Sentiment faces in office markets amid economic uncertainty and rising interest rates
National Australia Bank's Commercial Property Index faced headwinds in the second quarter due to fading sentiment in the office markets, while Industrial and CBD Hotels sectors continued to thrive.
Amidst economic uncertainties and rising interest rates, the number of developers planning new building works in the next 18 months has dipped below levels seen during the height of COVID uncertainty in mid-2020, NAB reported. Additionally, acquiring funding (debt and equity) remained challenging in Q2, and accessing funds in the next three to six months is anticipated to be harder than at any point since early 2019.
The Commercial Property Index, which measures market sentiment, continued to languish in Q2, slipping from -6 points to -7 points compared to the previous quarter, printing below the long-term survey average of -2 points. However, certain sectors maintained elevated sentiment levels, particularly the CBD Hotel sector, which experienced a substantial uplift of +38 points. Property professionals reported significant growth in revenue per available room (RevPAR) and solid occupancy rates in this segment.
Despite having outperformed significantly since late-2020, the Industrial index is now starting to "normalise," falling to +26 points, though still well above average levels. The Office Index, on the other hand, saw a sharp decline of -28 points, attributed to lower capital and rental growth, while the Retail index showed some improvement at -17 points, albeit still weak due to economic challenges and reduced consumer spending.
Confidence levels
NAB is observing signs of a sharp slowdown in activity following a robust growth period in 2022. With rising interest rates, the risks to growth are increasing. Consequently, commercial property confidence levels eased in Q2, with the 12-month measure falling to -3 points and the 2-year measure rising to +11 points.
Short-term confidence levels are highest in the CBD Hotels (+25 points) and Industrial (+22 points) markets, while the Office sector lags behind at -18 points. In the longer term, confidence is highest for Industrial property (+30 points), ahead of Office (+10 points), and Retail (+3 points).
Across different states, market sentiment was negative in all areas except for Queensland (+8 points) in Q2, with Victoria experiencing the lowest sentiment by a significant margin at -22 points. Property professionals in Western Australia (+14 points) and Queensland (+12 points) express the most confidence about market conditions for the next year, while Victoria is the least optimistic at -12 points. Queensland is the only state with positive confidence readings for all market sectors in the next 12 months, while Victoria is the only state with a negative confidence print for the next two years (-4 points), specifically in all market sectors, especially Office (-25 points).
Regarding capital growth expectations, Industrial property is expected to perform well in the next one to two years (0.8% and 1.4%), with the most promising prospects in New South Wales (2.3% and 3.3%), while Victoria's expectations are lower (-1.2% and -1.9%). CBD Hotel values were scaled back, and a decline is now expected (-1.3% and -4.9%). Office property values also took a hit (-3.4% and -1.5%), with expected declines in all states next year (from -2.1% in Queensland to -5.1% in Victoria).
Only Queensland is expected to see growth in property values in the next two years (0.6%), with Victoria facing the biggest falls (-3.6%). The outlook for Retail is largely unchanged (-2.7% and -1.5%), with values projected to fall in all states except for Western Australia in 2 years' time (2.3%).
Rental vacancies
The national office vacancy rate eased to 9.6% in Q2 (from 9.9% in Q1) but remains above the average (8.5%). Vacancy rates were reportedly lower in all states in Q2, with the highest in Western Australia (11.9%) and Victoria (11.3%) and the lowest in New South Wales (8.2%).
Retail vacancy rose to 7% in Q2 (from 6.7% in Q1) and varied from 13.7% in South Australia/Northern Territory to 5.9% in Queensland. The national Industrial vacancy rate remained steady at a survey low of 2.8% in Q2, with very low vacancy levels reported in all states, ranging from 2.3% in New South Wales to 4% in South Australia/Northern Territory.
Office rental markets are anticipated to remain under pressure in the next 12 months, with average rents expected to decline slightly by -0.1%, but show moderately positive returns in two years' time (0.7%). Queensland is expected to outperform all states for income growth in the next 1-2 years (3.6% in both years), while Victoria is the clear underperformer (-3.0% and -1.9%).
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In the Retail sector, property professionals are somewhat more optimistic, expecting average rents to decline modestly (-0.4% and -0.1%), with positive returns forecasted in all states except for New South Wales (-1.5% and -1.6%) and Victoria (-1.5% and -0.6%). In the Industrial sector, a positive outlook for rental growth remains due to structural under-supply and strong demand (2.5% and 2.0%), with all states, particularly New South Wales (3.2% and 2.5%), experiencing growth.
Construction slowdown
NAB's survey findings for Q2 confirm a continued slowdown in construction and building approvals data. The number of property developers expecting to start new building works in the next six months declined to a survey low of 26% in Q2 (from 33% in Q1). Another 37% are planning to start within six to 18 months, leading to a record low of 63% of developers intending to commence construction within the next 18 months, falling below the previous low set during the height of COVID uncertainty in mid-2020 (68%).
Recent ABS building approvals data indicates further weakness in construction activity and dwelling investment, with total approvals now well below their early-2021 peak. NAB's survey also found fewer developers planning to start new building works in the residential sector in Q2, with only 47% (compared to 51% in Q1) targeting this area. Additionally, a below-average 10% of developers are focused on Office and Retail spaces. Conversely, ongoing shortages and strong demand in the Industrial property segment have attracted above-average interest, with 18% of developers looking to initiate new works in this sector.
Funding conditions remain challenging
Funding conditions remain challenging. In Q2, the net number of property professionals who found it harder to obtain debt funding improved slightly but remained elevated at -34% (compared to -20% at the same time last year). Similarly, the number of professionals facing difficulties obtaining equity funding increased to -27% (nearly doubling from -14% at the same time last year).
Looking ahead to the next three to six months, more property professionals anticipate worse debt funding conditions (-37%), with the net number also expecting equity funding conditions to deteriorate further (-31%). This would make both debt and equity funding more difficult than at any time since early 2019.
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