggest opportunities in grade B assets in the coming years will be from asset enhancement, particularly upgrading ESG [environmental, social, and governance] credentials and ratings. Tenant surveys are all pointing to a theme that tenants, big and small, are preferring buildings with higher green scores. “Retrofitting grade B assets in markets with a large SME tenant base and limited supply growth, such as Tokyo, the Australian cities of Sydney, Melbourne and Brisbane, or Singapore, should present one of the most appealing value-add investment strategies in the coming years.” CBRE head of office and capital markets research Tom Broderick says commercial property leases in Australia generally included a CPI-linked annual increase in rent. Australia’s Effective Rents vs CPI, 2006-2026 ▲ Source: ABS, CBRE inflation Market dynamics impact these rents in the short to medium term, such as during the peak of the pandemic where a lack of leasing demand impacted on rents in the retail and office sectors. “We are now seeing rents rising, lead by the industrial and logistics sector, but also in office and retail. “Over the long term, market-effective rents have generally risen with inflation. The current inflationary pressures in the construction sector are partly the reason for this, as developers need higher rents to justify building new assets across all sectors.” Broderick says the higher cost of debt is putting pressure on capital values at the moment, but higher rental growth expectations are partly offsetting these pressures. “Capital growth on average has outperformed inflation three-fold over the past 20 years.” Australia now has the lowest vacancy rate for industrial and logistics assets in the world, dropping to 0.8 per cent in the first half of 2022. Demand for office space has also increased in the first half of 2022, up 11 per cent and almost a historic high in the second quarter of this year, according to Colliers. Colliers managing director of office leasing Simon Hunt says they received enquiry for almost 925,000sq m of office space, on par with the highest quarterly demand recorded in the first quarter of 2021. “We have witnessed a record amount of demand for office space in the first half of 2022,” Hunt says. “It’s promising to see businesses continuing to engage with the market across all office space sizes.” Economists warn that it’s a longer term play in the commercial market but it does provide a good hedge against inflation. Corelogic research has shown a downturn across 42 per cent of house and apartment markets as pressure from consecutive rate hikes , rising inflation and weaker consumer confidence comes home to roost. You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. Click here to learn more.

[+] Investors Seek Inflation Refuge in Commercial Assets

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