The commercial property market has had some mixed fortunes over the last few years. The onset of COVID-19 and the lowering interest rates saw investor interest skyrocket resulting in strong compression in investment yields across all asset types. With low interest rates came new investors. First time buyers looking to diversify their portfolios made their first forays into commercial property while larger syndicates, trusts, and funds competed for a wider range of property bringing new highs in capital values. In 2021 we saw peak investment activity after a subdued 2020 with renewed confidence emerging across commercial properties with finance availability high. Upon the commencement of interest rate increases in 2022 we saw a swift slow down in investment activity with buyers more considered given the uptick in cost of finance.
Volumes of sales fell considerably during this time and 2023 transaction volumes were akin to the uncertainty seen in 2020 during the height of the pandemic. Greater distress appeared in the marketplace as sales with increased yield ranges emerged, as the pool of buyers remained low due to reduced sentiment. As we entered 2024 a wave of optimism returned to the commercial property market. Spurred on by the most recent inflation numbers, giving confidence that the next move in interest rates was down and perhaps sooner than first expected. With talk across the economy suggesting two or three reductions this year, sentiment has lifted and enquiry levels across most markets have rebounded.
Across all asset classes, capital values have taken a hit according to MSCI data from December 2023. Reductions have been felt across major asset classes, with office one of the worst hit, down 10.5 per cent, and markets such as Parramatta, North Sydney, Canberra and Melbourne doing it the toughest. For retail, results have been far more moderate due to population increases driving more activity in retail centres, with a small pool of buyers for larger regional centres, prices have been propped up with greatest change in capital returns for smaller neighbourhood and sub-regional centres. Industrial remains the golden child of traditional commercial property investment, while increases in yields have had a negative impact on capital returns, currently sitting at -2.8 per cent, continued income growth has kept total returns in positive territory.
Alternative sectors have also had mixed results. Medical, despite its alignment with population growth, has seen some negativity surrounding capital returns given the increased cost of finance. For the hotel market, however, strong income returns have kept total returns in positive territory with capital declines marginal at 0.8 per cent
So given these results and the uplift in sentiment regarding investment, are we at the bottom of the market? Fundamentals for some asset classes are more difficult than others, such as office, which continues to be hampered by low occupancy and limited optimism surrounding rental appreciation in the short term. Industrial and its low vacancy and limited supply pipeline is keeping rents elevated, while the uptick in population may be fuelling an improvement in the retail and medical sectors. Similarly, continued international and domestic tourism growth has seen room rates and occupancy grow which could signal a turnaround for the hotel market also. An interesting time for 2024 as opportunistic funds seek out commercial property options which will likely slow yield growth and prop up capital value appreciation once again.
