4 June 2019
The Reserve Bank of Australia today changed the official cash interest rate for the first time since August 2016, cutting the base rate by 25bps to a record low 1.25%. Ostensibly this move is positive for real estate because it (in combination with expected further cuts) will support yield compression in most commercial sectors and expedite price corrections in the residential sector. But there are negative implications for occupier markets that should not be overlooked.

Lower interest rates lends further support to residential markets

The rate cut, and the prospect of further rate cuts – Westpac reckon the base rate will be 0.75% by year-end 2019; JP Morgan, 0.5% next year – adds to recent events that are boosting sentiment in the residential sector:
  • The result of the federal election (with negative gearing and capital gains tax changes off the agenda), which has removed a great deal of uncertainty for the markets.
  • The new assistance package for first home buyers, the First Home Loan Deposit Scheme, meaning some first home buyers will have opportunity to buy their first home with a deposit of as little as 5%.
  • What appears to be a controlled relaxation of credit constraints. APRA has already removed the cap on new interest-only loans that banks could provide (set at a 30% share in 2017) and the limit of 10% per annum growth in investor lending (set in 2014). Most recently (and likely most significantly), is the proposed removal of its guidance that ADIs assess a borrowers’ capacity to meet repayment obligations using a minimum interest rate of 7 per cent.

It remains to be seen if the full rate cut will be passed on from banks to borrowers. Only around half of the last rate cut in August 2016 was passed on. However, having recently been grilled at the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, moves by the banks will be under the spotlight and this might influence their behaviour. Mortgage interest rates will fall but the extent remains to be seen.

Lower yields on commercial real estate to come, but challenges to occupier markets 

Lower borrowing costs will improve asset bottom lines and enable investors to bid at sharper yields and achieve the same IRRs. Our view is that this will prolong the current yield compression cycle and deliver capital growth.

But investors should be wary of the underlying economic conditions giving cause for the RBA to cut the base interest rate, especially the impacts these conditions will have on occupier markets. These are just some of the impacts that we foresee from a weaker economy:

Office sector
  • Expansion plans for some businesses could be put on hold. Some businesses will contract.
  • Finance sector likely to experience slower credit growth. The flow to downstream professional services will slow.
  • White-collar employment growth will stagnate, and in some markets decline.

Industrial sector
  • The industrial sector is typically a bellwether of the economy, especially construction. The PMI (Performance of Manufacturing) and PCI (Performance of Construction) indices suggest these sectors will contract.
  • Logistics is benefitting from the rise of e-commerce. Whilst rate cuts are aimed at giving households more disposable income, a deteriorating economy gives rise to cautious consumers.

 

Retail sector
  • Cautious consumers and ongoing structural changes could see more retailers move into liquidation and thus more retail tenants defaulting.

Hotel sector
  • People concerned about job security will tone down holiday plans…
  • …but a weaker currency will keep Aussies at home and attract foreign tourists.

Tomorrow’s GDP result will confirm that the Australian economy is in poor health. But monetary policy in the form of interest rate cuts is medicine to an ailing economy; the RBA acting today (and again over coming months) is one of the elixirs that will assist in the economy’s convalescence for the remainder of 2019. We expect governments will step in with fiscal stimulus to aid in the recovery.