With inflation up and rising interest rates, consumers are feeling the pinch across all sectors; for many property owners these increases in costs are not meeting income returns, signalling the start of a difficult period for some commercial landlords or an opportunity for savvy investors.

Adding to these pressures has been construction costs which have seen significant growth impacting both residential and commercial markets. In the recent ABS results for June 2022, we saw average house price construction grow by 17.3 per cent over the last 12 months.  Melbourne was hit with a 20.0 per cent increase followed by Brisbane (18.7 per cent), Perth (18 per cent) and Hobart (16.9 per cent); while labour is a key concern across the building industry, the cost of raw materials will have an impact on the development pipeline across all sectors in the short to medium term. Timber prices have jumped by 24.2 per cent while metal products are up 18.4 per cent, these levels of escalation are making it difficult for developers to commit to new product which will have further impact on markets such as industrial which currently face a supply shortage.

Commercial property has often been perceived as a good hedge against inflation, however, the current inflation rate of 6.1 per cent will be a test for some landlords, in particular assets which have recorded increased vacancies as these will be challenging. Asset classes such as industrial, with high occupancy and growth in demand notably from the freight, transport, and warehousing sectors are likely to weather the storm given they have enjoyed strong levels of rental appreciation which can, to some extent, counteract these rising rates. Many of these increased costs are heavily passed on to the consumer with the freight and transport industry also recording a strong uptick in costs due to rising fuel, wages and accommodation expenses.  Road freight is now up 8.3 per cent over the last year while postal and courier services have grown 8.1 per cent over the same period.

Tourism assets have had a difficult two-year period with border closures, lockdowns, and reduced occupancy limits, however, an increase in domestic and international travel has seen the service industry raise prices. Again, plagued by rising wages, accommodation costs have grown by 16 per cent over the last year, while growing food prices, labour shortages, and supply chain issues have seen cafes, restaurants and takeaway food increase by 6 per cent. 

As office vacancies are up across most of the country and WFH now expected by a high percentage of the population, we are seeing tenants reducing their office footprints or only leasing adequate space, allowing WFH to cater for any growth. As a result, sublease space continues to climb and incentives will remain a key strategy to fill space. While rental appreciation is unlikely in the short term, there are opportunities for landlords to be more flexible or innovative in their lease terms and conditions to maximise future escalations. However, low yields which were on offer over the last couple of years appear unsustainable given the changing spread to bond rate.

For retail, convenience and food retailing have been the segments showing the most increase in turnover, followed by services; hairdressing and dry cleaning being key industries which have seen price rises up 4.6 per cent and 8.6 per cent respectively. With retail vacancies high, there is little sign of rental growth on the horizon.  There have been a growing number of property owners repurpose their assets (STCA) to allow a broader range of uses such as growth sectors of childcare, medical and even co-working to potentially increase their assets earning potential to hedge against this high inflationary environment.