Where to now for Australian property?

Empty streets, empty offices, empty malls but full homes have become a way of life over the last seven weeks since our fight with COVID 19 began.

Whether this will leave a lasting imprint or is a temporary blip only time will tell, but it will definitely change the way we invest, use and manage our properties.

However, not all of the of the changes the property industry is witnessing are due to the current COVID-19 crisis, but this has definitely hastened the changes that were long coming.

The Economy

Let’s start with the economy – the other elephant in the room.

In its Statement on Monetary Policy for May 2020, the Reserve Bank projected a significant contraction in the economy, which will affect the labour market immensely. It’s estimated that more than a million people will be out of work and the recovery in employment will be slow.

The National Australia Bank’s Business Survey indicates that the lockdown measures have caused a decline in business conditions and confidence, leaving installed equipment idle.

New housing approvals (seasonally adjusted) have dropped and banks have been reluctant to make new loan commitments for home purchases. Affected by reduced profitability and increased risk, banks have been cautious in lending.

The RBA’s cash rate, or the interest it charges on interbank loans, has been at an historic low of 0.25 per cent since late March, reflecting the poor immediate economic outlook.

Thankfully, the yield curve, or the trend for interest rates on bonds, is positive in that bonds that have a longer pay back time command higher interest rates.

This means the bond market still expects an improving economy in the longer term. Also on the positive side, turnover in retail has risen mainly due to growth in sales at the supermarkets and grocery stores as people stocked up or stopped eating out.

Against this backdrop, the property and construction industries are under immense pressure.

Retail property

In the retail property market, total returns have been declining following a long period of growth in rents that peaked in 2015. That rise in rents was fuelled by ownership in the market being highly concentrated, giving landlords strong market power.

But rents are now being weighed on by the shift to online shopping, and in the last few months, a number of retailers have closed.

Among shopping centres, the ones that are suffering the most are regional and super-regional shopping centres. Neighbourhood shopping centres are fine as they are supermarket based.

As far as retail property transactions go, there are more sellers than buyers and there are media reports that large centre owners are looking to sell their assets.

While shoppers will return to malls eventually, business models of super-regional or regional shopping centres that depend on entertainment, hospitality and leisure may have to be reassessed.

Going forward we’d expect retail property market to be characterised by lower growth as high vacancies and lower rents in the face of rising online shopping weigh on the market.

We’d expect to see higher incentives for tenants, and see landlords bearing more costs to support tenants. Capitalisation rates, or the ratio of operating income generated by a property over its value, are likely to soften.

Office Property

Sentiments in office markets are weak given the uncertainty in the economy.

Transaction volumes fell by more than 50 per cent in the first quarter of the year compared to a year ago, and are expected to slowdown further.

The market can also be expected to react to a potential shift toward more office workers continuing to work from home after COVID-19 restrictions forced many people out of their workplaces.

Before the crisis about a third of working Australians reported doing at least some work at home but we’d now expect that to increase.

Office property landlords with shorter term leases are the most vulnerable in this market, as will those operating a shorter term “co-working model” of serviced spaces for different clients.

Many office properties may have to be reconfigured if social distancing becomes the norm or even mandated in legislation.

We anticipate that landlords will increasingly have to offer concession packages to tenants, and invest in improved ‘building health’ – that is, ventilation, air filtration and cleaning.

The hotel and hospitality property markets have been the hardest hit and we’d expect the drop in occupancy rates to continue for the rest of the year at least.

Any return to normalcy will take time given the restrictions on travel and people remaining wary about travelling.

Industrial property

In industrial property, transaction volumes have tumbled by about 75 per cent in the first quarter compared to a year ago. COVID-19 has disrupted global supply chains which may encourage industry to move away from a just-in-time to a just-in-case delivery model.

We’d expect to see some re-shoring or near shoring of industry as firms seek to locate production closer to different markets.

Online shopping trends in future will also be on the minds of investors, damping down transaction values and volumes.

Residential property

The residential market will take some time to recover to where it was earlier this year. The market has been hurt by the social restrictions that have stopped buyers from inspecting properties or attending auctions, as well as the weaker economy.

High unemployment rates, increased lending risk and credit tightening are all looming as roadblocks to a recovery. The market could also be hurt by ongoing travel bans and possible restrictions on immigration.

The construction industry, in the short run, will face delays in completing projects as supply chains take time to recover. This could be exacerbated if the trade war between the US and China spreads.

But global supply chain disruption may also open up new opportunities to source materials on shore from Australian manufacturers.

So, what’s the outlook for Australia’s economy and property markets?

With the right policies and stimulus, it is possible to have a V-shaped recovery for the economy. Thankfully, the pandemic crisis isn’t a financial crisis. Given banks remain healthy, once economy activity starts going back to normal, the engines of growth will start moving.

Different property asset classes will see different recovery paths. The retail and office markets will likely see a U-shaped recovery with a long flat bottom.

Once household incomes and jobs start recovering, the housing market will also start moving ahead. The eventual lifting of travel restrictions will further lift the market out of its current state.

Of all the markets, industrial property is likely has the strongest trajectory and we’d expect to see a V-shaped recovery.

Overall, the COVID-19 pandemic will have economic impacts across the property board, but with any luck, as restrictions lift, we will see the beginnings of recovery.

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