• Australia expected to be at or near peak interest rates
• Capitalisation rates have been expanding as a result of the higher cost of capital, some further expansion is possible, although the bulk of the movement has now transpired
• Uncertainty remains about the strength of some office markets, with physical occupancy rates still well below pre pandemic levels.

Commercial property values have been slowly adjusting to the increase in interest rates over the past 18 months, this is being reflected in capitalisation rate expansion and decreasing property values.

Office transaction volumes remain low as a number of buyers remain on the sidelines, waiting for vendors to adjust down their book values and meet the market pricing expectations.  Major financiers also have a reduced appetite to fund larger purchases, greater than A$150m with a number of larger office buildings that were marketed in 2023 being withdrawn from sale.  

We see that transaction volumes should increase in 2024 as owners reduce their book values and pricing expectations.  Also, notably the cost of debt has eased in the past couple of months and this should support commercial property values over time. All major Australian banks now forecast the RBA cash rate to have peaked with rates to be on hold for most of the year and subsequent cuts to interest rates later in calendar year 2024.

Office occupier activity remains lower than pre pandemic levels, although there has been better interest in select office precincts and a preference for better quality office accommodation.  It is anticipated that physical office occupancy numbers will improve over time as senior management seek a return to office and employment conditions soften with a commensurate increase in employee uncertainty.

In this market purchasers are being selective and taking advantage of diminished competition, particularly in the case of office.  In several cases commercial property owners through a need to repatriate capital and/or reduce gearing are under pressure to sell their properties, although many are seeking off market interest and are not selling through formal sales campaigns.  Investor appetite is stronger for better quality assets with longer term leases to quality tenants, which means some owners are selling their better assets.  Terraplex has patiently been waiting for these market dynamics to work through before undertaking their most recent acquisition, being an A-Grade office building with a long lease to the Tasmanian Government.

In relation to other sectors, industrial, data centres and convenience-based shopping centres remain the more favoured asset classes, although as previously stated, there are emerging some good opportunities beginning to present for well leased, long WALE commercial properties.

Industrial investment yields have remained relatively tighter due to continued market rental growth expectations with good appetite for properties with shorter lease terms that provide the potential for positive reversionary income upside.

Anthony Wilson, a Director at Terraplex notes “Calendar year 2023 was a difficult year for commercial property as investment returns were impacted as a result of higher financing costs and challenging leasing markets. The office sector in some markets remains under pressure due to continued lower physical occupancy rates and subdued occupier demand.  As financing costs decrease and occupier confidence improves as more employees return to the office, we can see improved returns in this sector over time.”