Hosted by Mark Curtain, guests include Ashley Buller and Chris Fisher
Thursday 30 July 2020
MC:
Hello and welcome to Talking Property with CBRE. A podcast in which our team of experts share their insights into the real estate industry. My name is Mark Curtain Head of Office Leasing for CBRE’s Pacific Business and I’m your host for today's episode. Over the next little bit, we will be talking about the rise of the sublease market as the full impact of COVID sweeps across the Australian office market. I’m joined today by Chris Fisher, Director of our Sydney CBD Office Leasing business and also Ashley Buller, who heads up our Victorian leasing business. Thanks for joining me, Ash and Chris.
Firstly, Chris I would like to start with you and just ask you to give us an insight as to how the Sydney CBD office market is faring during the COVID crisis, and particularly where the sublease market is trending, too, since the crisis began.
CF:
Thanks, Mark. Looking at the market in Sydney, we did drop off significantly in April when the full effects of COVID came in. Then from May, June and July, we started getting a lot more positive energy, smaller enquiries - that sub-500 market was revving up and then some of the larger enquiries have started in the market. I guess, unfortunately, in the past two weeks, with Victoria and certain parts of Sydney having the COVID outbreaks, it has put a bit of a dampener on enthusiasm and we have shown that in the market.
In terms of sublease space, what we are seeing is almost at all-time highs. At the moment figures come in at 101,000 square meters and to put that in context, the average sublease space is about 55,000 square meters. At the height of the GFC it was around about 90,000 square metres, so we are quite high. The top level ever measured by PCA is 119,000 square metres. So that's sort of where we're sitting at the moment.
MC:
Yeah, it's certainly interesting and from all reports, the market that has been hit the hardest has certainly been Sydney with the in excess of 100,000 square metres that you alluded to Chris. I know in Brisbane CBD has hit about 30,000 square meters of active sublease space that's available and a lot of what's been talked about in Brisbane is the anticipated sub lease market that will emerge post the expiry of things like job keeper. Ash, turning to you in Melbourne. What are you seeing on the ground down there? And what’s your anticipated outlook for the conditions over the course of the next six months?
AB:
Yes, so it's really interesting. Similar to what Sydney has gone through, we started tracking this very closely on a weekly basis as of about the 20th March, when our first lock down came in and we’re now into the second look down here in Melbourne, which is not a great thing to say, but it's just the reality of things. We’re also somewhat worried about falling into Stage Four as well, so there's a lot of chatter about that and you guys are probably aware that we're about to start with mandated masks. So, everybody is now wearing a mask every time they leave the house and certainly look, there's no doubt that that's kind of put a bit of a dampener on the market.
After the first look down, we started to see some good resurgence in inquiries across our team we would have seen this about a month or so after the first lock down, we would have got up to about 30-40 inspections, so we were looking at a pretty healthy inspection rate. Now that we’re in a second lock down it's certainly fallen away quite dramatically and went back to doing things like, as an example one of my guys is out today doing an inspection via FaceTime. So, we actually physically walk around the space, that was actually interactive, by showing the camera around.
If you look at the amount of space we've got here, so we've currently got about 72,000 square meters of space, but there's another one that's just come along. So it's about 74,000 square metres of space and that's a fair increase so if we measure that from the start of the year we had around 20,000 square metres that we've measured at the start of the year when now we’re up to about 74. Where do we see this going over the next six months? Look, there's quite a lot of hidden vacancy. We think groups are certainly considering their long term goals and where they want to be as businesses in the future of work, if you want to call it that and we certainly foresee there'll be quite a bit of space coming on the market this year, probably fourth quarter.
MC:
Yeah, I think it's interesting to look at the state of the market pre-COVID and both Sydney and Melbourne were extremely strong, particularly from a vacancy perspective with 3-4% vacancy across those two markets. Then you look at a market like Brisbane, which is 12.9% and arguably the success of Sydney and Melbourne over the last 2-3 years is actually what's put the pressure back on those markets from the sublease perspective as they expanded so aggressively that obviously tenants are unwinding those positions to respond to the current market conditions, where a market like Brisbane and even Perth to some degree, a lot of tenants have been rightsizing over those markets over that same period and there wasn’t the expansion reactivity. So, I think it certainly makes sense what we're seeing on the ground.
I think the other interesting factor is that the industry groups in the tenant cohorts that are being impacted by the coronavirus and clearly areas like education, tourism, highly exposed areas of the professional services industry. Chris in Sydney, you seeing any cohorts of groups of tenants that are being impacted? More significantly, then others? What’s the on the ground feedback?
CF:
Interestingly, some of those industry groups you just mentioned are not high occupiers of office space in the Sydney CBRE. So, education, tourism, entertainment, they're not big occupiers of space. What we are seeing on subleases pretty much reflects the occupancy in CBD, so your banking and finance and insurance services, your professional services and your information technology and telecommunications. In that order, they dominate the sublease space, which is pretty much how they occupy the CBD, so there's no real surprises there.
One of the interesting things of the sublease space in Sydney is prior to COVID we came into quite a high sublease number, it was definitely in the 70,000 already, and that was largely as a result of relocation. So, a number of tenants have made the decision to relocate to a new development or relocate to a major backfill space, whether the developer carried that, the new lessor carried that or the tenant carried that. So, we had a high base to start with. The overall market vacancy at the start of COVID was about 3.9% which is quite low, you know, almost historic lows. But there was this sublease vacancy piece in the background increasing. What we've seen though since COVID, the main reason for the sublease space has moved from relocation to cost reduction or contraction.
MC:
Ash, I know the Melbourne CBD market has quite a high exposure to the education sector, with a number of the large universities leasing space, particularly in that sort of B-grade market. Are you seeing any insights or any anecdotal evidence of those groups subleasing and also more broadly, is there any groups that particularly stand out as being challenged by the current circumstances?
AB:
So, I was actually just going to add from a Melbourne point of view and it's not dissimilar to Chris from Sydney. What we're seeing is circa 72,000-74,000 square metres of space on the market. Only a small percentage of that relates to COVID, what we see later this year that's when we’re going to see the full effects. But when you look specifically at the segments, finance and insurance is probably the biggest sector here in Melbourne from a sublease vacancy point of view. We're looking at that about 35,000 square meters. Then the next sector down would be about 12,000 square metres in professional and science technology, and then it really kind of gets quite small from there. To talk to your question earlier though Mark, in relation to education and training, there is only a small about of space currently on the market for sublease, but Victoria is quite heavily influenced by that education and training area.
What we have seen most recently is a number of these groups that own buildings actually put them on the market. So an example is, we’ve just started marketing RMIT’s building there on Burke Straight. Victoria University also put their building back on the market and there's a couple of other buildings like that. So, there's examples of education users putting buildings back onto the market, but not actually officially putting sublease space onto the market. I think the challenge we’re going to have in that space as well is that education providers are obviously very particular about who they allow to come into the space. So, as an example they'd be reluctant to allow the competitors to come in. Now the challenge is, if you don't have a similar educational provider going to an education space, what other user groups will take that space. So, you know, it's going be really interesting to see the way that that area evolves.
Then equally, another sector I think is quite interesting is the IT area here in Melbourne. You know, we've seen all the public statements around groups like Twitter and Facebook and those kind of groups showing versatility around how they occupy space and a lot of those groups are actually happy to continue working from home yet in Melbourne, we still haven't seen a big influx of the space coming onto the market. So, I think those two sectors will be really interesting to look at later this year.
MC:
We talked earlier about the potential the ceasing of Jobkeeper will potentially impact the office market and I see that the government has actually extended the regime out to past January 2021. Undoubtedly that will have some bearing on the emergence of sublease space and how quickly it hits the market so that's certainly something that we need to consider as we go forward to shape our predictions for the year ahead.
One point I was keen to get your respective views on, particularly around sublease space and obviously, the fact that there's an existing fit out is place is one of the attractions for most businesses. One is the costing cost being removed and also the fact that the time associated with procuring a fit that can be anywhere up to 6-12 months, depending upon how big the fit out is. But my question is, are those fit outs still relevant Chris, in the Sydney market, when you're looking at factoring in things like social distancing and supporting a healthy working environment? Are people going to be able to use that space as effectively is what they could pre-COVID?
CF:
I think the interesting part about the fit out, as we see it at the moment is that most organisations don't quite know what their office of the future looks like. They're still grappling with the idea of the social distancing at the moment, obviously a number of firms have existing fit outs, so they're choosing to occupy every second seat as opposed to re-configuring and making a major change.
What we are seeing with a number of tenant inquiries in the market, they want good quality, fitted space and a lot of tenants and now seeking a deal and they say that there's a lot of sublease space on the market, which is fitted out, they say that there's a slowdown in the economy due to COVID. So, a number of tenants we're talking to are saying, ideally something that's fitted and show us what the deal is. So very sort of opportunistic tenants trying to take advantage of the current market climate in relation to whether they will just totally discount a fit out because of the spacing at the moment. We haven't seen the tenants balk at space by measuring the workstations and deciding that they're too close together.
MC:
Ash from a Melbourne perspective, there's an enormous amount of supply being delivered over the next 12 months, as some of the new developments complete. There is obviously a lot backfill space that tenants are leaving quality fit outs moving into the new developments. Is that space being marketed on a fitted basis and therefore is in direct competition to the sublease space or are owners taking the opportunity to upgrade, buildings, strip out the fit out, return the space to a clean shell for hand over for a new fit out, how is that playing out in Melbourne?
AB:
It's actually quite varied. Probably more recently, we've had a lot of owners talk about retaining existing fit outs, and we certainly recommend during this time that makes a lot of sense, especially if it's a good, usable fit out. The challenge is as well that I suppose a lot of those groups that have gone to new buildings have probably left a pretty old existing fit out. So, the question is, how attractive is it going be to the market? And as right now, no one is really back in the CBD. It's been hard to really measure, I suppose, the interest in those existing fit outs. I think one of the other interesting thing that's taking place right now, though, is that we're seeing owners who have done spec for some of the smaller suites offering those to market on shorter term lease arrangements. So certainly, I feel like the spec suites are competing against the sublease market.
I think the other thing to mention around the sublease market, you know, if you look at the longer dated leases in places, really kind of one main one that's coming to market for about 10,000 square mete,rs and that will act like an owner in the market but is kind of focused more on the government end, so will probably focus on the government based user. But it's certainly interesting time to see the way that it's all evolving, I don't think any owner has the perfect answer to that question right now. It's all still quite fluid.
MC:
Chris, undoubtedly in every challenge, there's an opportunity and I can't help but think that there's positives in this situation for landlords and tenants to collaborate on this issue. Is there any positive for landlords that you can identify through this subleasing opportunity that has arisen in the marketplace?
CF:
Yeah, I think more than ever we’re seeing landlords embracing their tenant and the sublessor if you like, to help them out and the majority of sublease space that we're looking at, we are in regular contact with the landlord, and they are promoting a longer term lease if a new tenant wants to do that. So, for the landlord, the positive will be you've got tenant in situ with a pending expiry at some point but they're being introduced new tenants by the sublessor who would look to take a longer-term lease. So, for the landlord, they're increasing their expiry profile there, also limiting downtime at the end of that lease because the new tenants coming in under the sublessors lease tenure. So, there's a few positives there and we're seeing a lot of collaboration between landlords and the tenants to help out with the sublease stock.
MC:
Ash, I know in Melbourne, you've talked about landlords handing back space in exchange for an extension of term, again I guess I see that outcome as a positive for landlords. Are you seeing that trend continue?
AB:
We certainly are. We haven't got any deal evidence yet, but there's certainly enough negotiations underway right now, so that's certainly one of the really big positives that can come from this from a landlord point of view in Melbourne.
MC:
I know we've talked a lot about it this morning, I guess a significant part of all of this really relates back to the overarching discussion that is taking place in the office market around, what is the workplace model for the future and that really being how many days a week do people work from home? Or do they completely work remotely? You know, there's a lot of extreme views out there at the moment. I know at CBRE we’re all migrating back to the office, with the exception of Victoria, which obviously needs to take a slightly different tact at the moment. But Chris, what’s your feedback on the ground at the moment? What is the marketplace saying, how do you see things going forward and where do you think we will be in 12 months’ time?
CF:
What's come out of COVID is that flexible nature of working. Most organisations, well pretty much all organisations had staff at home or working remotely, and it seemed to be working. So, the natural question is, how do we do that going forward for most businesses?
What we are saying is that the thought process is that a component of staff or staff will be offered that ability to work one day a week at home if that suits their scheduling or two days and each company will be a bit different. But what we have found is that coming back into the office is positive and the positives of coming into the office, that collaboration, that instantaneous information, the social aspect. You know, we're social beings, and it's just really refreshing to come into the office and meet up with your staff members, and I think also, we talk about the productivity. The productivity of just being about to lean over your shoulder and ask a question of someone or someone in a different division that you bump into in the hallway - it's huge because that contact might have taken a day or a week to organise and you get it on the run. So, I think the benefits of being in the office from our perspective, are massive and we love being back.
In the Sydney CBD, we certainly saw a lot of positivity coming back into the market and a lot of larger tenants poke their nose out and start that activity level. Unfortunately, we have had the Victorian and cases in New South Wales put a bit of dampener on that. In the next six months, what we will see and 6 to 12 months, are incentive levels increasing in the Sydney CBD. Where we're predicting that sort of 25-30% band in incentives you have to attract tenants and tenants are now seeking, with counter proposals much larger numbers than that. As long as we can keep the pandemic, I guess in check, we are seeing a lot of firms come back out and have to for their requirements because they do want a home and they do want a home of the future and they will need office space, so we will see that activity increase as long as we keep the virus in check.
MC:
Ash, I know you’re a parochial Victorian, and you said to me that you thought the office market would have an enormous bounce in Victoria when people could return to the office. Are you still forecasting that that’s going to be the case and what are some of your views as to what the next 12 months holds?
AB:
Yes, look there's no doubt I'm somewhat biased. I think we all are given the space we work in. We recently had Perth colleagues on the line to give a little bit of a motivational speech to our team here in Melbourne because Perth’s certainly on the other side of it and you know we’re going back into Stage Three and potentially Four.
It's really encouraging to see that in Perth, the markets flying again. So, you know that the discussion was there's lots of come 1,000-2,000 square metre deals going on there. So certainly, we see that that's the case here in Melbourne. It's probably just a little bit hard to see. Certainly if you looked at the first lockdown and that kind of took a little while to warm back up again and all of a sudden the market kind of bounced back, we’re certainly very hopeful that’s going to happen here as well.
So, what do we see for the next 6 to 12 months? Look, there's no doubt that Victorians are pretty frustrated with two weeks into our new six week lock down and this is a second lock down so it’s very frustrating. From an inquiry point of view, it’s certainly had a dampening on both inquiry and inspection levels. There are still inspections taking place, less in the CBD and certainly a lot more in that metro market. From an enquiry point of view, certainly government is still active during this time and look, this deal's going on as well. So, we’ve got deals taking place in both the CBD in the metro market, the volumes down certainly on what they were pre-COVID but there is certainly going to be transactions that complete during this time.
You then look at rents and incentives. So, to start off, it's probably important to talk to the total vacancy. We've seen certainly a big increase in vacancy within the Melbourne CBD. So, if you look at 2019 it was about a 3.2% vacancy. This year we’re predicting 6.3% and then for next year, it increases up to 10%. So that amount of space was always going have any impact on incentives and likely rents. Then add in the effective COVID and we certainly think that owners will do everything they can to protect face rents and therefore incentives will certainly be the lever that will be pulled to get deals done during this time. The big question is going to be demand and look, that's the million-dollar question. Certainly, when you look at some of the other states, there seems to be some good deal volume coming through with those groups that are through their lockdown period so we’re certainly very hopeful that takes place here in Victoria and we can start to reduce the amount of space on the market and then we get back to favourable trading conditions again.
MC:
Well, thank you Chris and Ash and thank you for listening to Talking Property with CBRE. If you like the show and want to check out more, please visit cbre.com.au/talkingproperty or subscribe through Spotify and Apple Podcasts.
Until next time.
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