A geopolitical crisis is a major risk to the steadily improving global economy in 2017 and continued growth in Australian commercial real estate (CRE) markets.
There have been a number of events over the past year with the potential to impact global economic growth such as the UK triggering Article 50, the fight for Raqqa, the US, French and Iranian Presidential elections, US rate rises and various terrorist events. Most of these have had little or indeed have had a positive impact. But in recent weeks, tensions between North Korea and the US have escalated and subsided, leading to concerns over how Australian CRE might be impacted if a geopolitical conflict were to occur.
The following note examines major conflicts or geopolitical events over the past 100 years or so and how Australian CRE, consumer sentiment, US bonds and Australian GDP have responded.
History suggests that most recent conflicts, or events that have de-escalated short of actual conflict, while hitting confidence in the short-term, have had little impact on Australian CRE.
A longer-term conflict involving our key trading partners such as the US, Japan, South Korea or China would be likely to hurt Australian economic growth and Australian CRE, however, at this stage this appears a low probability.
If this remains the case, Australian CRE should remain attractive, supported by an improving economy and relatively attractive yields when compared to bonds and major international CRE markets.
Australian CRE and historic conflicts
Figure 1 indicates that since 1985, Australian office yields, as indicated by the MSCI/IPD Office Income Return, have been influenced more by the domestic economy than conflicts such as the two Gulf wars or the 9/11 terrorist event. During Gulf War I (August 1990 to February 1991), yields did increase though this coincided with an Australian recession and CRE crash when vacancy rates in many Australian CBD office markets rose to over 20%. After the 9/11 terrorist event, CBD office market vacancy rates and office income returns recorded little change. Similarly, there was little change to yields after start of Gulf War II.
Sentiment and historic conflicts
While CRE yields have recorded little change due to conflict in recent decades, sentiment has been hurt in the short term. Figure 2 highlights a jump in consumer sentiment at the end of the Vietnam War and dips when the Gulf and Falklands wars commenced as well as after 9/11. However, the dips have been relatively short lived and also coincided with recessions in the early 1980s and 1990s.
US Bond Yield and historic conflicts
A key driver of investment demand for Australian CRE has been relatively attractive yields compared to alternate investments such as bonds. While our historic CRE yield series is relatively limited, US government bond data is available back to the 1870s. Figure 3 indicates that during the major conflicts of World Wars I and II, US bond yields were relatively stable. However, yields dipped in the months after both Gulf wars commenced and post 9/11 as investors initially sought the relative security of US government debt. Stable or lower bond yields suggest CRE should remain relatively attractive to investors. However, a reduction in CRE income through an economic slowdown could negatively impact demand.
Australian GDP and conflict
Tenant demand, vacancy and rental growth depends on economic growth. Figure 4 shows Australian GDP from 1900 to 2016 and indicates that the economy did suffer during prolonged periods of conflict. GDP falling by an average of 1.4% pa during World War I. Economic growth was more volatile during World War II. Initially dipping to 0.3% in 1939 and then experiencing strong growth averaging 8.2% pa from 1940 to 1943 before slipping to average -4.2% pa over 1944 1945. During the Korean War, GDP real growth averaged a solid 3.8% pa (but did dip to 0.9% in 1952) and averaged 4.4% during the Vietnam War (from the escalation of US participation in 1965 to 1975). As noted earlier, Australia suffered recessions in the early 1980s and 1990s that were more influenced by local factors than conflicts such as the Falklands and Gulf I wars. Since 1991, Australia has not experienced a recession, aided by our increased trade with China, while most other advanced economies were negatively impacted by the tech wreck, 9/11 and the GFC.
National Director, Research
Cushman and Wakefield
Office income return and historic conflicts
Source: MSCI; Cushman & Wakefield Research
Consumer sentiment and historic conflicts
Source: Westpac-Melbourne Institute; Cushman & Wakefield Research
US long bond yields and historic conflicts
Source: Robert Shiller; Cushman & Wakefield Research
Australian economic growth and historic conflicts
Source: OECD;ABS; Cushman & Wakefield Research