The buzzword for 2024 seems to be “inflation”.
Inflation signifies a general increase in prices of goods and services over a specific period, typically a year. This means that the purchasing power of your money decreases, as you can buy fewer goods and services with the same amount of money.
In 2024, Australia has experienced a gradual decline in inflation with The Reserve Bank of Australia (RBA) actively working to bring inflation back within its target range of 2-3 per cent. It has done this by implementing measures throughout the year , including interest rate hikes, to cool down the economy and reduce inflationary pressures.
Global economic conditions, supply chain disruptions, and geopolitical events have also influenced inflation trends in Australia.
But how does this affect commercial properties?
Here’s how:
Increased property values
- Commercial property can act as a hedge against inflation. As the general price levels increase, the value of real estate tends to increase, and this can lead to capital appreciation for property owners.
Higher rental income
- Many commercial leases have built-in rent escalation clauses linked to inflation indices, ensuring rental income keeps pace with rising costs.
- Strong economic growth often accompanies inflation, leading to higher demand for commercial space and increased rental rates.
Increased construction costs
- Inflation can drive up construction costs, making it more expensive to develop new properties, which can lead to reduced supply and higher property values.
Interest rate risk
- Rising interest rates: Central banks often raise interest rates to combat inflation, which can increase borrowing costs for property investors. Higher interest rates can reduce the affordability of commercial property investments.
- In recent times we have seen the rapid increase in interest rates have a detrimental impact on commercial real estate asset values due to the investors expectations of risk adjusted returns (yields) increasing due to borrowing costs and risk free investment alternatives (such as bonds and term deposit) yields increasing.
While inflation can present both opportunities and challenges for commercial property investors, understanding its impact is crucial for making informed decisions. Careful analysis of market trends, economic indicators, and individual property characteristics is essential to navigate the complex interplay between inflation and commercial real estate.