Impact of economic environment needs careful consideration by property investors

Investors should look at both the business cycle and the capital cycle, in an environment of “lower everything”, to help make sense of what is happening in property markets generally, according to property experts from Australian Unity Real Estate Investment (AUREI).

Ryan Banting, head of portfolio management at AUREI, said many investors may never have experienced an economic environment like the current one.

“Investors need to understand the implications of the  current environment of lower interest rates (both domestically and internationally); lower GDP growth rates; lower inflation; lower commodity prices; lower business investment; lower employment growth; lower business and consumer confidence; and a lower exchange rate.

“This is the first time in 20 years that Australia has experienced this combination of macroeconomic factors, and it is unfamiliar territory for many.

“To help understand the potential implications of this environment, it is helpful to monitor the business and capital cycles, which both impact the performance of property.

“The business cycle is in the fragile early stages of a recovery, however it doesn’t have any meaningful catalysts for growth at this stage.

“The capital cycle, in our view, has moved ahead of the business cycle, both as a direct consequence of historically low interest rates as well as the unconventional fiscal and monetary policy settings in place globally.

“As a result of these two cycles, we have seen the value of property generally strengthen over the past year or two, with capitalisation rate compression evidenced across most sectors offset partially by some weakening space fundamentals.

“Income return has generally been traded for capital return, yet there exists some pockets of good relative value across the asset class.

“However, investors should keep in mind that property should not be treated as a  homogenous asset class, but rather as a matrix of different sectors and different geographic areas, each with unique supply and demand drivers that requires specialist industry knowledge to navigate successfully,” Mr Banting said.

Mark Lumby, head of property funds – retail at AUREI, said the office and retail property sectors are a good example of the varying fortunes of different property markets and geographies, which investors need to take into account.

“The office property sector is facing negative rental growth headwinds overall, but in some areas – in particular Sydney and Melbourne – we believe we are seeing the start of an upswing.

“Capital inflows into office has been very strong – the last year being the strongest so far volume wise, and demand is expected to increase with the lower Australian dollar and the global hunt for yield in a lower return environment.

“Retail, on the other hand, continues to face headwinds despite the improvement in sales.  These are now back into positive territory but it takes around two years before it is registered in rising rent, so in the longer term, with increasing rents and tightening capitalisation rates, we see good value – particularly in neighbourhood shopping centres.” Mr Lumby said.