Moderating inflation driving pivot to lower rates

As we move into 2024, investors are increasingly confident that moderating inflation will allow central banks to pivot to interest rate cuts this year.

Growth in headline inflation across major advanced economies has declined significantly from recent peaks. While monetary authorities continue to highlight the uncertainty around the inflation outlook – including the potential for upside inflation surprises stemming from still elevated services price growth and the possibility of ongoing supply chain disruptions in the Red Sea – major central banks are increasing hinting at loosening monetary policy.

Headline inflation: Peak to current annual growth rates
Per cent

Source: Savills Research, Macrobond

Financial markets have responded by ramping up bets of monetary policy easing, pricing in around 110bps of cuts from the US Federal Reserve in 2024, with one 25-basis point cut fully priced in by mid-year, while the ECB is expected to deliver around 120bps of cuts. While market pricing is likely overstating the magnitude these policy moves – for instance, the median projection of FOMC officials is for 75bps of cuts this year – the shift to lower interest rates bodes well for a recovery in investment activity in commercial property markets. Australia is expected to lag its global peers, but financial markets are still pricing in one rate 25-basis point cut from the RBA this year.

Central bank policy rate: Market futures pricing    

Per Cent

Source: Savills Research, Macrobond

Market repricing to facilitate investment rebound

Also key to unlocking investment activity is market pricing adjusting to higher interest rates, and there are early indications that this adjustment is gathering momentum in Australia after a significant lag compared to major advanced economies.

According to the MSCI/Mercer Australia Core Wholesale Property Fund Index – which tracks the performance of major Australian institutional funds – annual capital growth declined by 10.7% on average in 2023 for all funds covered in the index, with office funds unsurprisingly recording the largest annual decline at -13.9%.

MSCI/Mercer Australia Core Wholesale Property Fund Index

Per Cent

Source: MSCI Real Assets

While benchmark performance indices for a broader range of commercial property assets are not yet available for Q4 (incorporating December valuations), the property fund performance data point to pricing adjusting more fully to the sharp shift to higher interest rates since mid-2022. This adjustment will reduce the gap between buyer and seller expectations, and ultimately, drive a recovery in investment activity.

Sectors and sector trends to watch in 2024

Given the promising signs of a recovery (albeit gradual) in investment activity in 2024, which sectors will investors seek out and what factors will underpin these decisions?

We expect investment capital will chase assets with the strongest underlying demand fundamentals to take advantage of favourable tailwinds. In particular, we think there will be:

• An ongoing focus on industrial and logistics, data centres, and cold storage. Population growth and ongoing expansion of e-commerce (and technology) will sustain the demand for industrial floor space.
• A reweighting to alternatives, including multi-family, BTR, and student accommodation, as well as a reweighting towards industrial and logistics (and data centres), residential, and social infrastructure (including childcare and healthcare).
• Selective hotel investment, underpinned by the recovery in tourism and migration flows, which is boosting tourism activity and hotel performance. This will drive investment demand for hotels, but buyers will be more selective as occupancy rates continue to normalise.
• Continued strong investor interest in student accommodation driven by the rebound in international student flows, occupancy, and outperformance in rental growth.
• Capital chasing scale in residential (multi-family, BTR, branded residence), with low vacancy of housing stock driving rental growth.
• Ongoing resilience in prime offices as a multi-speed leasing market continues, with secondary offices being more exposed to negative rental growth and leasing risk, while hybrid office working will increase the appeal of core locations and we may see more rationalisation of larger mandates, particularly outside of CBDs.

Top investment picks

Reflecting changing sector trends and fundamentals, competition for assets will shift as investment activity begins to recover in 2024. While allocations within commercial real estate are changing – with a shift towards sectors such as industrial and logistics and multi-family residential – investors will continue to seek out a broad range of assets depending on their investment strategy.

Source: Savills Research