OCR REDUCTION = YIELD COMPRESSION?

We have read various commentaries predicting that with the last cut, and the promise of more to come, of the Official Cash Rate, that yields will follow a parallel course and reduce also. It’s a simple premise – that as landlords can borrow for less, and if they have cash in the bank they will receive less interest for it, then they will be prepared to pay sharper yields. In theory that may seem a reasonable prediction. And some real estate agents spruiking tenanted investments will hope that if they say it enough, it will happen. In short, a self-fulfilling prophecy.

However, human nature is somewhat more complex than that, and landlords often have more experience than agents with newly minted property degrees would like to think.

The contrary caution to the theory that yields will parallel interest rates down, is that the need for such a large cut in the OCR indicates the economy really is in worse shape than we thought, and that even more caution is therefore needed. And that rather than a small cut in the OCR becoming a giant leap in values due to further yield compression, in fact the result is increased caution, and increased focus on tenant quality. If the state of the economy does deteriorate rapidly, whether due to inept management locally, or imported factors, then there will be businesses that suffer. And often those businesses are tenants. Which means that potentially the end result of  OCR reduction = increased focus on tenant quality.