The Reserve Bank of Australia (RBA) put an end to rate hike speculations in its May monetary policy meeting by raising the cash rate for the first time since 2010. The momentous decision took many by surprise as the quantum of the rate hike surpassed market expectations. However, the RBA did not stop and continued to walk on its monetary tightening path in its June meeting, increasing the cash rate further by 50 basis points.
The RBA turned more hawkish to rein in soaring costs of living and rising inflationary pressures across the country. At a time when interest rates have begun to increase, property prices have taken a swift turn downwards, potentially bringing a new wave of relief for homebuyers. In fact, some amount of stability seems to be returning to the property market as interest rates surge, reducing the demand-supply imbalance.
However, interest rate hikes have opened a new can of worms for mortgage holders in the form of high home loan rates. Meanwhile, commercial property owners are facing challenges of their own. It is worth noting commercial property lending and corporate lending is the highest source of risk in the credit market. And financial markets have been observing a jarring effect of the interest rate hike, with volatility spreading like wildfire across different financial instruments.
Rapidly changing environment for commercial real estate finance
In Australia, economists and analysts have been anticipating a rate hike much before it was conducted. Amidst this rising interest rate environment, the Australian Prudential Regulation Authority (APRA) has given a rather unsettling warning about the country entering a “very different” housing environment. As per APRA, borrowers could see possible repayment shocks as well as negative equity as ultra-low fixed rates expire.
While the impact of potential interest rate hikes on the residential property market is well-known, the commercial property has been witnessing multiple changes way before the May monetary policy meeting.
Before the post-pandemic rate hike, bond rates and margins or credit spreads were inching higher, with a sharper focus on valuations, loan-to-value ratios and interest rate covers. This has meant a quick jump in the cost of debt over the past six months for commercial real estate finance market participants.
Experts believe that the commercial real estate finance market has contributed to the interest rate sensitivity visible across the Australian economy, much like the housing market. In fact, higher interest rates could make this sector of finance increasingly volatile.
Fears loom that large hikes in interest rates could create a shock-like scenario in the financial market, causing a rapid decline in loan demand. This can quickly translate into a slowing economy, fuelling the risks of a recession.
Shifting demand for commercial property
The COVID-19 pandemic has caused a major lifestyle change for most commercial businesses. While the housing market could soon return to normalcy, the commercial property market seems to have observed an industry-wide change in setup. This is because of the widespread prevalence of remote working settings.
The work-from-home culture has blossomed in the lockdown-induced environment, forever changing the way businesses operate. This has inevitably reduced the demand for office spaces, which form an integral part of commercial real estate. Additionally, many corporations have completely shifted their business model online, making the need for a retail space redundant. Meanwhile, a relatively less number of businesses are now expanding their physical retail outlets.
Thus, commercial property is facing challenges in the form of reduced buyer demand amidst a remote working environment. Speculations are rife that higher interest rates could further reduce the demand for commercial property lending, adding a laggard pace to the sector.
Growing interest of international investors
While domestic investors appear to be taking a back seat in commercial property investments, foreign investors are tapping opportunities in the sector. These foreign investors are making investments on the basis of the location and size of the property, besides evaluating potential income from the desired property. The demand from these overseas investors has been little changed despite rising interest rates as they continue to execute deals from their home countries.
Meanwhile, Asian commercial property investors can be seen actively participating in the Australian property market. Particularly, south-east Asian investors have shown a high demand for essential services assets.
It can be said that the commercial property sector is benefitting from the inflow of foreign capital from Asian nations. It is yet to be seen if an upturn in Asian investments could potentially save the Australian commercial property sector from entering a complete lull. Interestingly, the re-opening of international borders has further increased the interest of foreign investors in the commercial real estate space.
Traditionally, Chinese investors have also been taking an active part in Australian commercial property bids, attracted by the stability and perceived safety of the country. As the Australian economy fared relatively better against the economic headwinds seen during the pandemic, many investors are now viewing the Australian financial market as their go-to option.
Some experts predict that these foreign investors could eventually shift with their families to Australia, further promoting better investment opportunities. While they may not see much harm in investing at a time when interest rates are inching higher, domestic investors are more likely to take a cautious approach toward commercial real estate borrowing.
As the RBA continues to walk on its monetary policy tightening path, it will be enticing to see how demand for commercial property will pan out in the country. Moreover, the commercial real estate finance market could face higher uncertainty in the days ahead as recession fears loom across the country. The fate of the commercial property market now depends on the measures and policies of the central bank and the new government.