Sydney, 11 May 2015 – The tide is turning in Australia’s office market, amid a six-year high in employment levels driving tenant demand on the eastern seaboard.
CBRE’s Q1 Office MarketView report shows the early signs of improved occupier demand seen toward the end of 2014 have been solidified in Sydney and Melbourne, with vacancy rates declining as tenants migrate to the CBD.
CBRE Regional Director, Office Services, Andrew Tracey said momentum was gaining in the Sydney and Melbourne office markets, driven largely by strengthening business conditions.
“Lower interest rates and the decline in the Australian dollar are supporting business and financial services in NSW and VIC, which is having a positive impact on office markets,” Mr Tracey said.
“Economic improvement is centred on Sydney and Melbourne, resulting in strengthening leasing activity and direct take-up, led largely by IT, education and finance sectors.”
Mr Tracey said solid levels of demand from the IT, finance and insurance sectors was emerging a key driver in Sydney’s office market.
“In the Sydney CBD, enquiries from the IT sector rose 220% over 2014, and has remained a key source of demand in 2015 to date,” Mr Tracey explained.
“Additionally, close to 25% of all enquiries in the first three months of 2015 was from the finance and insurance sector, following from 31% growth over 2014. This supports the notion that financial services is on its way to reaffirming its place as the most significant driver of demand in this market.”
CBRE Research Associate Director Claire Cupitt said demand for premium and A-grade assets remained high, as evidenced by yield compression throughout the major office markets, particularly in NSW.
“This suggests a degree of underlying confidence in the markets amongst existing owners and new purchasers and may translate into solid levels of activity through 2015, as owners look to reposition portfolios in search of value-add opportunities through the year,” Ms Cupitt said.
The report shows national vacancy rates remained stable over the first quarter of 2015, hovering at 11.3%, while 102,135sqm of net absorption is forecast in 2015 across the CBD markets.
Ms Cupitt said while leasing momentum would continue in the office market, conditions would remain favourable for tenants, particularly in Sydney, with CBD office construction ramping up from mid-2015, adding additional prime grade options across the board.
“In this setting, we expect face rents to remain fairly balanced and incentives at, or around, current levels to retain and attract tenants amongst the existing, new and refurbished options on offer. Those businesses currently driving demand will look to shore-up space requirements on favourable terms over the course of 2015 and into 2016,” Ms Cupitt explained.
Sydney
Ms Cupitt said Sydney’s office market was positioned to benefit from the improved economic environment, with white collar employment in the CBD increasing an estimated 1.3% from 2013 to 2014.
“Sydney’s CBD office employment has returned to levels not seen since 2009,” Ms Cupitt explained.
Strong absorption in the second half of 2014 saw vacancy dip 1% to 7.4%, falling further to 7.2% in the first quarter of 2015.
Ms Cupitt added: “Despite significant supply additions, vacancy is being supported in 2015 by large backfill options from tenants moving to Barangaroo being withdrawn for refurbishment.”
CBD office rents remained steady during the quarter, while incentives showed a slight easing, sitting at 34% and 33% for prime and secondary stock respectively.
Outside of the CBD, North Sydney maintained its momentum during the quarter with prime rents increasing 1% to an annual growth rate of 3%.
Prime space continues to be sought after in the North Sydney market, with no full floor options available and prime vacancy forecast to decrease to circa 3.8% over 2015.
“The outlook for North Sydney remains positive with expectations that occupiers will continue to chase quality, particularly in the prime market. North Sydney is now considered a genuine alternative to the CBD and other suburban office markets,” Ms Cupitt said.
In Q1, Sydney prime yields tightened 10 basis points to average 5.85%, the lowest level since June 2008, while secondary yields tightened to an indicative 6.95%.
Melbourne
Melbourne’s office market is benefitting from improved occupier conditions, with fringe and suburban tenants migrating to the CBD, boosting absorption as a result.
Despite strengthening demand conditions in Melbourne, vacancy is forecast to rise as a result of a continued strong supply cycle.
The second half of 2014 saw approximately 70,000sqm of new office space enter the market in the Melbourne CBD, while 29,000sqm is due in the first half of 2015.
“The new supply pipeline is being driven by four buildings currently under construction, which will bring an estimated 173,000sqm of new space to the market over the next two years – 75% of which is pre-committed,” Ms Cupitt said.
The report shows, after trending upwards for more than five years, prime and secondary incentives are expected to have reached their peaks, whilst growth in effective rents is forecast in 2015.
The Southbank and St Kilda Road office markets are both experiencing a flurry of residential conversion activity, shrinking stock supply as a result.
During 2014, St Kilda Road saw the withdrawal of 11,100sqm of office space for residential conversion, with a further 56,700sqm scheduled over the next three years.
In Southbank, four office buildings are earmarked for residential conversion, while two major office developments underway will add 51,000sqm of new supply to the precinct by mid-2017.
Strong investor appetite for prime office assets in Melbourne has continued in 2015, with major transactions over the quarter including 383 King Street for $52.5 million and 446 Collins Street for $34 million.
Prime office yields retained a firming bias, currently averaging 6.50% and reflecting a year on year compression of 25 basis points. A similar trend was evident in the secondary market, with yields compressing 45 basis points over the same period.
Brisbane
Brisbane’s office market remains relatively flat and tenant enquiry modest, with most originating from lease expiries and a degree of ‘flight to quality’.
“There is however some activity being generated by new entrants, particularly in the areas of Asian financial institutions, legal services and education/training,” Ms Cupitt said.
The supply pipeline was unchanged during the quarter, with 180 Brisbane (58,000sqm) due for completion in the second half of 2015 and 480 Queen Street (50,400sqm) and 1 William Street (74,853sqm) earmarked for 2016.
Investor demand for core assets with strong covenants should remain strong in the CBD, with yields averaging 7.25% in CBD and 7.90% in the Near City for prime stock and 9.75% and 10.25% respectively for secondary stock.
“Redevelopment opportunities should continue to be sought after, particularly from Asian capital,” Ms Cupitt explained.
“While the occupier market is soft at present, the low cost of capital and limited number of prime opportunities being presented to the market should help maintain the yield environment for prime assets in 2015.”
Perth
As Western Australia’s economy remains in a state of transition, Perth’s office market is experiencing negative net absorption, expanding vacancy, rising incentives and declining rents.
The decline in prime rents slowed in Q1 to 0.3% following a 2.5% fall in Q4 2014. In the 12 months to March 2015, prime face rents dropped by a total of 7.3%, back to levels seen in 2011.
Vacancy rates recently hit a 10-year high, which will be further exacerbated by substantial new supply this year and continued weak levels of demand.
Leasing transaction volumes reflect general churn as tenants take advantage of weak market conditions, renewing on favourable terms, or in some cases, upgrading their existing space, Ms Cupitt explained.
Vacancy rates in the Perth CBD hit 18% in Q1 2015, up from around 15% in Q4 2014, while sub-lease availability remained a feature of the market at 71,280sqm, or 4.4% of total stock.
Despite sluggish sales activity during Q1, the Perth CBD and West Perth office markets saw yield compression, partially driven by the interest cut in February.
Canberra
Canberra’s CBD office market continues to experience sluggish conditions, with government requirements for energy efficient works spaces and departmental consolidation expected to underpin major tenant moves.
Net absorption is expected to turn positive in 2015, with 8,900sqm of take-up expected, concentrated in the second half of the year.
Ms Cupitt said weak demand conditions had led to some landlords looking at alternative uses in office buildings, such as child care centres.
“Child care centres provide landlords long-term leases, supporting the overall WALE of an asset and improving a building’s service offering,” Ms Cupitt said.
Total vacancy in Canberra measured 15.4% in December 2014, with it expected to remain above 15% throughout 2015.
Adelaide
Adelaide’s office market is benefiting from growth in the professional, scientific and technical services sector, which has supported tenant enquiry over the past 12 months. Looking forward, growth in the education and healthcare sectors is expected to drive demand.
Conditions in the Adelaide office market currently favour tenants, with rising incentives and vacancy rates providing an abundance of stock supply including higher quality space.
“The flight to quality is particularly evident in secondary office stock. Close to 17,700sqm of negative net absorption was observed in the C and D grade office market, with vacancy rates rising to 17.7%, compared to 12% vacancy in prime grade stock,” Ms Cupitt said.
Over the past year, Adelaide’s CBD market has experienced strengthening investor conditions, with growing demand for well positioned, prime assets with solid income profiles.
As a result of strong demand for prime grade assets, yields have shown a modest firming bias, with prime yields compressing to 7.95% and secondary yields firming to 8.90% over Q1.
“The concentration of leasing risk in the broader secondary market is reflected by a widening in the risk differential, or yield spread, between prime and secondary office stock,”Ms Cupitt explained.
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