RBA rate cut to record low is good news for commercial property

RBA rate cut to record low is good news for commercial property

5 July 2019

This week, the Reserve Bank of Australia eased rates again by 25bp to 1%, the second such easing in consecutive months and to a record low.

Savills’ Head of Research, Phil Montgomerie, provides a unique insight into the RBA’s decision and its impact on the property market.

The RBA argues it is needed to “support employment growth and provide greater confidence that inflation will be consistent with the medium-term target”. The RBA is also uncertain about the “trade and technology disputes…affecting investment and means that the risks to the global economy are tilted to the downside”. The RBA is sending a clear message that it wants the economy to tighten up on spare capacity to weather any storms in the future.

However, perhaps the underlying reasoning could be the continuing benign economic growth at 1.8% (below trend), subdued consumption due to protracted low wage and income growth and declining house prices (the RBA with APRA did trigger this one through tighter macro-prudential rules).

While the RBA acknowledges employment growth has been strong and the participation rate is at a record level, there is still spare capacity with unemployment at 5.2%. Historically full employment has been seen with 5% unemployment, but this metric appears to have now been contracted…is 4% unemployed now deemed the sweet spot?

Underlying inflation is also deemed below ideal at 1.4% March 2019 (RBA is targeting between 2-3%), with the target to be circa 2% by 2020 and “a little higher after that”.

This is positive for Australian property overall, but in particular for office where, with the RBA’s backing, business is encouraged to invest into its future, resulting in stronger employment growth and as such stronger office space demand across all sub-sector types.

Savills believes office supply is becoming tight in the major cities and in particular Sydney and Melbourne. Rental growth, tightening vacancy rates and reducing incentives are beginning to bite into spare capacity in the CBD’s and having a flow-on effect into the major suburban CBD’s of North Sydney, Parramatta, St Kilda and some more decentralised locations. Our latest 2Q analysis highlights CBD net face rents are now at post GFC highs across all grades, while yields are at all-time lows.

Brisbane and Perth are also seeing demand driven tightness emerging, with asset price stabilisation and appreciation, helped by vacancy rates falling.

Savills’ expect national office to continue its capital valuation uplift, supported by rent growth and falling vacancies and incentives, which in time will result in further yield compression as investors rebase their investment returns requirements to an Australian environment of low for longer interest rates.

Of course global money has had this funding advantage for some time, which will add to the competition for assets and the further decentralisation of capital to select suburban CBD’s – North Sydney is an example of uplift by proximity.

Industrial property will also continue to see capital value growth as the second derivative to lower interest rates boosting economic activity and a more confident consumer. Logistics will be the primary beneficiary here, supported by supply constraints around population densities especially relevant to Sydney and Melbourne markets.

From a retail perspective, the RBA and the Government is wanting to encourage the consumer to spend. The Federal Governments Tax Cut Policy passed yesterday in the lower house and is now to be presented to the Senate will, if passed, give further impetus to the consumer to spend.

In the last 5-7 years, the consumer has changed its spending patterns influenced by online e-tailing; low income growth; employment frequency (casual versus full-time) and what Savills deem the “Canberra Effect” – Governmental policy indecision and political disruption of the last 10 years and its psychological impact on the electorate. Savills see the RBA move coupled with tax cuts as a positive pivotal moment for retailers and retail asset values going forward.

But it’s worth noting that RBA Governor Lowe stated that “Given the circumstances, the board is prepared to adjust interest rates again if needed to get us closer to full employment and achieve the inflation target”.

The RBA is clearly pursuing a path to pump prime the economy to boost confidence, employment and spending.

It is targeting all time low rates to partner with the Federal Governments Tax Cuts Policy, passed yesterday in the lower house and now in the Senates’ hands, to give the electorate circa $158bil back into their hip pocket over the next 5 years. If passed in the Senate, those earning up to $90,000 would get an extra $1,000 back in tax within weeks, that could be spent at your local mall or on a domestic holiday (The Aussie dollar may constrain the overseas holiday).

In summary, Savills’ believe that with the RBA’s easing to record lows and if the Senate passes the proposed Tax Cuts Policy with little amendment, retail could see a much needed boost into Christmas which in turn will boost landlord rental streams and stabilise asset values. Industrial, particularly logistics, will also benefit as retail recovers.

However, according to Savills, office property will be the near term winners, as business investment prompts employment growth and the demand for office space tightens an already limited supply base. Rental growth will continue and further cap rate compression will eventuate, as investment returns requirements allow for further asset purchases.