Talking Property | Which city is leading Australia’s office recovery?

KB

Hello and welcome to Talking Property, our CBRE podcast series where our team of experts, our clients, and industry specialists share insights into the way we live, work, and invest through the lens of commercial real estate. I'm Kate Bailey, a Director in CBRE's Pacific Research Team, and I'm your host for this latest Talking Property episode. Today we'll be talking about the latest Property Council of Australia office vacancy figures. We're going to cover off on some key insights, where the future opportunities lie and what landlords and occupiers should be focusing on in the year ahead. To help steer this discussion, I'm joined by Dexus' General Manager, Queensland and Project Leasing, Matthew Miller, along with CBRE's Pacific Head of Office Leasing, Mark Curtain, and our Australian Head of Office Research, Tom Broderick. Welcome everyone. 

Great to have you all here. So big week releasing some of that data and Mark, maybe we'll start with you. I know there were probably a few surprises in that latest data release of the PCA numbers. Love to hear your take on those stats and you know, I understand Brisbane was a real standout out of all of the markets, but there's some continued challenges in in other CBDs around Australia. 

MC

Thanks, Kate. I must say that overall I was particularly pleased with the results for the Australian market that were released, and yes, there is some concerns. And Melbourne is a market which clearly has a pretty robust supply pipeline over the forward few years, but the overall Australian vacancy rate was 12.5%. So it moved up. That was in line with expectations and I think importantly is the stories that sit behind that. And if you look particularly at Brisbane and Sydney in 2023, both markets either have neutral supply, well neutral supply in Brisbane, and we actually have negative 45,000 square metres of new supply in Sydney. So you can start to see the stability that will come into those vacancy rates over the next 12 months. And I think that's a really encouraging side. And then when you look at the forward book of stock in those two markets, again there's good pre-commitment to the stock that's coming online. 

And also I think really interestingly that with some of the challenges around construction costs, the pricing of new assets going forward in terms of what cap rates look like, I think we are going to see a tighter development pipeline, which again will help deal with the excess stock. There were elevated vacancy rates in Perth and Adelaide, but there's really encouraging signs from a demand perspective on the ground. And I guess with Melbourne, yes, 13.8% is getting into territory that, you know, starts to look worrying. But I do believe that Melbourne is a market that can enjoy a bouncing activity and perhaps the bounce that Sydney received last year, Melbourne, you know, still had lockdowns at the beginning of 2022. And so I think there's, again, from a demand perspective, some really encouraging signs in Melbourne and you know, I think we can start to chew through that vacancy if that demand does materialise. 

KB

That's super interesting. And look, I know that there's also been a really significant shift towards premium assets as well. And Tom, you and the team have been crunching the data on this and looking at office relocations over the past couple of years. Can you talk us through what your analysis has showed and what's sort of driving this in the office market? 

TB

I think the PCA numbers kind of confirmed some of the analysis that we've done, but basically we collect leasing deals across the country on a quarterly basis. And so we've got about 220 relocations over a thousand square metres in our database. And basically, what we did is we looked at what the market rent of the current building that the tenant’s in versus the new building that they're moving into, what the market rent of both is. And in general what we saw was about two thirds of those occupiers are upgrading, moving into a premises that commands a higher rent on a rate per square metre, 24% downgraded, and then 12% moved to a similar quality building. So it basically confirms what I think we've been talking about for say the last 18 months that tenants are continuing to upgrade. And the question then comes why are they upgrading? 

TB

And I think part of it is maybe it's an organic way to kind of encourage your staff back into the office if you move into a better quality building with better amenity, people just naturally want to be in that, in that location. So I think there's a bit of that playing out. Obviously the better buildings generally offer better ESG credentials, which is a focus for a lot of corporate occupiers now. And I think the final point is that throughout that period, 21 and 22, corporate revenues were really strong. And so that kind of cost containment pressure probably alleviated a bit across the tenant market. 

MC

Kate, I was just going to add to Tom's comments that I think it's really interesting if you sort of not necessarily look at vacancy rates across premium or A-grade, but if you just really look at the trophy towers across Australia, you know, whether it be 101 Collins in Melbourne or Waterfront Place in Brisbane, it’s really evident that premiumisation, was a struggle to get that word out, but those buildings are all enjoying hugely successful occupancy rates and you know, really reinforcing that that flight to quality and the, I guess notion that if we're going to get people back into the office, it's got to be the best, it's got to be high quality and you know, and that part of that's the space building, part of that's the office fit out, but certainly it starts with a premium asset. So that's very, very clear in our numbers. 

KB

Mark and Tom, great points on that sort of premiumisation piece. Yes. But that is a tricky word to get out, premiumisation. But you know, we know that there has been a really clear shift towards premium assets and Matthew bringing you into the conversation, I'm sure that's been super positive for Dexus' new two and a half billion dollar Waterfront Brisbane development. Love for you to talk us through your strategy for Waterfront and why you think there's been such a clear tenant shift towards premium office assets. 

MM

Yeah, look I can only echo what Tom and Mark said about businesses and the way they're viewing their workplace. I think a lot of businesses have looked at the pandemic, come out of it and their business model’s pretty robust, but they see that the workplace, even though there might be some flexible working happening now and in the future, they see their workplace is really critical to their operations. So that's meant let's get a better quality workplace. I suppose the great thing for us at Waterfront Brisbane is that we've approached this less about trying to develop premium grade office buildings, but more about trying to create a whole best of class workplace precinct. And this is something that we think is really going to help our current and future customers to not only attract and retain the people they've got, but also to attract people back to the office.  

So that stretches to things like the retail amenity that we're going to deliver, that's from affordable market hall style lunchtime and breakfast offers all the way through to a fine dining experience. It's about elevating your end of trip facilities out of basements up onto level three and four so that you can get natural light and natural ventilation into them. It's about best in class ESG requirements, five and a half star NABERS energy ratings, six-star, green star design targets. Currently our portfolio, the Dexus portfolio, is operating at net zero and we see that as a really powerful tool to talk to our customers about. Because a lot of businesses have policies around their carbon footprint and to be able to partner with someone like Dexus that's operating their portfolio at net zero is really, really important. We've got to get the basics right. Location is obviously really, really critical. 

So we're very fortunate that we control almost a hectare of land within the golden triangle on the river in the city. And we see Waterfront Brisbane as sort of re-orientating the centre of that sort of corporate heart of the city. Side-core, generous floor plates that have great access to natural light and great access to views is really important. Taking servicing off streets and putting it down into the basement, all those things are really, really important in terms of attracting the best quality organisations. But just to reiterate to the point, this is not a series of singular towers. This is about creating a whole new workplace precinct for the city of Brisbane. 

KB

Yeah, I think that's such an interesting way of looking at it, kind of creating that precinct and building that amenity within that precinct as well. And it sounds like a pretty incredible development. I guess on a more general note, I’d like to get a feel about what you're hearing from other occupiers as well, and particularly how they're progressing with their workplace strategies and how do you think that's going to start to play out in terms of occupancy trends across Australia and even more generally, you know, what do you think that landlords need to be focused on in this new environment? 

MM

Well, I think there's a couple of things. One of the things that we've had to grapple with, we've started to talk to some of our customers, you know, almost six years out from the delivery of this project. So, and it was an interesting time, it was sort of in the middle towards the back end of the pandemic and I suppose a lot of organisations weren't quite sure what their workplace footprint looked like in six months, let alone six years’ time. So, flexibility played a really important part of those discussions. Not only flexibility about how they can expand, but more about what are we going to offer within this workplace precinct that helps them on that flexibility journey. So, one of the other really key ingredients for Waterfront Brisbane is the third spaces that we're offering. The end of the day this precinct is going to have about a hectare of public realm, and we consider that a third space. 

We see that public realm as a space that customers, their clients and their guests can use during business hours, after hours for town hall meetings, for client events, for one-on-one meetings. We've designed the lobby in such a way that there's more than a thousand square metres in that lobby that people can utilise on a daily basis. Once again in quiet meetings, in quiet work for strategy days, for client events. We're taking Dexus Place out of Waterfront Place across about 900 square metres and putting it into about 2,600 square metres within the waterfront Brisbane development. And we've also built a wellness terrace. So the whole of level three is dedicated to wellness but can also double as a third space. There's about 1200 square metres of outdoor space. There's two dedicated wellness rooms where we'll curate a whole series of wellness activities, but we can also, that can be used as conference space as well. So that ability for our customers to have a clear line of sight to be able to utilise a whole raft of other spaces has really cemented their commitment to the development. They know that they don't need to build that extra training room, they don't need a conference centre within their own footprint. They've got that within the precinct and they've got a line of sight to that. So, we think that was a really powerful tool for us to talk to these customers about some six years out from this being delivered. 

KB

Yeah, I completely agree. I think that really shows a lot of foresight and it's a pretty credible offering to tenants. Speaking of tenants and top of the mind topic - office rentals, Mark can you give us your take on what you expect to see on the rental front for the remainder of 2023? 

MM

Certainly one of the key themes of 2022 was rental growth. And I guess in in line with what we were seeing more broadly in the economy around inflation it wasn't unexpected and a significant part of that being the construction costs in the property industry as it relates to whether it be office fit outs or building new stock. The two markets that recorded the highest effective rental growth, so it was true rental growth that was emerging as we saw that stabilisation in incentives, but the growth in face rents delivering the effective rent. So in Perth and Brisbane we had 11% and 10% respectively, more modest growth in Sydney and Melbourne of between 3% and 5%. But you know, it was there, importantly, and I think we're going to see that theme continue. I think it's very clear that because tenants are seeking best in class office outcomes, they are prepared to pay the price associated to get those outcomes and price, it feels to me very much like it's come down the ranking, you know, we've got to get the right space, it's got to have the ESG credentials, you know, we want the mixed mode space, we want the amenities that Matthew talked about and those amenities, let's face it, they come at a price and I think tenants are very clearly saying, yes, we're prepared to pay for that because we know it's a critical aspect. 

So yes, we're believers that there will be growth in face rents, which is important for a lot of landlords. There will be growth in effective rents. It might be not as strong in in some of those markets as it was this year, but definitely a theme that will continue in 2023. 

KB 

Maybe Tom, to wrap us up, I know that in your research role you also cover the capital market sector. How do you think these PCA stats are going to factor into investor decision making? 

TB

Yeah, I think, look, it's a really interesting time for the capital market space. Q4 2022 we saw about 2.8 billion worth of transactions that was actually the lowest Q4 result we've had in the past decade. So activity really slowed significantly in that back half of last year. I think basically we've kind of entered into a price discovery phase where there's a discrepancy between buyers and vendors. In terms of the PCA stats, I think what they really confirmed was the tenant upgrading story. The net absorption national figures were probably below what many expected, but when you actually look at the prime net absorption, it was almost bang on long-term averages. So that kind of demand story for prime assets is still strong and investors are buying into that. I think at the end of the day, the first half of this year, we're expecting to be relatively subdued on the transaction front just because investors want certainty on interest rates. 

And I think at some point during the first half of this year we'll get stabilisation in the cash rate and that'll provide some of that certainty, which means that we'll probably see more transactions in the back end of this year. In terms of specific markets, I know we've spoken a fair bit about Brisbane today, but the net absorption figures were really strong for Brisbane and I wonder whether that may interest some investors, particularly foreign groups during times of uncertainty. Often I think we find that foreign groups get laser focused on Sydney and Melbourne and kind of forget about the rest of the country, but the fundamentals of Brisbane are really strong. The vacancy outlook's really strong, the rental growth outlook is really strong. So I do wonder whether Brisbane might benefit from a bit of that, but certainly right now we're still seeing a lot of interest from foreign groups in Sydney and Melbourne. 

MM

And I think Tom, obviously from a supply perspective, Brisbane's probably coming into a good period as well where we're not seeing a lot of supply and I think that Mark made a pretty good point at the outset around construction costs and those sorts of things and cap rates also making it probably difficult for new product to get up. So, I think the market up here is in a really good shape and, as you said, you know, hopefully rents continue to grow, downward pressure on incentives and the capital comes because the Olympics of 2032 is probably not a bad line in the sand either. 

KB 

I feel like I need to book myself a trip up to the Sunshine State, very exciting things happening in Brisbane. Thank you so much for your time, Matthew, Mark and Tom, it's been a really great discussion. And thank you all for listening to Talking Property with CBRE. If you like the show and want to check out more, visit cbre.com.au/talking-property or subscribe through Spotify and Apple Podcasts. You can also read our full analysis on the PCA office vacancy report by clicking on the link in our show notes. Until next time.