The tenant merry-go-round

Factors such as economic growth, development of new space and consumer demand are all key to the level of tenant demand and movement.

In 2011 a number of these factors are in direct conflict – the Australian economy, unlike the global one, is in reasonably good shape – development activity and consumer demand, on the other hand, are not so sprightly. So just how is this impacting on tenant movement?

Office

Michael Greene, head of tenant representation with Jones Lang LaSalle (JLL), says the amount of tenant churn in the office sector is currently reasonably low compared to previous periods as a result of tenant caution and low levels of property development during and since the global financial crisis. In some areas tenants may wish to move or expand their operations but there is simply nowhere to go, particularly for those seeking premium grade office space.

“In office, rental growth did start but not as much as we thought it would. That means we haven’t seen tenant incentives drop, even for premium space,” says Greene.

Take Canberra, for example, which is dominated by Commonwealth Government tenants. The office vacancy rate in Canberra is around 14 percent, which would seem to indicate an oversupply of space. In fact, while there is an oversupply of secondary buildings, there is a shortage of A Grade contiguous space, particularly for tenants requiring more than 8000sqm, says Greene.

“There are just no options for tenants at that end of the market – they have to pre-commit and have new space built if they want to move. And once that new space is built, owners of the secondary stock will be faced with a large amount of backfill. There will be major refurbishment required and secondary stock could linger for years.”

The situation is similar across the major cities, says Greene. The tightness of the premium end is apparent in vacancy rates. In Melbourne the current headline vacancy rate for office is 6 percent and for Prime 4 percent; in Sydney it is 8 percent and 4.7 percent, respectively. In the over 1500sqm category, which accounts for 20 to 25 percent of the market in Melbourne and 12 to 15 percent in Sydney, the vacancy rate is 2.5 percent and 3 percent respectively.

This is backed by the Property Council of Australia’s July 2011 Office Market Report, which shows that it is the premium end of the market experiencing tenant demand, while secondary office space experienced negative demand and vacancy increase.

Net absorption, which shows the change in occupied space from one year to the next, provides a picture of how much tenant movement is taking place. The National CBD office market graph below from Jones Lang LaSalle shows that net absorption nationally has declined markedly in 2011.

In Melbourne, a number of large tenants have pre-committed to new, larger, and often more sustainable, space. These include BHP Billiton, the Australian Taxation Office, NAB and Mercer. Some of the backfill created by these moves has already been taken up.

Brisbane and Perth both have very tight supply due to increased demand from the resources sector, with mining and engineering companies expanding at a rapid rate. Some, says Greene, may have to commit to new buildings to meet their requirements.

In Adelaide vacancy rates, at 7 percent, are the lowest they have been for years. Some large tenants, such as the ATO, Bendigo Bank, SA Water and Australia Post, have pre-committed to new developments and will leave behind stock that needs to be refurbished, says Greene. This will free up the market for more tenant movement.

Maria Lee, senior project manager at BIS Shrapnel, says the latest A-REIT results show that tenant retention levels in the office sector are high. Whether this is a result of a lack of available space or general caution about moving is unclear. Lee believes that once more confidence returns to business, there will be more movement.

“A number of industries have been impacted by the strength of the Australian dollar, but in between there are a whole lot that are doing well, such as finance and property services. It will get to a point where they have to re-invest but this may push out to 2012,” says Lee.

Matt Whitby, national director of research with Knight Frank, says office lease renewals have increased over the past year on the back of corporate uncertainty and higher relocation costs. In addition, landlords have been keen to keep the security of income/cash flow.

“This has led to a reduction in tenant churn in recent years which has assisted in cushioning the impact of patchy demand for office landlords,” says Whitby.

Many building owners took the opportunity during soft market conditions to undertake sustainable upgrades, says Whitby, particularly as most government tenants and many private occupiers require at least 4.5 NABERS energy and water ratings.

This has helped reduce churn.

Retail

Retail is a mixed bag right now with some sections reporting significant downturns, and others expanding. Overall, retail sales are down and consumer caution high. As a result, tenant movement varies markedly across the various categories.

According to Whitby, retailers have started to feel the pinch in 2011 and hence churn has increased, albeit marginally. Major shopping centre portfolios still sit at around 99 percent occupancy.

“The major shopping centre landlords have generally been successful in filling any space left behind by vacating retailers, assisted by the emergence and increased interest from international retailers.

Major owners such as Westfield, Colonial and GPT have also continued to report positive re-leasing spreads,” says Whitby.

Strip shopping malls are less resilient, although high rents in CBD precincts persist. In Sydney, rents in prime CBD retail precincts are extremely high, according to a recent report by international real estate firm Cushman & Wakefield, with rents in Pitt Street Mall increasing by more than 33 percent in the past year, making it the fourth most expensive retail precinct in the world. In Melbourne’s Bourke St Mall rents rose 11 percent and Adelaide’s Rundle Mall 23 percent.

Elsewhere, rents have declined, a sign of the difficult trading conditions, particularly in some strips. In Sydney’s Oxford Street rents have fallen by 23 percent, according to the report, and in Melbourne’s Queen Street Mall by 10 percent. Churn and vacancies in these areas have been relatively high.

The high rents in prime CBD locations reflect demand for these sites from international brands. According to Andrew Ballantyne, JLL’s director, research and consulting, Victoria, prime retail sites and high quality regional centres will continue to see strong demand with a low level of tenant churn. Where some retailers may fail, other high profile international brands are taking up the space. Recent examples include clothing labels Zara, Gap, and Gap’s sister brand Banana Republic.

“If you went by their US store penetration Gap should have 90 stores and Banana Republic 40 in Australia, but they are applying a bricks and clicks strategy where they set up fewer stores in prime locations to support growing online sales,” says Ballantyne.

It is a strategy that we will see more of, says Ballantyne, with the medium priced retailers the most likely to be impacted by online sales and secondary retail space impacted by tenant churn.

Josh Loudon, regional director retail services group, at CB Richard Ellis, agrees, pointing out that Australian-based fashion retailers have been facing challenging trading conditions and would continue to do so, while food and service-based retailers were doing well.

“We’re seeing a decline in Australian-based fashion while food and beverage franchises such as Grilled, Guzman Y Gomez, Salsa’s Fresh Mexican Grill and Pie Face are moving in to take up their space. Banking and financial institutions are also taking up space in prime retail locations when they become vacant,” says Loudon.

Neighbourhood and food-based shopping centres have been doing well while sub regional centres with an emphasis on Australian-based fashion are experiencing higher vacancy rates and more churn.

Industrial

Renewals have also increased in industrial space over the past year, with tenant churn less of a major issue due to the one-tenant nature of the sector, says Knight Frank’s Whitby.

“That being said, the major owner developers in the space are actively seeking pre-commitments to attract occupiers to relocate as well as recommencing the speculative development cycle, which will continue to see major tenants consider their requirements. Due to this the churn will mainly be focused in the secondary market as limited prime options have created tight conditions around the country, especially in Perth and parts of Brisbane,” says Whitby.

“Groups like Goodman have great relationships with their major tenants and are actively seeking to recycle these tenants from older-style, existing warehouses in their portfolio into newer, more efficient, purpose-built accommodation.”

Christian Schilling, senior project manager with BIS Shrapnel, says tenant churn in the industrial sector is very specific to individual tenants and sectors.

“It is a market that does not act as one. During the GFC there was an overall tendency for companies to put plans on hold and to only commit to short-term leases,” says Schilling.

“But there were some exceptions to this, mostly the large retailers who have continued with warehouse expansion plans but with an emphasis on improved efficiencies to offset the cost of moving.”

Coles, Woolworths, Aldi, Target, K Mart, Best & Less, Dick Smith and distributor/importers such as EB Games and plumbing supplier Reece have all been expanding and moving.

In Brisbane and Perth, businesses related to mining have also been actively seeking new industrial space. Once these new premises are completed there will be a level of churn, says Schilling, but other sectors such as residential construction are still in recovery mode.

JLL’s Michael Greene says there is unlikely to be much movement in industrial in the near future because of continuing uncertainty.

“Occupiers are cost conscious and uncertain about conditions at the moment. Many wholesalers are affected by low retail sales,” says Greene.

“Rents haven’t been moving up and there is not a great deal of speculative development. Australand has done some and had success with that, but there hasn’t been much of it happening.”

Ballantyne says developers who have been actively developing new space have spent a lot of time putting their business case together.

“Developers have been sure of the demand and requirements before they’ve built new facilities. And occupation rates for the major [industrial] A-REITS are very high, which is the top end of the market. At the half-year update it was around 3 percent,” says Ballantyne.

Vox-pop forecasts Office “While the lending market has contracted, offshore investors are starting to take some risk and are investing in new office buildings. This will create some tenant movement in the market and provide larger tenants with more options. We expect to see more of this happening.” – Michael Greene, head of tenant representation, Jones Lang LaSalle “Over the next 12-24 months tenant churn in buildings can create opportunities for existing tenants in office buildings to expand into adjacent floors that were otherwise occupied. There is also the potential in an improving market for owners to capture positive rental reversions on space that is vacated, hence adding value to the asset,” – Matt Whitby, national director, research, Knight Frank Retail “We’re seeing some dynamic offshore retail companies entering the Australian market – their strategy is to have a few high end bricks and mortar stores to support their online business and this is going to continue.” – Josh Loudon, regional director retail services group, CB Richard Ellis “Better quality regional shopping centres will continue to see strong demand. Food based retailing and entertainment will also be fine but the middle section will suffer unless they offer something that online retailers don’t.” – Andrew Ballantyne, Jones Lang LaSalle’s director, research and consulting, Victoria “Long term the retail sector here has to take a good look at itself and offer what consumers want and that includes price. We may see a lower rate of retail floor development,” – Maria Lee, senior project manager, BIS Shrapnel Industrial “With the high Australian dollar local distribution companies are expecting continuing expansion. Their demand for warehouse space will depend on whether they keep their distribution operations here or move these activities offshore and import goods straight to the retail outlet. This could be an issue in the future.” – Christian Schilling, senior project manager, BIS Shrapnel “The excess capacity within the sector was absorbed in 2009 and 2010. Vacancy rates are low and tenants who are looking for new space will have to pre-commit,” – Andrew Ballantyne, Jones Lang LaSalle’s director, research and consulting, Victoria