Will the end of rate hikes lead to a surge in investment opportunities?

Amidst the uncertainty surrounding the full impact of rate hikes on the property market, an expert lays arguments as to why investors should hold an optimistic outlook for the future of real estate.

Keith Ong, the co-founder and chief executive officer of RealVantage, said the movement by central banks globally — led by the US Federal Reserve — to tighten monetary policy has impacted investment markets.

He highlighted the real estate sector was not spared, as higher borrowing costs dampened investor sentiment.

“Home prices have taken a huge beating due to rising mortgage rates for most of last year, due to rising interest rates. High costs of borrowing have put a dent in the demand for homes, leading to sliding home prices in many markets,” Mr Ong stated.

The country’s official cash rate currently stands at 3.85 percent, which is the highest level since 2012. This follows a series of 11 rate hikes doled out by the Reserve Bank (RBA) that started in May 2022 to combat surging inflation.

“In Australia, home prices continued to fall for the ninth straight month in January 2023, down 7.2 per cent from a year ago, as higher mortgage rates bear down on household wealth,” he added.

However, Mr Ong expects the rate hikes to slowly but surely taper off as the year progresses, citing the movement by the Fed as a potential bellwether to the direction of interest rates around the world.

“As the Fed is slowly but surely taking its foot off the gas on rate hikes, it is widely expected that interest rates are going to peak at 5.0 per cent in the first half of this year and possibly start to decline in the next,” he said.

He further explained that supply chain disruptions are expected to ease and inflation is expected to moderate, leading to a slowdown in economic growth. This would result in many other major central banks, including the RBA, to slowing down their pace of rate hikes as well.

But while there are indications that the end of the latest rate hike cycle is on the horizon, Mr Ong said it is important for investors to first recognise that even though rate hikes are likely to end this year, this does not imply that “interest rates will fall imminently”.

“Therefore, I expect any fundamental shifts in the market to only take place possibly in 2024, depending on the extent of a potential economic slowdown,” he forecasted.

If the pace of rate hikes slows down and comes to an end soon as widely expected, Mr Ong predicts the housing market will “likely to witness a reprieve and see more stability”.

“This means that the demand for homes is likely to progressively increase and, in turn, push up asset prices. In addition, existing home owners will also be able to refinance their mortgages, which will free up cash flow and make it easier for them to keep up with their monthly mortgage payments,” he explained.

Mr Ong said this upward pressure will “prevent a potential spate of property foreclosures and benefit the overall health of the residential property market”.

Commercial properties to get boost in post-rate hike era

Mr Ong said the positive effects of ending rate hikes won’t be limited to residential properties alone.

He pointed out that commercial properties are also expected to benefit from the turning of the tide on interest rates – opening up investment opportunities.

“If interest rates were to peak and be timely enough to stimulate economic growth and steer economies away from the mire of a deep and protracted recession, business optimism could rise and boost investment and rental demand for commercial properties,” he said.

He explained an uplift in economic activities could generally lead to an increase in demand for office, retail and industrial properties, among others.

Supported by low vacancy and strong demand, he forecast industrial properties in Australia will hold up well against the economic headwinds and could benefit further if rates peak.

Notably, Mr Ong said the rate hikes’ trajectory is not the only factor at play when it comes to how demand for office space will trend.

“Demand for office space is more complex as it is also subject to the evolving post-pandemic work models adopted by corporates — a “flight to quality” from occupiers — as well as a shift towards the occupiers’ needs for the environmental, social and governance (ESG) aspects of a workplace,” he stated.

Recently, JLL’s latest Future of Work research showed Australia’s corporate real estate leaders’ view of the workplace is evolving as the hybrid work model continues to rise in popularity, with 45 per cent of CRE executives viewing “collaborative working ’’ as the primary purpose of office space.

In March, data from CBRE Research showed 66 per cent of the 220 tenant relocations that took place over the last two years resulted in companies moving to buildings with higher market rents than their previous premises, with companies increasingly investing in premium office spaces to align their accommodation strategy with their ESG commitments.

“Office demand will hinge upon how well asset owners are able to flexibly optimise their office space for an all-round, high-quality workplace experience for their occupiers to attract and retain talent, as well as whether they will be able to incorporate fit-outs that support the ESG objectives of corporates,” Mr Ong said.

And although the RBA is expected to reach its peak on its rate cycle “sometime this year”, the expert acknowledged that demand for office assets will be contingent upon the extent of an economic slowdown in the economies.

While demand for premium office space continues to rise, Mr Ong acknowledged the outlook for retail properties remains uncertain.

He explained that even as pandemic restrictions ease and more consumers return to shopping malls, slowing economic growth and elevated inflation are expected to drag down demand for retail space in the near term.

“Even if rate hikes were to cease, the cautious consumer is likely to cloud the outlook for retail properties in the near term, which will affect both rental and investor demand,” he stated.

Outlook for real estate investments remains “optimistic”

Mr Ong highlighted that appetite for real estate in the post-rate hike world will also be affected by other factors, including the state of the economy.

“[Whether] the economies are heading towards a soft landing or a deep recession will have a significant impact on their respective real estate markets,” he stated.

Notably, other experts have issued alarm bells on how the RBA’s rapid rate hike cycle will negatively impact the economy.

Calling back to how the previous rate hike cycle ended, Dr Shane Oliver, the head of investment strategy and chief economist at AMP, recently commented that a similar rate rise cycle back in the late 1980s eventually “knocked the economy off the edge.

On the upside, Mr Ong struck a positive note on how the economy will perform in 2023, pointing out that while Australia is expected to experience “a slowdown in fiscal growth this year”, it is “not expected to go into a deep and protracted recession.”

“[The] Commonwealth Bank of Australia predicts that despite an economic slowdown across 2023, the economy will be able to avoid a recession. The bank expects the Reserve Bank of Australia to cut rates as early as Q4 2023 and that a tight labour market and strong exports and non-mining investments will continue to help hold up the Australian economy,” he said.

With all this said, Mr Ong concluded that his outlook for real estate “remains optimistic” and expects the Australian property market to “bounce back stronger” especially as a soft landing is expected to occur in the economy.

He also advised investors to always capitalise on investment opportunities in the real estate market, no matter what phase of the economic cycle we are currently in.

“Real estate value also tends to increase over time across various economic cycles. And the fact is, there will always be investment opportunities across different economic cycles that investors could participate in and benefit from, whether it is a real estate equity or debt investment.

As a smart real estate investor, it is critical for one to also examine the specific aspects of a real estate deal before making an investment, besides taking macroeconomic factors into account. So, while one keeps a finger on the pulse of the real estate market, be sure that one is fully cognisant of the details of the deal,” he concluded.

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