Pressure remains on Australia’s major office markets

​Sydney, 6 February 2014 – Forthcoming supply is expected to keep upward pressure on office vacancy rates and a lid on rental growth in all CBD markets over 2014 and 2015 according to new forecasts from CBRE.

Commenting on the latest Property Council of Australia office vacancy statistics, CBRE’s Head of Research for Australia, Stephen McNabb, said tenant demand had reached a low point in 2013, contributing to vacancy rate increases across the country.

“Our overall view is that tenant demand will improve in 2014 and beyond, however forthcoming supply will place continued pressure on the market and impede rental growth in all CBD markets over the next two years,” Mr McNabb said.

CBRE Regional Director, Office Services, Andrew Tracey, said the strong positive for the market was the long awaited improvement in tenant demand and deal flow in Q4, 2013 with clever tenants doing “once in a cycle” lease transactions.

“We are closely watching business confidence and our lead indicators point to a more positive environment in 2014 and 2015, so we expect a further improvement in demand conditions in the second half of this year,” Mr Tracey said.

“What we have been experiencing is an “under demand” scenario rather than one of “over supply” in most markets.  We are now closely watching the withdrawal of sublease space and the “residential conversion effect” which is starting to play out in markets across the country to see what impact this will have on leasing market fundamentals.”

Further analysis of the major office markets is below:

Sydney

Mr McNabb said vacancy had remained relatively flat over the second half of 2013, however this was largely due to limited new supply entering the market, which had been largely absorbed.

“Expectations are for a moderate improvement this year on the weak absorption witnessed in 2013 as confidence and economic growth improved and businesses started to grow,” Mr McNabb said.

“This improvement is likely to be concentrated in the second half of the year. Low supply additions will also offer some support to the market this year, however we don’t expect a material decline in vacancy over this period. Further out, we expect vacancy will increase by around 2% as the Barangaroo development completes, with the vacancy rate to peak in 2016.”

CBRE Senior Director, Office Services, Jenine Cranston said tenant confidence had visibly improved, particularly at the small end of the market.

“Cost containment remains a top priority for businesses and this is unlikely to change during 2014. As a result, we see little change to commercial lease terms this year. However, it is encouraging to see that sublease offerings have contracted to 62,843sqm, the lowest level in 12 months,” Ms Cranston said.

“Another encouraging sign is that businesses are being more strategic in their decision making processes, rather than making short term, cost cutting decisions. For the mid to large size tenants, there is a trend to invest in fitouts for long term leases rather than having a complete focus on fitted out options.”

Ms Cranston said the 1,000 to 2,000sqm market remained highly competitive, with close to 300 options in this market, the majority of which were located in the financial core.

"Standing out in this market is challenging and we are seeing more speculate fitouts in this size range along with other initiatives in order to cut through the vast competition,” Ms Cranston said.

Ms Cranston also noted that a raft of larger enquiries were expected to move into a decision making phase in the first half of 2014, which would put pressure on the number of contiguous options available in the CBD in the next 12 months.

Melbourne

Vacancy in the Melbourne CBD remains elevated, despite the PCA recording a decline over the second half of 2013 from 9.8% to 8.7%. CBRE estimates vacancy to be moderately higher, impacted by significantly higher sublease vacancy in the order of 1.8% of stock.

"Certain grades and precincts of the market are continuing to feel the impact of the tail end of what has been a strong supply pipeline,” Mr McNabb said.

“A flight to quality has left leasing issues in backfill space, some of which is largely redundant. This has seen vacancy in the traditional CBD core move higher with development concentrated in the Docklands precinct.”

However, CBRE Director, Office Services, Shane Burns said that while Melbourne tenants were still enjoying favourable market conditions, deals completed in late 2013 and current well qualified tenant demand had given a much needed boost to market sentiment.

“Landlords are continuing to push to attract tenants whether it be through services upgrades, new end of trip facilities, splitting tenancies or through providing tenant fitouts,” Mr Burns said.

“These measures are typically being rewarded with well located, well presented buildings continuing to be sought after.”

Brisbane

Office market vacancy in Brisbane has reached a record high of over 14%, with net absorption for calendar year 2013 the worst on record at circa negative 100,000sqm.

Mr McNabb said this was largely a result of Queensland state government rationalisation and resource sector contraction, which had a flow on effect on overall business confidence. One of the impacts has been a rise in the amount of sublease space available, currently in the order of 80,000sqm and mostly attributable to resource/resource services companies and the public sector.

"Occupier markets are expected to remain challenged well into 2014, with recovery gradual and broad-based, reflecting economic trends. Queensland’s economy is rebalancing from one driven by resource/energy focused engineering investment to one driven by a much broader range of industries, not all of which will be major direct generators of office-based employment,” Mr McNabb said.

Limiting the prospects of a significant turnaround in aggregate net absorption in 2014 will be the moves by Bank of Queensland and Ventyx to new supply in the Newstead and Fortitude Valley respectively, vacating in the order of 18,000sqm, and the possibility of further sublease space being released to the market by Arrow Energy.

Looking forward, Mr McNabb said an absence of major supply additions until 2016 and a return to positive, albeit modest, net absorption at around the long term average (in the mid-30,000sqm range per annum in 2015 and 2016) should see the total vacancy factor edge lower and be in the order of 12% by the end of 2015 before rising again as the next wave of new supply impacted.

“Up to 100,000sq m of secondary stock withdrawal is possible by 2018, however, and this may temper to a degree the next vacancy peak. The prime vs secondary vacancy split is expected to remain wide and favour prime stock,” Mr McNabb said.

CBRE Director, Office Services, David Prosser said Brisbane’s office market was being weighed down heavily by current sublease opportunities.

“A large proportion of sub-lease tenancies available are whole floors which do not split easily. Given the active enquiry is weighted more heavily towards smaller space users at the current time, demand for sub-lease space is weak. On this basis sub-lessors are looking to ‘fire sale’ space in some instances at well below market rents in order to create demand,” Mr Prosser said.

“As the year progresses CBRE is of the view that the quantum of sublease space will reduce quite quickly as some leases simply expire and other tenants decide to make use of excess space rather than leave continue to find subtenants in vain.”

Perth

Vacancy in the Perth CBD continued its upward trend in the second half of 2013, impacted by negative net absorption. This is due to a decline in the amount of space required by mining related companies, many of which are transitioning from construction to production phase with a subsequent fall in required office space. CBRE estimates sublease availability in the market at circa 4% of total stock, inflating overall vacancy.

“As higher levels of supply start to filter through to the market in 2014, vacancy is likely to move moderately higher during the year,” Mr McNabb said.

CBRE Senior Director, Office Services, Andrew Denny said the  12 months negative net absorption figure of 46,442sqm was the worst since the early 1990s for the Perth market.

“The next 12 months should see a recovery in tenant demand. This coupled with low levels of new stock entering the market will mean a far more balanced year,” Mr Denny said.

“Despite this, 2014 will be a year for tenants with attractive leasing deals available.”

Adelaide

Office net absorption has historically been driven by public administration and business services both of which have been focusing on cost containment.  Vacancy jumped to over 12% in the first half of 2013 and consolidated at these levels in the second half of the year.

However, CBRE Director, Office Services, Andrew Bahr said there was a general consensus that the market would return to some normality this year with a positive level of activity post the State Election in March.

“The latest PCA vacancy figures back this up, showing only a slight increase in the overall vacancy rate from 12.1% to 12.4% as at January 2104.  In fact, the direct vacancy has actually decreased over the past six months, with the overall increase due mainly to the amount of sublease space increasing to just over 20,000sqm, the main contributors being Bendigo and Adelaide Bank.”

Mr Bahr said the Adelaide market was uniquely positioned whereby the basic fundamentals should rebound quickly with levels of supply thought to have reached a maximum level and unlikely to change dramatically well into 2016.

“Tenants are currently seizing this opportunity, achieving some of the best deals seen in the market for many years. This is expected to swing back to owners by year’s end, with rental growth expected to return to long term averages and incentive levels to drop as available space is taken up,” Mr Bahr said.

Of the business sectors hardest hit, it appears the engineering sector, with a significant reduction in contracts on offer, has had to cut numbers with many of the top Adelaide firms looking to sublease not insignificant amounts of space.”

Gold Coast

The Gold Coast office market has seen further vacancy rate reductions throughout 2013 with over 13,077sqm of total net absorption. CBRE Gold Managing Director Tania Moore said this represented the highest take-up of space since 2007 and - when measured against the total take-up from 2008 to 2012 of 17,255sqm - the current statistics clearly demonstrated a resurgence of business confidence.

“This improvement in the Gold Coast office market can be attributed to an overall uplift in business confidence since late 2012,” Ms Moore said.

“We anticipate this will continue and there to be a resurgence of interest in the commercial hubs of Southport, Surfers Paradise and Broadbeach following the completion of major constructions work in preparation for the Light Rail project to be operational by mid-2014.”

Ms Moore added; “With the combination of continued business confidence and only a 1,300sqm supply addition in 2014 and no other supply additions programmed for the next 18-24 month period we anticipate vacancy is likely to reach sub 10% by 2016. This ongoing reduction in vacancy will put pressure on rents to increase and incentives to soften. The challenges for the market moving forward are limited large scale space for users of 800sqm plus with currently only a handful of options available across the entire market.”