After much speculation, the Reserve Bank of Australia officially raised interest rates to 0.85 per cent in June, before raising them again to 1.35 per cent in July. After years of extremely low interest rates, this sudden change will throw into question exactly how match-fit the Australian economy is, with many landlords and property managers now accustomed to cheap debt. The office sector, which is already grappling with sluggish occupancy rates in the wake of COVID, is set to be hit particularly hard by these changes.
In terms of immediate effects, rising interest rates will cause those with variable loans to see a rise in repayments, impacting their return on investment. This could easily spell trouble for office property managers and landlords who have a significant amount of debt that they expected to stay cheap for a long time. Many younger business owners will have only ever known how to operate in a low-interest rate economy, meaning they could be in for an unexpectedly difficult few years.
Putting further pressure on the sector is stagnating office occupancy rates. According to The Property Council of Australia’s latest Office Occupancy survey, whilst average office occupancy across all cities spiked by 30 per cent in May, overall worker numbers are significantly lower than they were one year ago. The survey also revealed wide variations in occupancy, with worker numbers peaking mid-week and slumping on Mondays and Fridays to less than 30 per cent in Sydney and Melbourne.
It is clear that employees, who have relished the comfort, flexibility and time savings afforded by remote working, are still resisting a complete return to the office, an attitude that has been met with mixed reactions from employers. Whilst many business owners tout the benefits of in-person collaboration, they have also come to accept that flexible work accommodations have become a top priority for workers. Due to the tight, competitive labour market at present, most employers are still reluctant to draw a hard and fast line on this issue with concerns that inflexible working policies could lead to resignations or have them miss out on future talent.
The true impact of rising interest rates and stagnating occupancy rates will materialise in the coming months, as lease terms roll around for renewal. Prior to the pandemic, it was commonplace for office tenants to enter four-, six- or even 10-year leases. But the flexible working revolution now has business owners re-evaluating just how much office space they really need, with some tenants deciding to do away with a physical office entirely.
Amid this economic uncertainty, landlords and property managers may have to accept shorter lease terms in order to fill these vacancies. They should also ensure they are conservatively geared when it comes to the amount of debt they are taking on. Any landlords that require their office building to be 100 per cent occupied to be able to service their debt are in an incredibly risky position, as any drop in vacancies, mixed with higher debt to service, could very well cause their asset to end up underwater.
However, it’s not all bad news. Rising interest rates and an economic downturn can create healthy competition in the market, breeding ample opportunity for patient buyers. Many property managers and landlords will have been sitting on cash but struggling to get into the market due to inflated property prices and fierce competition, which is likely to drop off now in the current environment. These individuals will be well-poised to buy in the drop and start a new wave of investment. Any turn in the market, even a turndown, ultimately breeds both opportunities and risks.
Tom Wallace is the chief executive of Re-Leased.
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