As the world treats COVID‑19 as a distant memory, there is an increasingly strident push (from employers and landlords) to bring white‑collar workers back to the office, to encourage collaboration, restore productivity and revive city centres.

After a taste of freedom at home, workers have been slow to swap tracksuits for work suits, resume their commutes and return to their desks. For many employers and employees, the compromise comes to about 3–4 days a week physically in the office.

Amid a cyclical slowdown due to higher interest rates and a structural shift to working from home, there has also been a material reduction in office net absorption over the past three years. Some of this missing office demand is permanent, which will ultimately be reflected in occupancy rates, rents and asset pricing.

As more workers return to their desks, they are being more selective in the location, quality and amenity of their workspaces. This is driving a widening gulf between the city and the fringe and between the different office grades and service offerings.

Meanwhile, a long‑awaited price correction is unfolding in Australian office markets. Certainly, there is more adjustment to come locally, but offshore markets are already finding that market‑clearing price, enough to bring investors back into play.

For investors, there is clearly a tale of two markets. Equity investors are being highly selective, keenly seeking the right entry price. Investment‑grade credit exposures are still very resilient, even as major lenders retreat from this space and impose much more conservative lending terms.

Amid the long-standing calls for a big housing market correction, residential returns to recovery. Prices are rising broadly again, while rents are surging ahead. This cycle is being turbocharged by undeniable demographic drivers, specifically robust population growth.

What is unusual this cycle, is the aggressive and persistent uplift in mortgage rates. Historically, rate cuts precede the turnaround in prices. This time, the strength of housing demand is generally outweighing the adverse drag of higher funding costs.

Without a doubt, the strength in housing demand is structural in nature. On the one hand, strong migration inflows and population growth – quite unlike many parts of the world – are driving urgent housing needs. On the other, personal living preferences (with more singletons and couples) are also adding to that housing requirement.

This demand uplift is occurring alongside a faltering supply pipeline, waylaid by higher input costs, higher funding costs and unseasonably wet weather. While feasibility is challenging, the sale opportunity is looking firmer upon completion.

With surging demand and lagging supply, we are looking at a sustained undersupply for much of this decade, notably concentrated in the major cities and more skewed towards higher-density apartments, which offer more affordable entry price points.

For investors, there is a sizeable and durable opportunity ahead in Australian residential, to address the urgent need for private and public housing, to enable the rapidly emerging multifamily rental sector, and to fund the diverse equity and debt capital needs of this substantial, multi-year home-building cycle.

Supply chain disruptions and elevated energy prices have combined to drive an outbreak of global inflation not seen since the 1970s. The inflationary surge for housing construction is even more severe, marked by outsized price gains for all types of building materials.

In 2023, there are more consistent signs of slower inflation (or prices rising at a more moderate rate). Indeed, swiftly responsive inputs like fuel and steel are already showing outright price falls. Meanwhile, slower and less responsive inputs like timber, tiles and cement are still showing price gains, albeit at a more subdued pace.

After the peak, the step down in price inflation will look much like the initial step up in reverse. Historically, the cost passthrough – both over time and across different components – follows a consistent sequence upwards and downwards. In short, the construction sector is on track for a broader phase of slower inflation in 2023 and 2024.

Higher input costs have been driving a big squeeze on construction profits and some high‑profile builder failures. As cost inflation eases and sales improve, the worst of the cost squeeze is now behind us, as builders move to restore margins in a strengthening residential market with considerable undersupply.

In this new landscape, builders are resetting their feasibility thresholds to account for higher materials and funding costs. Notably, contract builders are opening their books, moving off fixed‑cost contracts and building in more contingencies to account for cost and other uncertainties.

The unexpected surge in costs since 2020 has reshaped the building and contracting landscape in 2023, as inflation eases and builders move to restore profit margins, at a time when selling prices are showing a strengthening rebound.

The days of ‘NICE’ – the Non-Inflationary Consistently‑Expanding market – are well behind us, as we move to the world of ‘WINE’ – Wild Inflation, Negligible Expansion – which requires a marked shift in investor strategy for some years to come.

With inflation remaining well above the official target, central banks are responding with aggressive rate tightening. On current money market expectations, rates are likely to be higher for longer, ruling out the passive levered beta strategies of prior years and driving investors to look more keenly for alpha returns.

Investors are keenly seeking the right hedge, partly to offset the recent weakness in global demand and mostly to hedge the adverse impacts of high funding costs on equity returns. Australian real estate credit is a strategy that is well positioned to provide this hedge.

From an equity investor perspective, real estate sectoral market trends are diverging widely across a booming industrial sector, a resurgent residential sector, an uneven retail sector, and a deeply out‑of‑favour office sector.

From a credit investor perspective, divergent sectoral trends are not presenting the same degree of risk. Australian real estate values are more resilient, less prone to deep drawdowns that erode equity capital and expose debt capital.

In our view, Australian real estate credit is well poised to deliver strongly for investors, with resilience across the cycle and a strong hedge to high interest rates. Moreover, we see considerable scope for this segment to diversify portfolios and improve risk‑adjusted returns.