Australian real estate stocks are positioned for further growth, with potential interest rate reductions likely to enhance property valuations and demand across key sectors, based on insights from Citi. The investment bank anticipates that retail and residential properties will gain most from this evolving rate landscape, while industrial assets continue to attract interest, even amid heightened supply concerns. Conversely, the office sector remains sluggish, despite signs of stabilisation.
### Rate Cuts to Boost Affordability
Citi’s economists are predicting four interest rate cuts by the close of 2025, which may drive the cash rate below 3% by 2026. This development is crucial for improving affordability, particularly within the residential market, where property prices have consistently eclipsed income growth since late 2020. The lower rate environment is expected to favour first-home buyers, as they may benefit from reduced mortgage costs and new government support initiatives. Historical data from the 2013-14 rate cuts indicates a possible 20% increase in housing transaction volumes, although current affordability issues may temper price growth expectations.
### Robust Fundamentals in Retail Sector
Australia’s retail real estate market demonstrates strong supply-demand dynamics, with declining vacancy rates projected through the first quarter of 2025. New retail space construction remains modest, totaling just 13,140 square meters, while a year-on-year population increase of 1.8%, bolstered by a 379,800 surge in overseas migration, underpins robust demand.
Retail transaction activity surged by 158% compared to the first quarter of 2024, reaching $1.6 billion, which reflects a 75% rise over the 10-year average for first-quarter activity. Additionally, capitalisation rates have begun to decline across all retail sub-sectors, supporting valuations while rental income continues to show stable growth.
### Industrial Market Remains Attractive
Investor interest in the industrial and logistics sector remains strong, with national rents rising by 7% year-on-year in the first quarter. Brisbane and Melbourne led this growth, posting increases of 9% and 8% respectively, while Sydney and Perth maintained solid 6% growth. Vacancy rates remain below 5% across most metropolitan areas, though there has been a slight uptick from record lows experienced between 2022 and 2023. However, significant supply increases are anticipated, with over 3.5 million square meters of industrial space expected to be completed by 2026, up from 2 million in 2025.
### Improving Conditions for Residential Developers
The growth rate of construction costs has considerably decreased, falling below post-COVID averages, creating a more advantageous environment for development margins. The residential market is likely to gain from both lower interest rates and government stimuli aimed at first-home buyers. Developers with significant exposure to first-home buyers and affordable housing are ideally positioned to benefit from an expected rise in demand as affordability issues begin to ease.
### Office Sector Stabilises, Yet Challenges Remain
Despite stabilisation in office vacancies across many cities, rates are still high, with vacancies at 15.3% in Sydney and 18.6% in Melbourne—significantly above the long-term averages of 8.5% and 10.1%, respectively. While prime-grade properties continue to attract solid demand, high tenant incentives and necessary capital expenditures remain obstacles to effective cash flow generation. First-quarter transaction volumes were low at $1.4 billion, though investor interest may improve as interest rates decrease and the bid-offer spread tightens in selective transactions.
### Investment Outlook and Stock Recommendations
Citi continues to favour high-growth real estate stocks that stand to gain from the anticipated interest rate cuts, with Goodman Group (ASX: GMG) being identified as a top pick due to the long-term growth potential in data centres. Scentre Group (ASX: SCG) has also been elevated to a preferred position ahead of the upcoming results season, thanks to strong retail fundamentals, high occupancy rates, and decreased debt costs.
In the residential sector, Citi prefers Stockland (ASX: SGP) over Mirvac Group (ASX: MGR), attributing SGP’s stronger positioning toward first-home buyers and affordable housing solutions as beneficial in light of rate cuts and government incentives. The firm expects SGP’s earnings to significantly improve as the residential market recovers.
For those seeking industrial opportunities beyond GMG, GPT Group (ASX: GPT) and Stockland are noted for delivering attractive income growth from their industrial portfolios, while Charter Hall (ASX: CHC) and GPT stand out among diversified firms sensitive to interest rate cuts.
In specialised sectors, Ingenia Communities (ASX: INA) leads in land lease investments, while National Storage REIT (ASX: NSR) is prominent in the self-storage sector, both expected to gain from demographic trends, including Australia’s ageing population. Citi has upgraded several stocks based on relative valuations following their recent underperformance, including Lifestyle Communities, Charter Hall Long WALE REIT, and Lendlease.
Although there’s an element of stabilisation within the office sector, Citi’s outlook remains cautious compared to retail, industrial, self-storage, and the residential sectors, with GPT identified as its key value selection in the office category.
