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May 14, 2015

Australia’s record low interest rates and the depreciation of the Australian dollar since late-2014 will continue to spur overseas demand for real estate even as bond yields have risen, according to JLL.

The Reserve Bank of Australia (RBA) cut the official interest rate to an historic low of 2.0 percent earlier this month to support the transition in the economy from mining sector investment spending to more broad based domestic demand drivers. Speaking in Canberra, Treasurer Joe Hockey was quoted as saying that the cut would “put fertiliser” on green shoots in the Australian economy.

Corporate Australia is sitting on close to record cash reserves and the RBA hopes that the cut will spur borrowing and encourage companies to spend and invest. The RBA has also lowered its economic growth forecast to 2.50 percent for 2015, compared a projection of 2.75 percent made in February.

While investment spending in most sectors, particularly in mining, has been weak, the one area where spending has been particularly strong is in residential real estate. In fact as the RBA’s rate cut will inevitably fuel an already buoyant housing market, the banking regulator, the Australia Prudential Regulation Authority (APRA), is running a parallel campaign to monitor housing investment lending. APRA has urged lenders to limit growth in mortgages for property investors to 10 percent a year.

Part of the growth in real estate prices has been attributed to strong demand from overseas investors, in particularly, from Chinese buyers. China has become Australia’s biggest source of approved foreign investment for the first time after investing A$12.4 billion in real estate last financial year, according to the Foreign Investment Review Board’s annual report. The real estate sector had a significant increase in investment approvals with 23,428 approvals in 2013 14, compared with 12,025 approvals in 2012 13. Proposed investment in commercial real estate climbed, from A$34.8 billion in 2012 13 to A$39.9 billion in 2013 14. Proposed investment in residential real estate also increased, from A$17.2 billion a year ago to A$34.7 billion in 2013 14.

While a weaker Australian dollar may attract offshore capital, strong foreign investment is also a double-edged sword. The RBA is anxious to see the currency decline further, but the flow of money into the country has kept the currency well bid. Despite a series of interest rate cuts since November 2011, the AUD hasn’t fallen as much as the central bank wanted.

The rate cut has also not led to a fall in bond yields. Typically a rate cut would push yields down as investors seek better returns elsewhere. But the yield on 10-year Australian government bonds rose to 3 per cent as of May 7, its highest level this year, up from 2.32 per cent at the end of March.

One explanation for the sharp rise in bond yields is that the RBA’s rate move coincided with a sell-off in the global government bond market, which has sparked a jump in bond yields.

“The rise in Australian bond yields is not solely due to the RBA rate cut. There is also an expectation that this will be the last of the series of ten interest rate cuts in the current cycle and we will now have a period of stability before rates increase again,” explains Andrew Ballantyne head of research for capital markets Australia.

“Even with higher real bond yields, commercial property still looks to be good value and is continuing to attract capital,” says Ballantyne.

“The spread between commercial property yields and real bond rates is high by historic standards and remain significantly wider than their recent low preceding the GFC (Global Financial Crisis), despite the fact that yields have tightened in recent months. This is true in Australia but also across most global developed markets,” he added.

The global bond sell off has also weakened equity markets. The S&P/ASX200 A-REIT index has declined by 4% over the past four weeks, Nevertheless it is still up about 6.8% year to date.

Andrew Ballantyne

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