Commercial property outlook: Positive signs amidst market pressures

Challenging economic conditions continue to weigh down valuations across Australia’s commercial property market, however there are positive signs conditions will improve in the coming months.

Valuations across the market have been negatively impacted by the Reserve Bank of Australia’s (RBA) aggressive interest rate rises, which saw the cash rate rise from 0.10% to 4.35%. These sharp rises resulted in higher capitalisation rates, putting valuations under pressure regardless of a property’s underlying fundamentals. Even rental growth has not been able to offset the extent of capitalisation rate softening in many sectors due to the extent of the rises.

Looking forward, whilst the impacts of the Trump administration’s approach to trade tariffs are yet to play out, the current consensus amongst Australia’s big four banks is that interest rates have peaked and will start to come back down in 2025. A reduction in the cash rate is expected to positively influence property values, the cost of debt and investor sentiment.

Strong demographic trends also suggest a more favourable outlook for the commercial real estate market in the medium term. Australia’s population is projected to grow by 1.1 million people from 2023 to 2025, and by 4.0 million by 2033, driving demand for new shopping centres, industrial spaces, office spaces, and hotel rooms.

Improving conditions, with market factors such as lower supply and higher demand, are expected to support stabilisation, providing a more optimistic outlook for the Australian commercial real estate market.

Industrial

The Australian industrial property market has proven to be the most resilient among all commercial property sectors, showing robust performance despite the broader economic headwinds. As of June 2024, rental growth in the industrial sector remains strong, with many Australian industrial markets experiencing rental increases of over 10% in the past 12 months. This growth has been supported by low vacancy rates, which stand at around 2% nationally.

Industrial vacancy rates and rental growth

	Brisbane	Sydney	Melbourne	Perth	Adelaide
Vacancy rate	2.7%	2.0%	2.0%	1.2%	1.3%
Avg. 12-month rental growth – Prime	13.8%	7.1%	13.6%	8.0%	9.2%
Avg. 12-month rental growth – Secondary	18.7	2.3%	5.8%	1.8%	14.5%

Source: CBRE Research Q2 2024

Tenant demand within the industrial market has exhibited some bifurcation, both in terms of size and location. There is stronger demand for spaces ranging from 3,000 to 10,000 square meters, compared to larger spaces over 10,000 square meters. Additionally, urban infill markets are seeing more robust tenant demand compared to the urban fringe. This trend reflects a tenant preference for locations that offer better connectivity to population zones, which reduces transport costs to customers and provides better access to labour.

In terms of supply, approximately 3 million square meters of industrial space is expected to be delivered nationwide in 2024, with around 60% of this space already pre-committed. This level of new supply is in line with the 10-year average take-up rate, suggesting it is unlikely to significantly impact vacancy rates. However, the majority of this new supply is located on the urban fringe and features unit sizes exceeding 20,000 square meters, which does not align with the current demand patterns favouring smaller spaces in more central locations. As a result, existing industrial properties in urban infill areas are likely to continue enjoying strong tenant demand and rental growth.

Looking ahead, several structural tailwinds are expected to continue driving growth in the Australian industrial market. These include increased e-commerce adoption, which is boosting demand for logistics and warehousing space; population growth, which is driving consumption and the need for local distribution networks; and the onshoring of production, which is increasing the need for manufacturing and storage facilities.

Office

Current development feasibilities have been impacted by the rising cost of construction combined with expansion in capitalisation rates. We have already seen significantly less development activity driven by cost-prohibitive feasibilities requiring high economic rents that have grown c.60% since 2020 and are far exceed prevailing market rents. This will reduce the future supply of office, drive growth in office rents and fill vacancy across existing real estate.

Sentiment around office has improved in recent times with ‘return to office’ mandates gaining momentum across Australian markets. Over the last 18 months, some large banks, corporates and most recently the NSW government have enforced mandates on all workers to return to the workplace to boost productivity across all cities.

Finally, Australia’s population growth forecast is expected to positively impact the office sector. CBRE projects two million sqm of additional office space demand by the end of FY25 to meet the migration requirements alone.

Retail

Retail floor space supply growth is projected to remain slow over the next five years. This tightness in retail floor place supply is likely to help incumbent majors and drive up rents.

The Centuria retail portfolio covers both shopping centres (daily needs and sub-regional centres) and large format retail centres (big box retailers like Bunnings, Harvey Norman, Spotlight, etc). Both of these sectors have experienced strong sales growth in recent years which has been well ahead of rental growth. This has resulted in lower occupancy costs and put upward pressure on rents.

In terms of the retail property market overall, it is showing signs of recovery but the pace and strength of the rebound is expected to vary across different segments.

Healthcare

While no sector of the Australian commercial property market has been immune to challenging conditions, the outlook for the healthcare property market remains optimistic due to pent up demand that is set to surge in the coming decades.

Demand for healthcare services is set to rise significantly, driven by Australia’s ageing population and an increase in chronic health conditions. Within the coming 40 years, the over-65 population is expected to double, while the over-80 population is projected to triple. This demographic shift, coupled with a significant rise in chronic conditions—which have nearly doubled over the past 15 years—will drive substantial demand for primary healthcare services and innovative healthcare facilities.

Technological advancements are also playing a crucial role, allowing surgeries to be performed on older patients, further contributing to the increased demand for healthcare services.

To meet this growing demand efficiently, new models of care are being developed that focus on cost-effective delivery through day and short-stay hospitals. Although some hospital operators in Australia are facing headwinds, day/short stay hospitals benefit from efficiencies compared to long stay hospitals. These facilities are designed to minimize overhead costs and increase patient throughput, enabling more financially sustainable operations. The emerging model of day and short-stay hospitals is proving to be highly profitable, with operators in mature markets like the US already experiencing significantly higher margins.

This pent-up demand, together with supply-side innovation, are significant tailwinds for the Australian healthcare property market, positioning the sector for sustained growth and making it an attractive proposition for long-term investment.

Agriculture

While transaction volumes across the sector have been low, primarily due to limited supply, several recent developments demonstrate how the market is growing to meet increasing demand. Notably, Flavorite has expanded by an additional 12 hectares at their Tatura farm in Victoria and the CORVAL group has commenced a significant new build with a 20-hectare facility in Tongala, Victoria, near Shepparton, costing approximately $120 million.

Rising labour, material and energy costs are headwinds for the sector but these are expected to be offset by tailwinds such as growing demand, advancements in technology and consumer preference for locally produced, pesticide-free food. As a result, the overall outlook for the CEA sector remains positive despite higher cost bases.

Summary

While economic headwinds have presented challenges for the Australian commercial real estate market, the outlook remains positive. The combination of lower supply, increasing demand and gradually improving economic conditions are expected to drive market stabilisation in the coming months. These factors provide a solid foundation for recovery, suggesting a more optimistic future for investors.

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