In formulating our outlook for 2020, it’s interesting to reflect on the extent to which our prognostications for 2019 were overtaken by broader macroeconomic events.
I think it's fair to say that I and many of my peers across the industry didn't foresee the aggressive interest rate cuts handed down by the Reserve Bank over the course of the last year. Now, it appears likely that we’ll see another couple of rounds of monetary stimulus in the early months of 2020, and analysts’ thinking is, for the most part, predicated by what lower rates for longer and longer will mean for the sector.
Generally speaking, the primary impact of the low rate environment for both residential and commercial real estate will be to drive higher valuations; however, this effect will not be felt equally across all sectors and markets – particularly those exposed to the flagging areas of the economy which necessitated rate cuts in the first place. Here are some key commercial property markets which we think are likely to perform particularly strongly in the current environment.
The office market still continues to offer the highest returns to investors in the commercial property sector, but this year it will be eclipsed by the logistics market. As the long run of healthy rental growth recorded in office space over the past five years cools along with broader economic growth, sectors more aligned with discretionary and high-level consumption, such as logistics and e-commerce, will begin to out-perform.
There will still be large pockets in the office sector, such as Melbourne and Sydney, where yields are likely to remain steady, offering sound defensive positioning to investors, as well as opportunities in other markets such as Perth and Brisbane which may offer shorter-term upsides. Property with potential for updates or renovation also offers investors the chance to secure higher returns in a slowing market.
Logistics, in contrast, looks set to be a very strong performer this year, coming off a 2019 that exceeded the expectations of many analysts. Global capital demand for this sector will continue to surge on the back of long-term tailwinds in technology and e-commerce. In our view, online retail sales are set to rise from about 7% today to something in the order of 9 or 10% by the end of the year, given current rates of growth, and demand for property to service this industry will be hot.
Identifying the trend is one thing, gaining access to opportunities in this space is the major challenge. Whether it's in Sydney, Melbourne, Brisbane or even in Perth, building a portfolio in high quality logistics real estate is very expensive and very time consuming. Typically there are two strategies that can be employed: infill, where you’re able to attract a new tenant to an existing site due to location, infrastructure and adjacency to their customers; and outer urban logistics, where you find and develop a greenfields site, with the intention of attracting a new tenant in the market.
Currently, we see infill as the preferred strategy, given the greater potential for these sites to retain their attractiveness over the long term.
Heading into 2020, the properties that continue to perform most strongly are likely to be those which are firmly planted in either the convenience or the experience space.
At one end, this would suggest that there’s value to be found in neighbourhood centres, particularly in high growth corridors in Melbourne, Sydney and Perth, where increasing population and housing development has the potential to support sales growth.
On the other side of the ledger - accessing the larger shopping centres through the managed funds and wholesale funds – investors might see some small deterioration in values this year due to cooler global sentiment towards the sector. That said, we are starting to see early signs of recovery in some markets, and further stabilisation in the broader economy will drive higher retail sales. Investors should seek to position themselves in the most defensive parts of the sector while that growth is still in its early stages.
As you can see, the outlook for property markets in 2020 is somewhat mixed. Early rounds of interest rate cuts will support private sector investment and employment, which will have healthy implications for the commercial office sector and for consumption more generally. On the retail front, I think we're going to see a lot of the benefits of higher consumption shift from shopping centres across to online, with particular upside for logistics property portfolios. Ultimately, however valuations across all commercial asset classes should remain very robust, held up by lower interest rates and global capital demand. Building the right exposure for your portfolio to commercial real estate may become slightly more challenging and competitive, but all in all the sector continues to offer compelling investment opportunities.
Subscribe below to SMSF News to receive my latest articlesLuke Dixon, Head of Real Estate, Research
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