Impact of the 5th cash rate cycle on Australian office sector

Over the past 30 years, the Australian economy has experienced four major interest rate tightening cycles, having varying impacts on office yields and sales transaction volumes. We are going through a fifth monetary policy tightening cycle which has seen the RBA cash rate move from 0.1% in Q4 2020 to 4.35% in Q1 2024 (Figure 1).

Figure 1: Interest rate hike cycles and Australian midpoint office yield movements

Source: Reuters, JLL Research

Australian CBD office investment volumes totalled AUD 4.42 billion over 2023, the lowest level of investment activity since 2009. The low transaction volume is primarily attributed to the rise in the risk-free rate (treasury bond) and liquidity crunch due to the higher cost of debt. To mitigate the risks, A-REITs have taken proactive measures to refinance their office portfolios and engage in strategic capital recycling or sales processes. This approach will allow A-REITs to generate capital to bolster positions amidst declining asset values. This is evident in the most recent reporting season (December 2023), where the majority of A-REITs have taken conservative gearing positions due to the office sale process.

Looking ahead, the ASX futures market has priced in one potential rate cut by the end of 2024 (3.96% as of 18th March 2024). Additionally, green shoots appear to be emerging, as investors have greater clarity on interest rates and therefore have more clarity on pricing office stock. This is evident as majority of the A-REITs have lowered the interest rate hedge compared to 2023 level, indicating confidence in the Australian economic outlook. We expect that well located assets with strong covenants are top of the list for larger domestic and offshore groups which has seen several high-profile assets come to market in the Sydney CBD and Brisbane CBD will provide insight to pricing levels over 2024.