The key question is whether 2025 marks a turning point for valuations or simply another step in the ongoing search for equilibrium.

The post GFC period of falling interest rates created a tide that lifted all boats. It was a period of limited, gradual change, with it seemingly harder to fail than succeed. That changed in 2022 when interest rates rose, exposing the cracks in Australia’s economic facade.

The US is heading towards a higher growth, higher wage environment underpinned by improving labour productivity. Whereas, Australia appears to be drifting back to the moribund environment that existed before covid. With the economy reliant on population growth and government spending for mediocre growth.

If Australia is to return to its pre-covid funk, it begs the question, what type of assets performed well during this period? The answer is commercial, and particularly, industrial property. In the five years leading into covid, listed property returned over 17% per annum in a period. In contrast, the 5-yr post covid, returns have been flat as the rising cash rate, which increased by 4%, weighed on valuations even as the underlying properties remained strongly tenanted and with sizeable rental growth.

The office sector remains the most challenged, particularly in Sydney and Melbourne, where vacancy rates remain elevated, and secondary assets face significant valuation pressure. Post-pandemic shifts towards hybrid work arrangements have weakened demand, while corporate cost-cutting has further impacted leasing activity.

Premium-grade office assets in prime locations continue to attract tenants, benefiting from a "flight to quality" trend. However, overall sector weakness is expected to persist for several years as the market works through an oversupply issue. Given these dynamics, further valuation write-downs are likely in 2025, making broad-based investment in office REITs a cautious proposition.

Industrial property has been the standout performer over the past decade, benefiting from the boom in E-Commerce and supply chain reconfigurations. The sector experienced three distinct phases: pre-COVID stagnation, a COVID-driven boom, and now, a return to equilibrium.

While rental growth remains positive, supply is beginning to catch up with demand, and capitalisation rates have risen from their 2022 lows of ~4% to the ~6% range. This suggests valuations are stabilising. Investors should expect continued rental growth in 2025, driven primarily by lease renewals and contractual escalations rather than speculative expansion. The long-term outlook remains positive, but the outsized gains of the pandemic era are unlikely to be repeated.

Retail REITs remain a mixed bag. Large regional shopping centres have struggled with slow foot traffic recovery and weak rental growth, while neighbourhood and large-format centres have fared better.

With the interest rate cutting cycle kicking off earlier this year (notwithstanding our Higher-For-Longer interest rate view: read our Interest Income Securities Outlook here for more information), household disposable incomes may improve slightly. However converting this into higher net effective rents will be challenging. Valuations remain under pressure, with further capitalisation rate expansion expected over the next 12–18 months. Investment opportunities exist, but selectivity is key, favouring centres with exposure to growing residential areas and essential retail.

We see the potential for REITs to outperform, as population growth and a gradually slowing economy provide tailwinds for demand and valuation. More people increase the demand for commercial property – whether that be industrial assets to handle the increase storage and transport requirements, retail shopping centres, or offices for an expanded workforce.

On the supply side, construction costs, both labour and materials, remain high and planning approvals are slow. Creating a barrier to entry that will slow new supply to the market, making existing stock more valuable. With interest rates now past their peak we expect declining interest rates to provide a tailwind. For property, it is a case of boring being better for returns.

Cameron Harrison's Listed Property strategy remains focused on delivering stable, inflation-linked returns through a carefully curated portfolio across a variety of sectors. As the market seeks stability, the outlook for REITs remains sector-dependent:

Overall, 2025 is unlikely to be a breakout year for listed commercial property REITs, due to their synergy with long term bond yields. However, this asset class plays a key role in a diversified portfolio due to meeting the objective of long term inflation protection, cash flow generation and access to real assets.