Property - Australia’s property market on the path to “adjustment”

For property, 2022 was punctuated by a retreat in residential values, transaction volumes and optimism. Borrowing costs are at their highest level in 10 years, driven by the RBA raising the cash rate. Despite this, commercial, industrial, healthcare and logistics assets in prime locations continue to perform driven by the perceived security of these assets and credit availability.

Based on inflationary pressures, interest rates are expected to keep rising, placing strain on values and sentiment yet to wash through the market. Conservativism is expected from investors, owner occupiers and capital providers, with 2023 predicted to be an “adjustment year” for property. We expect the following key themes to emerge:

• Additional debt servicing pressure: With rate rises continuing to bite and capital buffers eroded, borrowers will find it more difficult to service their loans and refinance (noting the RBA estimates around 23% of home loans will switch to variable rates in 2023).

• Credit availability: Given interest rates and cost of living pressures, it is expected that residential values will further decline. This is expected to lead to a more conservative approach by capital providers (including wholesale funders), leading to debt becoming more expensive and cumbersome to secure.

• Enforcement by non-traditional lenders: While major banks adhere to strict lending protocols, alternative financiers have not had the same constraints. These lenders generally have higher risk loans, increasing market share and are typically more likely to enforce on defaults than the Big 4 banks as a means to recycle capital into more attractive deals. As a result, enforcement and distressed selling will begin to occur and certain non-bank lenders may come under their own pressures from capital providers.

• “Return to normality”: Despite debt servicing costs and credit constraints, we expect market pressure will be partially mitigated with the resumption of migration and “business as usual” circumstances. Overall, we expect investment into non-residential subsectors to continue on a growth trajectory. Noting higher debt costs and the impact on internal rates of return, this trend will be concentrated in prime locations and asset classes.

To navigate changing market conditions, property sector participants should look to:

• Build equity buffers to navigate the debt and capital value rebalancing expected.

• Focus on key fundamentals including location, quality, and yield.

• Diversify sources of capital and investment.

• Proactively manage relationships with key counterparties including lenders, builders, cornerstone investors, anchor tenants and joint venture parties.