Economic factors to drive demand in Australia’s office markets

Sydney, 6 August 2014 – Improving economic conditions and rising business revenue for office-occupying industry groups is expected to underpin improved demand in Australia’s major CBD office markets from late 2014, 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 the results were moving in line with expectations for 2014, with Sydney and Melbourne the more balanced of the markets, while Perth and Brisbane were seeing the most vacancy pressure and highest vacancy rates emerge.

“While subdued demand for office property during the first half of 2014 continued to keep upward pressure on office vacancy rates, improving economic factors will support a more positive demand outlook in 2014 and 2015,” Mr McNabb said.

“At a national level, we expect CBD office demand to shift into positive territory over the second half of 2014, gaining momentum in 2015.”

Mr McNabb said results across Australia’s major office markets were mixed.

“Most of the improvement in demand is expected to come through the Sydney and Melbourne markets initially, with economic momentum shifting to the south-east,” Mr McNabb explained.

“Most of the demand drag is coming from Brisbane and Perth, which is not surprising given the significance of the infrastructure investment boom - 80% of which was concentrated in these two markets - and the government sector, which was an important contributor to growth in Brisbane over the past decade. Both of these sources of demand are now contracting.”   

Mr McNabb added: “The flow on impact to market rents has been limited due to the extent of growing supply levels across all markets, although prime markets in Sydney and Melbourne are expected to experience the lowest vacancy peak – 2-3% points above current levels.”

CBRE Regional Director, Office Services, Andrew Tracey, said demand conditions were improving as businesses looked to start growing again after a prolonged cycle of cost cutting.

“Our recent data in Sydney and Melbourne tells us that 50% of the companies we are dealing with are in expansion phase and looking to grow. These companies are at the front end of the curve and are going to be the real beneficiaries of the amount of space available in the market. They will get to lock costs in and benefit from better margins than their competitors in the years to come,” Mr Tracey said.

“These are ‘once in a cycle’ deals and provide a real value proposition to smart companies, but smart companies are also selective, they understand that to attract talent they need better quality accommodation and the flight to quality in the market is apparent.”

Mr Tracey added: “We continue to monitor business confidence closely and the indicators we care about point to a more positive demand environment for the next 18 months, and as such, we expect to see increased activity in the market.”

Further analysis of the major office markets is below:

Sydney

Mr McNabb said vacancy tightened slightly over the first half of 2014 to 8.4%, supported by buoyant net absorption and net withdrawals over the six month timeframe.

“The Sydney CBD is benefiting from signs of improving demand in combination with subdued supply levels, which we expect will persist over the second half of 2014, driving vacancy even lower. Withdrawals supported the first half number, with net supply contracting,” Mr McNabb said.

“Heading into 2015, this dynamic is set to change with the much anticipated entry of towers two and three of the Barangaroo development and the associated impact of backfill vacancy.

“While vacancy is expected to rise on the back of this new source of supply, the combination of a further round of withdrawals and momentum in demand should see vacancy peak at around 11% in 2015. This outcome means the Sydney CBD is well placed among other major capitals in terms of the vacancy outcome in the short term”.

CBRE Senior Director, Office Services, Jenine Cranston said the Sydney market had seen an improvement in tenant behavior.

“There is evidence of tenants expanding across a broad range of business sectors, which is certainly encouraging for the Sydney office market. Additionally, the topic of attraction and retention of staff has re-emerged after several years’ absence. The number and regularity of these conversations is well beyond anything we’ve experience since the GFC,” Ms Cranston said.

Ms Cranston said the move to re-engineer the workspace was also encouraging tenants to relocate.

“In recent years, we have seen fewer tenants choose to stay put,” Ms Cranston explained.

“While rationalisation of workspace design is a widespread theme for larger tenants, close to 70% of tenants under 500sqm in size are focused on finding fitted out premises. Many of these companies are resource and time constrained, issues which are to some degree resolved by securing fitted out space.

“While it is encouraging to see the re-emergence of the financial sector, Sydney has also had very strong representation from the IT, media and telecommunications sector, accounting for close to 50% of our enquiry by number year to date. Interestingly, the growth in this sector is extraordinary, especially as many of these firms did not exist a decade ago.”

Ms Cranston said 2014 remained a highly competitive marketplace with a good deal of choice in all size sectors.

“For example, tenants seeking a floor of 1,000sqm plus - there are over 250 options available. This necessitates our clients presenting their stock so as not to be missed amongst the crowd. Imagine being faced with 250 options if you were to be in the market for a suit?”

She continued: “Some pressure relief has come from residential conversions, especially in the southern sector, however, this shouldn’t be overstated. For the most part, competition in the prime grade sector remains fierce with the stock additions in 2015 and beyond coming from new development stock including Barangaroo.

“Our deal flow year to date has lifted 40% on 2013 and the average deal has increased in size by 17%. We view these as encouraging facts in a market which we envisage will continue to gain in health in the second half,” Ms Cranston said.

Melbourne

Following a period of net supply decline in the second half of 2013, positive supply additions in the first half of 2014 are leading the next supply cycle, which is forecast to add a further 228,000sqm of stock to the CBD over the next three years.

CBRE forecasts vacancy rates in the Melbourne CBD, currently at 8.5%, will rise as forthcoming supply drives up vacancy from the second half of the year, outweighing the continued positive outlook for demand.

According to CBRE’s Q2 National Sublease Barometer, more than 75,000sqm of sublease space is available in Melbourne, placing a floor under incentives.

Mr McNabb commented: “Vacancy is forecast to rise to over 9% by the end of the year, before moving closer to 11% by the end of 2015. This will keep a lid on rental growth, despite our expectation for continued improvement of demand in the office market.”

CBRE Director, Office Services, Shane Burns said there was without question a steady improvement in demand and tenant sentiment.

“The horror that was 2013 for the Melbourne leasing market is well behind us, with better activity and conversion rates apparent, albeit with some way to go to true equilibrium. We are well through the bottom of the market and deals are happening again. Clever CBD tenants are recognising that the tenant friendly terms currently available will not last forever,” Mr Burns said.  

“Equally, we are seeing traditional fringe and suburban tenants take advantage of deals in the CBD and Docklands, with effective rents providing a compelling reason to make a generational shift. This is going some way towards containing the vacancy rate.”

Brisbane

While conditions in Brisbane’s office market have improved since 2013, it largely remains in contraction phase. According to the latest PCA figures, office market vacancy lifted from 14.2% to 14.7% in the first six months of 2014.

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 79,000sqm and mostly attributed to resource/resource services companies and the public sector.

“The Brisbane CBD continues to show signs of weakness, with expectations for another year of negative net absorption in 2014. The underlying economy is yet to take up the slack from a decline in government and resource tenant demand. Fortunately supply is limited in the short term, with no major projects due to enter the market until 2016, which will limit increases in vacancy until then,” Mr McNabb said.

“While demand is also expected to improve in line with momentum in other major CBD markets from 2015, it is still well below the long term average and from a very low base in 2013.”

Mr McNabb added: “Investors are looking for protection in the Brisbane market, with premium grade assets in Brisbane still attracting strong support from capital markets. Yet investors are clearly discerning of risk with secondary asset yields increasing in Brisbane, a different trend to that evident in the more balanced Sydney and Melbourne markets.”   

CBRE Director, Office Services, John Walklate said while vacancy in the CBD continued to rise on the back of subdued demand, leasing enquiry levels had increased from the corresponding 12 month period.

“The bulk of Brisbane’s vacancy is contained in the secondary market,” Mr Walklate explained.

“While demand for this stock remains low, we are seeing a flight to quality from tenants favouring Prime and A-grade stock that is presented to a high standard. Stronger levels of enquiry and transactions in this sector continue to support a more positive outlook.”

Mr Walklate said conditions were also likely to improve in the sublease market.

“Sublease vacancy is high by historical standards, however, at present there are a number of sublease transactions underway, and combined with some sublease withdrawals, the quantity of sublease vacancy is expected to reduce,” Mr Walklate commented.

Perth

Vacancy in the Perth CBD continued its upward trend in the first half of 2014, rising to 11.8% as a result of negative net absorption due to the contraction of mining related tenants. These companies have entered the transition phase from construction to production phase, leading to declines in space requirements.

CBRE estimates sublease availability is approximately 4% of CBD office space – 63,000sqm – with the overall impact pushing vacancy to over 12% in June 2014.

Mr McNabb commented: “A rise of new stock entering the market – approximately 144,000sqm – in 2015 and a softening in demand fundamentals, is likely to push Perth vacancy higher.”

CBRE Senior Director, Office Services, Andrew Denny said despite rising vacancy levels in Perth’s office market, conditions were at their most attractive from a tenant perspective.

“The substantial rise in vacancy rate, coupled with new supply entering the market in the next 12 months, means we are currently seeing the best conditions in nine years for tenants in the Perth CBD,” Mr Denny said.

“The rise in vacancy has seen attractive terms, with some lower face rents and attractive leasing incentives on offer for prospective tenants.”

Mr Denny continued: “Over the past six months, transaction levels in the CBD have increased, when compared to 2013, with some of the best leasing opportunities in the sublease space already gone.

“These options had very high quality fit outs available at no cost. We expect tenants will now increasingly move to clear new office space as the next best leasing option, with the new office buildings being available in the next 12 months.”

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 12.4% in the second half of 2013, rising to 13.8% in the first six months of 2014.  

Mr McNabb commented: “Demand has softened but with a fairly contained supply pipeline, we think that Adelaide is close to its peak vacancy rate now”.

CBRE Director, Office Services, Andrew Bahr said despite a further increase in the overall vacancy rate, the prime end of the market was in a strong position.

“By grade, the prime end of the market is much tighter, and similar to other states, there has been a real flight to quality, which should see vacancy decrease further in this sector,” Mr Bahr said.

“The sublease market is also under control. The only real sector that appears to be feeling the pressure on space is the engineering sector, due mainly to a lack of major project work.”

Mr Bahr said the lack of new supply entering the market would be a boon to the sector.

“A shortage of new supply well into 2016 and beyond will be the Adelaide office market’s underlying growth driver. However, there is concern for growing vacancy in the secondary market. Unlike the eastern seaboard, there isn’t the same kind of market for residential conversions that could absorb obsolete stock.”

Mr Bahr added: “Owners with vacancy in this market will need to be on top of their game, with refurbishment and a commitment to energy performance key." 

Gold Coast

Vacancy rates continue to tighten in the Gold Coast office market, with more than 9,635sqm of total net absorption driving levels down to 15% in the first six months of 2014.

CBRE Associate Director, Office Services, Nick Selbie said the almost 2% vacancy decrease over the first six months of 2014 was evidence of returning business confidence on the Gold Coast.

“The new light rail infrastructure is complete and in operation, and with the Commonwealth Games on the horizon, combined with the re-emergence of developers, attitudes across the community are positive,” Mr Selbie said.

“The decrease in vacancy can be associated with some further large absorption carrying on from the back half of 2013 and supported by a lack of new supply – a trend we expect to continue for the next 12-18 months.”

Mr Selbie said the vacancy rate was not expected to further decrease however.

“Vacancy levels may in fact slightly increase throughout the second half of 2014 due to a couple of major lease expiries in Q3 and Q4, where those occupiers will likely be absorbed into existing premises,” Mr Selbie explained.

“We expect to see activity and take up continue, but this will more than likely backfill those expiries and space, resulting only slightly in positive net absorption for the second half of 2014.” 

Canberra

Canberra experienced a small spike in vacancy levels during the first six months of 2014, lifting from 12.9% to 13.6%.

CBRE Senior Director, Office Services, Helen Davies said while the Canberra vacancy rate was at a historic high, there had been a pick-up in leasing activity over the past six months.

“Leasing activity has been steadiest in the smaller end of the market, which has helped keep a lid on vacancy rates rising any higher,” Ms Davies said.

“A number of large enquiries from the private sector, which were previously put on hold, have reemerged and should absorb some vacancy, assisting to counter the lack of leasing activity from the Commonwealth sector.”

Ms Davies said while internal vacancies within Commonwealth tenancies were difficult to monitor, there were still large tranches of space available, ranging from 2,000sqm – 10,000sqm.

“It is anticipated that these will grow as government continues to rationalise and implement efficiency dividends,” Ms Davies commented.

“The ongoing political instability is causing hesitancy in the market, and both public and private sector tenants are waiting for the determination and legislation of government policies, as well as some clear direction to be given.”