Sliding values leave property trusts feeling the squeeze as interest rates bite

Landlords warn the big reset in commercial property markets is only just starting to play out as they face a cocktail of higher interest rates, soaring building costs and uncertain demand.

Landlords have warned that the big reset in commercial property markets is only just starting to play out as they face a cocktail of higher interest rates, soaring building costs and uncertain demand from big tenants.

The trusts that reported, including office landlord and funds house Dexus, shopping centre group Vicinity Centres and developer Mirvac, insist they can navigate the tougher environment which is also crimping their ability to get projects off the ground.

They were hit by writedowns on their portfolios as the value of office buildings was cut and malls were again trimmed with further cuts expected across the industry as disposals are finalised.

Dexus chief executive Darren Steinberg. Picture: Britta Campion

The hits to office landlords are coming when vacancy levels are running at their highest levels since the 1990s and retail players were buffeted even before Covid struck.

The results showed that large office sales are being drawn out in Sydney and Melbourne although the landlords said outcomes should emerge within weeks and that Australia was still attractive to global investors.

The property companies said asset valuations had come under pressure due to rising rates and also called out the uncertain world environment.

“We anticipate that fiscal 2024 will remain a challenging period as capital flows and market sentiment continue to be impacted by inflation, higher interest rates and geopolitical risks. This environment is expected to put further pressure on the valuations of real assets,” Dexus chief executive Darren Steinberg said.

The property and funds group believes real estate markets are returning to more normal levels after the era of cheap money.

An artist’s impression of the Dexus Waterfront Brisbane development. Picture: Richard Walker

Mr Steinberg said that having a cost of debt at about 5 per cent was just getting back to normal levels after the period of extraordinarily low interest rates. This drove a hunt for income in which asset prices soared and total returns shrank to about 5 per cent, which is now coming back to the 7 to 10 per cent range.

He said Dexus’s recent sale of an office block in Sydney at a 17 per cent discount to valuation was only getting back to 2018 levels. More is to come as he expected capitalisation rates to expand by another 12.5 to 25 basis points this year but the company was confident Australia remains attractive to global investors.

“Despite everything we’re going through here, it looks really good on a global scale because we’ve got a relatively robust economy, supported by very strong migration levels,” he said.

Vicinity Centres CEO Peter Huddle. Picture: John Feder

On the retail front, Vicinity chief executive Peter Huddle said that big adjustments had already been made on shopping centres.

“During the middle of the pandemic we did valuation adjustments across our portfolio and we are still probably 9 per cent below in terms of the total value of our portfolio pre-pandemic and in our CBD probably 20 per cent below,” he said.

Mr Huddle said in the last year there was a 1.6 per cent valuation decline, some of which reflected softening capitalisation rates, partly offset by income growth.

He said the company acted early enough. “We took the hit early through the pandemic, had some growth coming but with increasing interest rates and cost of capital we have adjusted the valuation, offset by income growth.”

An artist’s impression of redevelopment proposals for Vicinity Centres’ Chadstone Shopping Centre in Melbourne.

Vicinity chief financial officer Adrian Chye argued there were differences between offices and malls, saying towers were facing structural issues due to working from home impacting rents.

Retail landlords are also optimistic that they will be able to wring more out their tenants and Vicinity is forecasting a 3 per cent rent increase as its malls, including Melbourne’s Chadstone Shopping Centre, hold up in the face of cost of living pressures and retailers warning on the sustainability of profits.

Developer Mirvac, which straddles housing, offices and retail, gave a cautious outlook statement, trimming its distribution. But housing is still performing and the company is also spreading its wings in build-to-rent as well traditional apartments and housing.

Mirvac chief executive Campbell Hanan. Picture: NCA NewsWire / Nikki Short

CEO Campbell Hanan said the company was well-aligned to the impact of 12 interest rate rises. He noted it had agreed to sell major offices in Sydney and Melbourne despite the industry tumult.

He argued that there was diversity across different assets, with premium grade assets performing but others at risk.

“There are some older A grade assets that are certainly struggling particularly if they’re not in the heart of the CBDs, and even more so if they’re in suburban fringe markets. There are winners and losers in office markets, more so than there has been in the past,” he said.

Mr Hanan was cautious about retail, where spending could slow. “We should expect to see the impact of higher interest rates slowing down consumer spending, and certainly that would be the intent of higher rates in the first place.”

Originally published as Sliding values leave property trusts feeling the squeeze as interest rates bite