Prediction: Two more rate cuts

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There is a high chance that the Reserve Bank of Australia will further cut rates next year, which, in turn, will help boost investment activity in the real estate sector, according to the latest forecast by Knight Frank. 

The persistent slack in the labour market, weak wage growth, and low inflation could push the RBA to ease its monetary policy further, cutting the official cash rate two more times to hit 0.25%. 

Knight Frank chief economist Ben Burston said the sharp downward shift in interest rates would drive the investment market to new highs, prolonging the property price cycle.

"In many ways, we are in uncharted territory, with the global economy and property market cycle entering its 11th year since the last downturn — a record expansion by some measures," he said. "Despite an extended cycle, we are yet to see the re-emergence of inflationary pressures and higher interest rates."

Also read: RBA leaves rates on hold – but for how long?

Burston said lower interest rates would help buoy the demand for commercial property assets as investors reassess the potential for further yield compression. 

"Strong demand from institutional investors for prime office property assets has been evident in 2019 and this should continue next year," he said.

Furthermore, with the improving economic outlook and sustained capital growth, Burston said smaller private investors are poised to become more active next year. 

Offshore investors are also expected to contribute to investment activity. They are likely to be attracted by the relatively high yields in Australia compared to many cities in the Asia Pacific region.

Implications of rate cuts

Knight Frank identified three market implications that could arise following the rate cuts.

While the outlook is set to improve, growth will likely remain low by historic standards. In this scenario, firms would be more cautious and absorption would remain subdued.

Occupier market performance could also converge to some extent, especially as economic and employment growth becomes balanced across states.

Lastly, monetary easing could provide a significant stimulus that can boost activity in capital markets and drive values higher. 

Also read: Sydney, Melbourne likely to remain vulnerable?

Office property — a bright spot?

Capital growth is projected to pick up a little over the next two years after slowing down this year. This is particularly true in the office and industrial markets, said Chris Naughtin, Knight Frank associate director for research and consulting.

According to Knight Frank's estimates, the capital growth of office property will likely pick up by 5.8% in 2020 and 6.4% in 2021.

"Sydney and Melbourne have dominated occupational market performance in both the office and industrial sectors over the past five years, substantially outstripping Brisbane, Adelaide and Perth in terms of rental growth, capital growth and overall returns. In 2020, we expect to see the start of a shift to a more even pattern of growth moving forward," Naughtin said.

However, office vacancy in Melbourne is set to increase as a large wave of new office supply comes to the CBD. In the next two years, there will be around 590,000 square metres of office supply to be delivered in the city.

"Melbourne office market conditions have been very tight for the past two years, as the market has benefited from a sustained run of high net absorption, which has driven the vacancy rate to a low 3.3%," Naughtin said.

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