How are interest rate movements impacting the commercial sector?
The Reserve Bank of Australia cut the official cash rate three times in 2019 in a bid to re-stimulate a weak Australian economy, taking official interest rates from an already conservative 1.5% to a record low of 0.75%. With many economic indicators including inflation, consumption and business investment continuing to lag, the wider consensus is that we can expect two further rate cuts in 2020 as the government pushes for an uplift in subdued inflation and greater employment/wage growth.
A move away from interest bearing investments
The low interest rate environment has had, and will continue to have, a negative impact on returns from safe interest bearing investments such as term deposits and government bonds, which are struggling to keep up with inflation and in many cases generating returns of sub 2%. This is pushing more yield-focused investors away from traditional floating rate products to alternative income-generating investments, with commercial property and unlisted/listed property funds presenting an attractive and viable alternative with stronger yields of 5.5-7.5%.
Benefits for commercial investors
Reduced debt-servicing costs improving bottom lines
For investors who are in established funds or already exposed to commercial property, the falling interest rates hold positive benefits through lower borrowing costs, which could in turn help to improve asset bottom lines. Depending on the debt structure, property funds will be impacted differently. Funds that have hedged their debt (in part or full) won’t be effected in the short term until existing facilities expire. On the other hand, funds with variable interest rates receive the immediate benefit with reduced interest costs. This could hold a number of different advantages depending on the strategy taken by either increasing returns to existing investors, allowing the fund to pay down debt or facilitating the growth of cash reserves to future-proof assets through capital expenditure and hence mitigate risk for future vacancies.
Competition likely to drive price growth
For new investments, lower borrowing costs and improved asset bottom lines mean that investors will essentially be able to pay more for commercial assets while maintaining the same returns. This, combined with rising levels of competition from those looking to gain exposure to the commercial market, means the sector is likely to see continued upwards pressure on property prices.
How will yield compression impact future funds?
With the weight of capital looking for exposure to commercial property driving competition for high-quality stock and compressing yields, the challenge for commercial investors and fund managers lies in adding assets into existing funds to maintain current levels of distributions. Our view at Mair Property Funds is that yield compression across the market will most likely lead to a reduction in benchmark returns (albeit remaining well above those of bonds and term deposits), with the upside being that higher levels of competition will assist in supporting the longer-term capital growth of assets.
Whilst we are already seeing property funds offering products at sub 7%, our strategy will continue to focus on maximising rental performance through proactive leasing and value-add strategies, with a specific look towards counter-cyclical opportunities that offer greater rental and capital growth potential with an aim to offer investors superior returns.
To stay ahead of upcoming investment opportunities, visit the Mair Property Funds website, or contact Key Relationships Manager, Brad Dunn at firstname.lastname@example.org