Melbourne’s CBD office market has outperformed its counterparts around the country for the past two years, but nipping at its heels is the Perth market, which has stormed home in 2011 to position itself well for the year ahead.
According to Colliers International research, strong demand for Melbourne CBD office space by tenants and investors is set to continue over the next 12 months, with a lack of stock shaping up as the biggest possible impediment.
However, Perth and Brisbane CBD office markets are also showing increased demand, which is flowing through to rental growth and investor interest. Evidence of the two-speed economy is particularly apparent in these markets, with mining employment driving high levels of net absorption.
Sydney CBD, meanwhile, has remained constrained by poor levels of tenant demand for much of 2011, primarily due to its dependence on two sectors of the economy that are not performing all that well at present – finance and insurance, and the global economy.
Despite this, Sydney CBD office assets remain hotly contested by investors, particularly from offshore.
Melbourne CBD was the first office market to head into the early stages of an upswing and, as such, it has been the star performer among Australia’s property markets over the past two years.
It has had the highest level of tenant demand of all national CBDs, its rental growth has been the strongest and its transaction levels have been the highest and have also seen the largest increase.
The real problem for Melbourne isn’t that there is too little demand – the issue is that there is too little space.
Although the Melbourne CBD office market has seen the strongest levels of tenant and investor demand of late, the main issue constraining rental growth during the next 12 months will be the confidence of owners to increase rents.
Over the next two years, the vacancy rate is expected to remain well below equilibrium. Supply has been so closely moderated that there is only one building coming up that has been developed speculatively.
All other buildings have high levels of pre-commitment and, as a result, rental growth is assured.
With so little available space to lease, owners have the opportunity to increase rents when it comes to re-negotiation time.
Over the next three years, tenants will have to accept these or leave the Melbourne CBD.
With limited options in suburban markets, St Kilda Road is one location that should benefit. Right now, it is the only market with a significant amount of space available, but it is doubtful this will last long.
In the next 12 months, the Melbourne CBD will be a market that favours owners rather than tenants.
Markets are continuing to improve elsewhere, but there is likely to be enough interest in Melbourne’s CBD to sustain investment volumes.
This is provided, of course, that owners are willing to sell. Just as there may not be enough stock available for tenants, there may also not be enough stock available for investors.
Demand for office space in Perth’s CBD has picked up remarkably quickly. Although the vacancy rate was 7.8 percent mid-year, it is now likely to be less than 4 percent.
The Perth CBD office market has experienced the most movement of all the major capital city markets in the past few months.
We all hear enough about the two-speed economy to know that the Perth market should be experiencing strong office demand on the back of mining growth.
True to form, it is now seeing a big pick-up in tenant demand. Average net absorption over the past 12 months was more than triple the long-term average. This market has shown incredible strength during 2011 and has ended the year with a bang.
Although rental growth was constrained in 2009 and 2010, the Perth CBD office market saw a whopping 24 percent increase in rental growth over the past 12 months and a strong decline in vacancy rates.
There are a number of new buildings completing in 2012, including 125 St Georges Terrace (C2), and this will help to moderate rental growth. However, demand is expected to remain high and encourage continued rental growth.
Despite rental growth being particularly strong, investor demand has not been as high as in the Sydney or Melbourne CBDs.
This is partly driven by more limited stock – both in terms of total volume, as well as the amount coming on to the market – but also by lower levels of interest from offshore investors, who generally show a preference for larger markets.
Tenant demand is also strong in Brisbane but, like the Perth CBD, high levels of supply in 2012 will assist in moderating rental growth.
Net absorption in the Brisbane CBD has been particularly strong in the 12 months to July 2011, coming second to Melbourne CBD and higher than both Perth and Sydney CBDs.
Net effective rental levels, however, have declined slightly, primarily due to a higher than average vacancy rate and a number of new buildings still to be completed.
Tenant demand in Brisbane CBD is driven by both the mining and government sectors, however, it will be demand from firms linked to the mining sector that will really lead to continual high levels of net absorption over the next 12 months.
It won’t be until 111 Eagle Street is completed that vacancy will start to decline and rents start to show strong growth.
Our view is that by the end of 2012 rents will again begin to climb at similar levels to that being experienced over the past 12 months in the Melbourne CBD.
In Sydney, low levels of net absorption in the first half of 2011 were a bit of a surprise.
We always knew the vacancy rate was going to rise – there were a number of major completions occurring including 1 Bligh Street, Darling Quarter and 20 Bond Street – but what was surprising was the weakness in net absorption.
The last six months of 2010 were very strong. In fact, it was the strongest level experienced nationally, as well as the strongest level of net absorption Sydney CBD had experienced since the first half of 2007. We thought Sydney was back in a big way.
It is also surprising that employment growth hasn’t slowed down in the Sydney CBD, but instead has grown.
Firms are hiring, but they have not yet taken more space for the extra people. Generally, decision-making is put on hold when tenants are not confident about the state of the market.
It is likely that confidence amongst tenants in the Sydney CBD has been hit by global jitters. A significant proportion of occupiers in the Sydney CBD have global headquarters or high exposure to global markets.
Based on leasing deals known to have taken place since the end of June 2011, as well as more moderate supply, the vacancy rate has started to decline in Sydney.
Employment growth is forecast to continue, with Access Economics tipping an additional 5700 people will be working in offices in the Sydney CBD over the next 12 months.
In addition, there is pretty much no new supply over the next 18 months, with just 85 Castlereagh Street completing this year. There are no major developments due for completion in 2012, a situation that has not occurred since 1990.
A further indication is the increase in tenant enquiry levels in the Sydney CBD – in 2011, they were the highest of all capital cities.
Our forecasts predict that the vacancy rate in Sydney CBD is going to come down very quickly once tenant demand returns. And that is the big issue – how sensitive will Sydney CBD remain to poor conditions offshore?
From an investment perspective, the past few months have been astounding in terms of volume of transactions taking place. Investors are in the market and they are very optimistic – there are high levels of demand for assets.
The vacancy rate in the Adelaide CBD showed a slight decline in the first half of 2011, but tenant demand remained relatively weak over this time.
Since July, however, tenant demand is believed to have picked up and this, combined with limited new supply entering the market, is expected to lead to downward pressure on vacancy rates. By the end of 2012, it is expected to reach 5.5 percent.
The positive outlook for the market has led to speculative development taking place in the Adelaide CBD, something that has not occurred in this market for some time and, indeed, has not occurred much nationally over the past three years.
Site works began at 70 Franklin Street in July 2011. It is anticipated that the first of the tenants in the 20,000sqm development will be announced in the coming months.
Although relative to other Australian CBDs, transaction volumes are low in Adelaide, global investors have been active in this market, accounting for the majority of deals in 2011.
Nerida Conisbee is national director, research, at Colliers International