Looking for a safe retirement income? It pays to understand the property market

If you’re looking for a regular monthly income stream, with as much protection as possible from market fluctuations, building a diverse portfolio is key. This typically involves a careful balance of assets, including shares, bonds, and property.

Among these, property can offer unique benefits, but it also requires an understanding of its natural cycles to maximise potential returns. Savvy investors benefit from a basic understanding of the property cycle, helping them make informed decisions and stay focused on their long-term goals.

Starts at 60 spoke to the experts at Cromwell Funds Management about important factors to consider when investing in commercial property today.

Of course, you don’t need to navigate these waters without expert guidance. As an established, award-winning funds manager, Cromwell has a proven record of managing unlisted direct property funds and delivering peace of mind to investors, thanks to their in-depth knowledge of the property market.

The four basic phases

In Cromwell’s view, the property market follows a natural cycle with four key phases: peak, slowdown, trough and expansion.

• Peak: This is a phase of strong economic growth, rising property prices, and high investor confidence. However, such periods of optimism can also lead to assets being overvalued. Interest rates may also start to rise in this phase as the Reserve Bank seeks to take some ‘heat’ out of the economy.
• Slowdown: In this phase, market dynamics shift, leading to weaker demand and softening prices. Construction, which typically picks up in the expansion phase, starts to create an oversupply and vacancy rates increase. Interest rates continue to rise, impacting jobs growth and slowing the economy. Sentiment worsens, and in turn, prices fall.
• Trough: Prices hit their lowest point. This is a period of low investor confidence and sometimes widespread despondency. However, it can also be a strong opportunity for investors to buy undervalued assets at attractive prices. Towards the end of this phase, rate cuts often stimulate activity and lay the foundation for asset appreciation.
• Expansion: During this phase, economic and financial conditions improve, boosting investor confidence and supporting asset prices. This is typically the longest phase, underpinned by moderate growth rather than the sentiment-driven extremes of the market peak and trough.

While property market cycles repeat, it is important to remember that each cycle is unique. The intensity and duration of a cycle depends on a multitude of factors, such as macroeconomic conditions, geopolitical events, investor sentiment, and unexpected occurrences like natural disasters or global pandemics.

It is also important to remember that even within a market, different sectors and locations can be in different phases of the cycle at the same point in time.

Now that we have the basics covered, let’s take a look at the current property market:

What does the current market look like?

Here are just a few of the factors Cromwell Funds Management considers when selecting, acquiring, and managing income-producing commercial properties to maximise your return on investment.

The macro landscape

Macroeconomic conditions play a big role in property cycles. Recently, Cromwell has observed a significant increase in interest rates, which in turn has significantly impacted commercial property prices.

However, many believe that interest rates have peaked for this cycle. Other countries such as the US, Canada, New Zealand, and several across Europe, have already started lowering rates. Australia’s inflation cycle took hold around six months later than peer markets and rate cuts are also expected to commence a bit later (around early next year). Cromwell expects lower interest rates will boost market confidence, stimulate transaction activity and support property prices.

Property pricing

Cromwell is seeing signs that property prices may be stabilising. The pace of capitalisation (cap) rate expansion (a driver of declining property values) is slowing for retail and industrial properties, an indication that the cycle may be turning for these sectors.

It is important to note that because the valuation cycle lags, it is best not to wait until the bottom of the cycle, where market valuation cap rates start to compress. Those who wait will find the best opportunity to buy has actually passed them by.

For office properties, cap rate expansion has yet to slow down, but should follow the example of retail and industrial properties, in part supported by the emerging cap rate differential to the other sectors, which will boost the relative attractiveness of office investment. Increased transaction activity is another sign that the market cycle might be turning.

Office fundamentals

While the macroeconomic and capital cycles appear to be becoming more favourable, they would be of little consequence if office market fundamentals were too far out of sync. Despite some challenges (like high vacancy rates in Sydney and Melbourne), there are still reasons for investors to be optimistic about the office market.

Firstly, rents are at cyclical lows, similar to the levels seen after the early ‘90s office market blowup. With rents at low levels, occupiers aren’t under financial pressure to reduce their space or avoid expanding if they’re growing. This also means that cutting office space or rent isn’t the first option for saving costs. Companies understand that losing staff or having lower productivity due to a poor work environment is a bigger risk to their profits.

The other cyclical element of office fundamentals is the development pipeline (i.e. supply risk). This is relatively small, with the amount of national CBD stock expected to grow by only 0.9% per year from 2024 to 2028¹, compared to the 20-year average of 1.6% per year². It’s not practical to build new offices unless they are already under construction or part of an infrastructure project, due to low rents and high construction costs affecting profitability.

It’s unlikely this dynamic will be resolved any time soon, with construction cost inflation expected to remain elevated and state infrastructure pipelines set to continue outcompeting for scarce resources and labour for at least several years. The lack of new development is good for the performance of existing buildings, helping to balance supply and demand and support rental growth.

The long-term trend

Over the past 40 years, investing in Australian office, industrial, and retail properties has generally paid off, with property values growing steadily despite facing a number of downturns and crises. While looking at a shorter timeframe will accentuate cyclical ups and downs, the market has shown a long-term upward trend.

Adopting a long-term approach when investing in property means investors can benefit from this steady growth. This approach helps avoid the stress of predicting market movements. Sticking to a disciplined, long-term strategy based on solid fundamentals can help investors navigate market cycles, reduce risk, and build wealth over time.

Getting in on the ground floor

It’s hard to know exactly when any market will peak or bottom out, but there are signs that can give clues about the general position of the commercial property cycle—whether it’s falling, stabilising, rising, or peaking.

Cromwell believes that for investors who have the courage and capital to buy now, the benefits can be significant. Attractive prices are available, with buyers able to take advantage of distressed sales and the gap between market fundamentals and sentiment.

While choosing the right properties is still crucial for investment returns, getting in early and riding the market upswing can provide a strong advantage for investors.

If you’re looking for real, regular income with long-term capital growth potential, speak to the experts today.

This communication has been prepared by Cromwell Funds Management Limited ABN 63 114 782 777 AFSL 333 214 (CFM) without taking into account your objectives, financial situation or needs. Before making an investment decision, you should consider the relevant PDS and TMD and assess, with or without your financial or tax adviser, whether the relevant product is appropriate for you having regard to your objectives, financial situation and needs.

¹ Source: Cromwell (Jun-24)
² Source: Cromwell analysis of JLL data (Jun-24)