Inflation Expectations

By Richard Matthews
Associate | Industrial, Development & Commercial

I was listening to a great podcast on the origins of the 2% inflation target recently. Turns out it came from NZ originally. What was of particular interest was the reference to Inflation Expectations being a precursor to actual inflation. Inflation being a driver of interest rates and interest rates being a driver of Industrial property Cap rates among other things.

The above shaded areas are US recessions and typically follow a rise in expectations. Tellingly this is a long time before the inverted yield curve in bonds appears which is typically another telling precursor to recessions much watched in financial markets.

With US inflation expectations falling relatively quickly in response to Central Bank interest rate rises, there are now many suggesting we could avoid not only a larger recession but even a small one. Let’s all hope so.

Cap rates are effectively the ‘yield’ in commercial property and cap rates were at all-time lows recently for Industrial. Cap rates can expand with either rents growing and / or values falling. Rents have been growing at almost unprecedented rates in Industrial property of late. As Cap rates are critical to Industrial property negotiations, they are discussed daily in the industry. So, most would agree that cap rates in 2023 are rising and really any debate is about the quantity.

There are many mitigating factors in that general statement and one critical one is leasing quality. This UK metric tracks the impact of leasing quality on office values.

It correlates with my anecdotal observations on the Sydney office market the last few years.  The lessons from B & C grade offices should ring true in part for Industrial in 2023. It could be slightly more of a buyers’ market and poorer quality assets will no longer be the flavour of the month. To the contrary, quality Industrial assets with A grade leases and tenants will hold better value if other commercial asset classes are any indication.