CBD prime yields soften in some markets as investment markets become more aligned with leasing fundamentals
CBD prime yields soften in some markets as investment markets become more aligned with leasing fundamentals
3 November 2014
Sydney, 04 November 2014 –Soft growth expectations and sluggish tenant demand are placing pressure on sectors of the Australian office market, with rising vacancy rates driving up prime yields in some capital cities.
According to CBRE’s Q3 2014 Office MarketView, prime yields in Perth and Brisbane softened in the three months to September; largely as a result of the outlook for vacancy due to the contractionary effect of mining investment spend pulling back and strong supply pipelines.
Perth CBD prime yields lifted seven basis points to 7.93%, while secondary yields eased15 basis points to 9.38%. In Brisbane, prime yields softened nine basis points to 7.25% and secondary yields remained steady on the back of a 50 basis point softening since the start of 2013.
By comparison, average Australian CBD prime office yields compressed by just over 50 basis points from September 2012 to September 2014.
CBRE Associate Director, Research, Claire Cupitt said the low growth expectations facing some markets were starting to become evident in the pricing environment.
“While the extent of the compression in prime office yields to date has been relatively muted compared to other major markets across the world, directionally, pricing trends, and more importantly rental growth expectations, have been out of sync with market fundamentals,” Ms Cupitt said.
“This is now beginning to change with evidence of softening in yields in Brisbane and Perth.”
Despite the weaker market fundamentals in some markets, CBRE National Director, Capital Markets, Josh Cullen said investment demand remained strong for quality office assets at a national level.
“Nationally we are not witnessing the same trend and it has been evident this year in the major east coast markets that core yields have tightened and will continue to strengthen if stock is available,” Mr Cullen said.
“In particular, appetite for assets with residential or future residential potential are being sought after and yielding stronger than expected results.”
Highlighting the strong investment appetite levels emerging in Australia’s office market is the jump in transaction activity year-on-year.
Office transactions during Q3, 2014 totaled $3.97 billion, a 62% increase from the corresponding period in 2013.
Mr Cullen said: “Vendors right now are disposing of assets that they have positioned to capitalise on the strong capital inflow. Globally, we are still very attractive and buyers are accepting lower total returns.”
According to CBRE Research, the stronger NSW economy is expected to support modest growth in office demand from next year.
“Sydney’s relative position in the context of forecast vacancy remains supportive of strong investor demand,” Ms Cupitt remarked.
The report shows vacancy is rising across the nation, with incentives expected to remain at historic highs until the cycle troughs.
Ms Cupitt said the peak in vacancy rates was expected to be highest in Perth (19%), followed by Brisbane (18.5%), Canberra (16%), Adelaide (14%), Sydney (11%) and Melbourne (10%).
“While the outlook for vacancy in Sydney and Melbourne remains within the realm of previous cycles, forecast vacancy in Perth and Brisbane are well above levels seen over the past two decades,” Ms Cupitt said.
Sydney – shift in growth supporting eastern states
Sydney’s office market is benefitting from improvement in job growth, with total employment lifting 1.3% in the year to June – the highest annual growth since December 2012.
Sydney’s CBD vacancy rate remained steady over the September quarter at 8.4%, slightly lower than the 8.9% recorded during the corresponding period in 2013.
Ms Cupitt said due to minimum supply levels at present, vacancy was likely to drop to approximately 8.3% by the end of the year.
“From 2015 however, this trend is expected to unwind, with vacancy steadily rising to a peak in 2017 due to large supply additions centred in Barangaroo, Martin Place and George Street developments,” Ms Cupitt said.
The report shows prime rents in Sydney’s office market experienced a modest growth of 1.0% in Q3, led by a slight increase in lower A grade face rents.
Investment appetite for office assets in the Sydney CBD remains strong, with foreign and domestic buyers pouring just over $1 billion into the market in Q3. Significant sales included 52 Martin Place for $533 million to REST Superannuation and a 50% share in 275 Kent Street, sold to Blackstone for $435 million.
Ms Cupitt said secondary assets with potential for residential conversions remained highly sought after, a trend likely to continue and support vacancy at lower levels than otherwise would have eventuated given the new gross office additions.
She commented: “Secondary markets across Sydney have seen noticeable yield compression over 2014. This places Sydney’s secondary market as the strongest in Australia, with secondary yields averaging between 7.35% in the CBD to 10.30% in Chatswood.”
Melbourne – tenant migration continues as CBD terms remain attractive
Tenant migration to the Melbourne CBD continued during Q3, with attractive leasing terms luring tenants including Viva Energy, Cardno, Australia Post, Brookfield Multiplex, Leightons and Jemena.
Other significant transactions during the three month period included law firm Maddocks (7,000sqm) at 727 Collins Street and Central Queensland University (8,000sqm) at 120 Spencer Street.
Institutional investors continue to target the Melbourne CBD, with acquisition mandates supporting tight pricing.
During the quarter, Cbus Property sold its CBW complex to listed GPT Group and its unlisted GPT Wholesale Office Fund, with each acquiring a 50% share, for $608.1 million at a reported initial yield of 6.10%. Cbus Property also sold 700 Bourke Street to unlisted AMP Wholesale Office Fund for $433.5 million.
Ms Cupitt said Melbourne was expected to remain an attractive investment destination, particularly among offshore buyers, for at least the next 12 months.
“With Melbourne CBD being a gateway city, and favourable yields in an international context, the pricing environment is expected to remain firm and therefore, buying conditions favourable, in the medium term,” Ms Cupitt explained.
Brisbane – CBD vacancy at its highest mark on record
The move of the Queensland economy away from its resource engineering investment focus to a broader base of drivers has underpinned a drop in white collar employment in the Brisbane CBD.
CBRE Research shows white collar employment dropped by 2.1% in 2013 – the first year of negative reversion in 20 years of monitored data. This is however, forecast to improve, returning to positive territory later this year, before gradually strengthening to 1.4% growth in 2015 and 2016.
The weak employment base in the Brisbane CBD, coupled with soft growth expectations, is set to push vacancy to a peak of 17.5% in 2016. Additionally, the CBD still faces the addition of three prime buildings, comprising 180 Brisbane, 480 Queen and 1 William, in 2015 and 2016.
Despite the high supply pipeline forecast, the majority of new space will be offset to a degree by stock withdrawals for conversion or redevelopment to non-office uses (largely residential or hotel). Around 130,000sqm is expected to be withdrawn by 2017-18, with potentially higher levels dependent on the sale of several assets.
CBD vacancy lifted to 14.7% at July 2014, its highest level on record, while prime vacancy remained below total vacancy and had stabilised at 11.0% and secondary vacancy reached 18.2%.
Notwithstanding Brisbane’s record high vacancy rate, tenant activity has increased over the course of 2014. CBRE Research shows several tenants with lease expiries are taking advantage of competitive face rents and incentives by upgrading to higher quality buildings.
Investment markets appear to have been impacted by the Brisbane’s weaker office occupier market. Whilst prime assets remain in demand, the volume of activity is easing and some signs of a slight yield softening emerging.
Perth – Office market fundamentals continue to deteriorate
The effects of Western Australia’s mining investment downturn continues to impact on the capital’s office market, with business confidence in the state now ranking equal lowest amongst Australian states.
White collar employment growth in the Perth CBD has more than halved over the last year to 2.2% in June 2014, with little scope for employment over the next 12 months.
As a result of weaker business conditions and an upturn in stock supply, vacancy levels have jumped from 11.8% in June to 14% in Q3. This result was underpinned by sublease availability, which increased 4% to 65,695sqm over the quarter and a total of 8,195sqm net stock additions in 2014.
Upcoming completions are set to add a further 19,000sqm in Q4, while just over 150,000sqm is forecast for delivery in 2015, of which 61% is pre-committed.
Kings Square represents the largest development in the pipeline, adding a further 61,000sqm of new space over four buildings. The Old Treasury building is also due for completion in the first half of 2015, and will be occupied by the State Government.
The CBRE MarketView report shows tenant demand remains weak in the Perth CBD, with prime net face rents dipping 7.7% over the 12 months ending September 2014. With incentives rising to 25%, net effective rents declined 23.3% over the same period.
Transaction activity in the Perth CBD office market has continued to slow, with just over $224 million in property changing hands this year, marking the lowest annual volume over the past decade.
Reflecting the weaker conditions in Perth’s office market were increases in prime yields during the quarter. Prime yields softened seven basis points to 7.93%, while secondary yields eased 15 basis points to 9.38%.
Adelaide – Abundance of refurbished space expected
While Adelaide’s office market remains flat, demand for space should be supported by professional services, healthcare and education sectors over the medium to long term. This, however, is likely to be offset by a contraction in public administration – the largest employment group in the South Australian capital – as a result of the delayed effects of cuts to public services.
According to CBRE Research, vacancy levels are expected to remain elevated at 13.9% in December 2014, while there is also scope for further increases as some tenants renewing existing leases may relinquish space.
The Adelaide CBD recorded $387.8 million in office sales over the 12 months to September 2014, with $293.6 million involving sales to listed and unlisted funds.
Ms Cupitt said momentum in sales activity was expected to continue into the last quarter of 2014, with 151 Pirie, which forms part of the SachsenFonds portfolio, expected to transact.
“With many prime office assets offering medium to long term lease covenants and stability in returns, the Adelaide CBD office market may attract further interest AREITs and unlisted wholesale funds,” Ms Cupitt said.
Prime grade capital values in the Adelaide CBD increased 2.4% over Q3 to average $4,905 per square metre off the back of modest rental growth yield compression. By comparison, secondary grade capital values fell by 1.9% over the same period to average $2,450 per square metre.
Canberra – Soft labour market continues
White collar employment growth in Canberra is expected to slow to an annual pace of 0.5% by the end of 2014, impacting the CBD office market as a result.
Ms Cupitt said uncertainty continued to be a factor affecting the Canberra office market.
“Occupiers remain hesitant to commit to long term leases or additional space,” Ms Cupitt said.
“Given the high proportion of federal government tenants and the current rationalisation of government departments, questions around head count and space requirements remain a feature of the occupier market.”
Net face rents remained flat across the quarter, while incentives also remained at historically high levels.
The soft occupier demand currently being seen in the Canberra office market is reflected in the high levels of vacancy seen across the city since 2014. Vacancy rose to 13.6% in June, with this figures expected to rise to 15% by the end of the year due to new supply and negative absorption.
The supply pipeline continues to be dominated by government requirements for buildings with a high NABERS rating, with the majority of this stock located in the non-civic precinct.
Despite the soft occupier market, Canberra remains attractive for investors, as evidenced by the sale of the Australian Defence College for $30.5 million.
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About CBRE Group, Inc.
CBRE Group, Inc. (NYSE:CBG), a Fortune 500 and S&P 500 company headquartered in Los Angeles, is the world’s largest commercial real estate services and investment firm (in terms of 2013 revenue). The Company has approximately 44,000 employees (excluding affiliates), and serves real estate owners, investors and occupiers through more than 350 offices (excluding affiliates) worldwide. CBRE offers strategic advice and execution for property sales and leasing; corporate services; property, facilities and project management; mortgage banking; appraisal and valuation; development services; investment management; and research and consulting. Please visit our website atwww.cbre.com.au.