New Zealand Research Report | June 2023

What now for yields as peak in OCR is signalled

Having raised the cash rate at the most aggressive pace in its history, the Reserve Bank of New Zealand (RBNZ) recently signalled it has reached the top of the cycle. This will encourage the view that property yields have also reached their cyclical peak. Further movement, albeit limited, may be expected over the short-term.

The return of inflation ends the period of low interest rates

The GFC that began in 2008 prompted central banks in Western economies to slash interest rates as a means to bolster their struggling economies. Over the following years, economic performance gradually improved, but interest rates remained at historically low levels.

However, when the Covid-19 pandemic hit, governments and central banks around the world swiftly implemented emergency measures to support their economies. One of these measures included aggressive interest rate cuts, driving them to record lows in numerous nations.

As economies cautiously reopened, a new challenge emerged: surging inflation. This inflationary trend has been attributed to various factors, such as disruptions in global supply chains, shortages of essential workers, and a surge in consumer spending coined as ‘revenge spending’.

Consequently, central banks found themselves compelled to increase interest rates. This move aimed to curb excessive demand within the economy and work towards restoring inflation to target levels set by policymakers.

New Zealand first to start, first to finish?

The RBNZ took swift and aggressive action as New Zealand was amongst the first countries to combat rising inflation by increasing interest rates. Starting from the Covid-19 induced emergency level of 0.25%, rates were lifted in October 2021, and at each of the subsequent 11 Monetary Policy announcements.

However, the RBNZ has indicated that the current OCR rate of 5.5% will likely be the peak of this cycle, and they anticipate initiating rate cuts in the third quarter of 2024. This announcement surprised experts who expected the recent surge in migration to fuel demand, contribute to inflation, and require further rate hikes.

NewZealand First to Start, First to Finish?

TheRBNZtookswift andaggressiveaction as NewZealand wasamongst the countriestocombat rising by increasing interest rates. Starting from theCovid-19inducedemergency levelof0.25%,rates were liftedinOctober 2021, andateachofthe subsequent 11 MonetaryPolicy announcements.

However, theRBNZ has indicatedthat thecurrent OCRrateof5.5%will likely be thepeakofthiscycle and they anticipate initiating rate cuts in thethird quarter of 2024. This announcement surprisedexperts whoexpectedthe recent surgeinmigration to fuel demand, contribute to and require furtherratehikes

In contrast, the RBNZ asserts that inflation has already peaked and will continue to ease. Although government investment is predicted to grow, the overall fiscal policy is expected to be contractionary. The RBNZ believes that demand in the economy is softening, citing a slowdown in consumer spending and an easing of residential construction activity. Furthermore, they foresee migration levels gradually returning to pre-Covid-19 trends in the coming quarters.

In contrast,the RBNZ assertsthat hasalready peaked and will continue to ease.Althoughgovernment investmentispredicted to grow,the overall policy is expected to be contractionary. The RBNZ believes that demand in theeconomy is softening, citing aslowdown in consumer spending and an easing of residential construction activity.Furthermore,theyforesee migration levels gradually returningtopre-Covid-19trendsinthe coming quarters

Property Values to Stabilise After Wild Ride

Property owners will welcomethe Reserve Bank’ssignal that the(OCR) hasreached itspeak, consideringthe impact that therapidlyrisingrates have had on capitalvalues. Over theperiod fromearly 2020tolate 2021, thevalue of assets,including commercial andindustrialproperties,surgedprimarily fueled by historically low borrowingcosts

Property values to stabilise after wild ride

Thesubsequentrapidincrease in theOCR,however, has ledtohigher costs, causingarecalibration of yields resulting in apartial reversal of thecapital gains previously generated.

Thebest illustration of themovementin yieldsisprovidedbythe Aucklandindustrialmarket, giventhe relatively high number of sales. In December 2019, average yieldsfor Auckland industrialproperties stoodat5.3%, falling by theend of 2021, to 4.1%.By March 2023, howeveraverage yields had risento5.6%. While yield movement varied across sectors and locations,the overalltrend remained consistent

Data released by MSCI revealsthe impact of this cycleonproperty values.Average annual capitalgains for all commercial and industrialproperties peaked at 14.5%inthe year endingSeptember 2021. However,overthe year to March 2023, averagecapitalvaluesdeclined by 6.3%

Property owners will welcome the Reserve Bank’s signal that the (OCR) has reached its peak, considering the significant impact that the rapidly rising rates have had on capital values. Over the period from early 2020 to late 2021, the value of assets, including commercial and industrial properties, surged primarily fueled by historically low borrowing costs.

Valuevariations across sectors also depend on rental trends,which mirrorcurrent demand dynamics.Inthis respectthe industrialpropertysector has been thestrongestperformer,withanextendedperiodoftight market conditionsresulting in rental growth over thepasttwo years. Thisgrowthhas mitigatedthe impact of rising yieldsonproperty values.

The subsequent rapid increase in the OCR, however, has led to higher financing costs, causing a recalibration of yields resulting in a partial reversal of the capital gains previously generated. 2 New Zealand Research Report