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Australia: views from down under

Mike Keogh

Michael Keogh, Associate Director of Research & Strategy, discusses how changes in cross-border investments in Australia will impact the commercial real estate market.

The Australian market has performed resiliently in recent years, and has witnessed a rise in cross-border investor interest, attracted by a healthy yield relative to its Asia-Pacific neighbours. We believe this trend will continue, despite some concerns of a slower economy and soaring house prices, with a currency that has depreciated 14% against the US dollar in the past six months. The ‘moderation’ in growth is, to some extent, linked to a slowdown in external trade (namely with China), with a decline in mining investments acting as a drag on output.  However, despite market confidence being scaled back, Consensus still expect positive household spending to support growth of 2.6% in 2015 – a 25th successive year of expansion. The RBA cash rate currently stands at 2.25%, and although unemployment has ticked up to 6.4% (its highest rates since September 2002), the Central Bank has room for manoeuvre, as indicated by the currency’s depreciation. Although the RBA kept rates unchanged last week, markets have factored in at least a 25bp cut in the near-term, and all else being equal, a weaker Australian dollar should support exports and help domestic industries compete with imports.

So what does this mean for commercial real estate?

The likely introduction of some macro-prudential measures to cool investor activity in the housing market will give the RBA room to leave rates lower for longer. Yields on 10-year Australian government bonds have edged down to 2.36%, 44bp above US treasuries. This spread was over 100bp six months ago, and it could fall further, given the prospect of divergent monetary policy. The subsequent spread between Australian prime property assets and bond yields suggests further falls in prime yields in 2015, aided by overseas capital hunting for yield and enticed by the weaker Australian dollar. This may feel keen, given that pricing in many prime areas of the Australian market is already at, or close to, previous market peaks.

Australia still, however, looks very competitive against many other Asia-Pacific markets, for growth and structural reasons. Furthermore, over the coming years, interest rates may normalise at a slower pace than in previous periods. The cash target rate is not forecast to return to its estimated neutral rate of 4.75% until 2018/2019, with the borrowing rate curve looking smoother.

Currency, base rates and growth

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Michael Keogh

Mike Keogh

Director of Research

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