Underlying drivers more supportive in the South East
Underlying drivers more supportive in the South East
3 August 2014
Sydney, 3 August 2014- Melbourne and Sydney are best placed to capture underlying growth from the improving economy according to CBRE’s Q2 2014 Office MarketView for Australia.
The report states that while Perth and Brisbane are experiencing the contractionary effect of mining investment spend pulling back, and Canberra, the impact of fiscal and departmental consolidation, Sydney and Melbourne will benefit from improving demand from finance and business services which has been flat since 2008.
The Australian economy grew at a stronger than expected 3.5% pace in Q12014, driven by housing and export contributions. The report states that while this is above the long term average, this rate is unlikely to continue in the short term as mining capex declines and non-mining capex remains flat. It will have to wait until later in 2015 for a stronger improvement.
The office market will follow a similar timeline. Office occupying industries are slowly returning to ‘positive’ revenue compared to 2007 and although supply is coming on at levels close to long term average, demand is generally weaker.
CBRE’s Associate Director of Research, Claire Cupitt, commented that investors continued to favour prime grade assets, with long lease tails and secure tenants. Secondary assets are still transacting well although she warns that secondary investment opportunities should be concentrated in markets with fairly modest expected vacancy peaks.
“Secondary assets in weaker markets appear to be pricing in the risk of significant vacancy increases going forward. This is most notable in the Brisbane market, where the yield spread between prime and secondary assets has widened by 85bps over the last year, in contrast to a contraction in Sydney CBD of 25bps over the same period,” Ms Cupitt said.
CBRE’s Regional Director of Office Services, Andrew Tracey, said that across the country they are seeing an increase in enquiry levels as sentiment gradually improves.
“Tenant enquiry is finally translating into real commitment rather than just price checking in the market. Progressive businesses are exploring new ways of working and this is changing the leasing landscape with buildings having to deliver better quality services and healthier environments,” Mr Tracey said.
“In the next few years we will see a lot more movement as business thought-leaders understand that they will again battle for talent, and that a more people focused workspace will be a key differentiator in this battle. The impact on the market will be greater building obsolescence and a continued flight to quality. Successful landlords will reap the rewards of the work they do today to future proof their assets and give the tenants what they want - better working environments.”
In the office investment market, the appetite for Australian office assets has seen prime office sales grow steadily from circa $7.1bn in 2011 to $12.8 bn over the last twelve months supported by strong foreign investment injections. In contrast, weak occupier demand persists and with the supply pipeline growing in all major markets, vacancy profiles are rising, stifling projected market rental growth over the short to medium term. This combined with persistently high incentives and lower marginal effective rents, puts future office incomes under pressure.
Sydney remains in high demand from investors
Due to the soft occupier demand, premium net face rents were flat over Q2 14. Incentives are still at historically high levels (33%), with landlords attempting to hold face rental rates. Prime net face rents have also been on a flat trajectory, underlined by weak demand.
“The current environment is still in occupiers favour, with tenants negotiating more favourable lease terms as landlords look to secure longer WALE’s.”
Vacancy in Sydney’s CBD is expected to dip below 9% by the end of 2014 before rising in 2015 as new supply comes to the market and major tenant moves leave backfill space.
Parramatta is still seeing strong tenant enquiry levels, indicated by low levels of vacancy in the market, particularly prime. This is due to solid white collar employment growth over the recent years coupled with minimal supply. The report states this is expected to continue until 2016 when supply enters the market in the form of Parramatta Square Stage 1.
“There have also been a number of tenants looking at Parramatta as an alternative to the CBD, in addition to tenants from suburban markets looking to relocate to a more central location within the Sydney metro region.”
“Nationally, we expect Sydney is best placed in terms of vacancy and income risk over the next three to five years. Through the next supply cycle from the end of 2015, vacancy is expected to peak 1-2% higher with uncertainty still remaining around backfill from large tenant moving to Barangaroo. This compares to alternate CBD markets where the forward looking supply/demand imbalance is more pronounced.”
Just over $1 billion transacted in the office market in the Sydney CBD in Q2, 2014. Ms Cupitt said strong interest was seen from both foreign and domestic buyers and is further indication that Sydney remains in high demand from investors.
In the CBD there is still a focus on prime assets, particularly in the core precinct. econdary building transactions have been led by the intention of conversion to alternate use where planning allows.
Major office sales in the June quarter include 275 Kent Street to Blackstone for $435 million; 66 Goulburn Street to GDI Property for $136 million and 6-10 O’Connell Street to Investa Office Fund for $134.5 million.
North Sydney also experienced a strong quarter for sales, largely part to a competitive investor market in the CBD. The Fujitsu Centre building sold for almost $90 million to an investor due to its strong relative value compared to an asset of a similar price in the CBD.
Parramatta continues to be attractive to investors due to its low vacancy rate, highlighted by the sale of the NSW Police HQ at 1 Charles Street for $240 million.
Tenant migration supporting the Melbourne CBD
Office supply in the Melbourne CBD has increased with Cbus’s 47,000 sqm 720 Bourke Street development, (64% committed to by Medibank), reaching practical completion. One other project, 150 Collins Street (20,500 sqm, 72% committed to Westpac), is expected to reach completion in the second half of the year.
A number of tenants are taking the opportunity to consolidate operations and tenant migration into the CBD is expected to aid net absorption when the moves are recognised. The most recent example of the suburban tenant migration is Jemena, who will consolidate into circa 12,000 sqm of space at 567 Collins Street when it reaches completion in 2015. Further tenant moves scheduled to be recognised this year include Australia Post, Cardno and Brookfield Multiplex.
Despite this, CBRE’s forecast of a 1.0% fall in prime net face rents through to the end of 2014 remains unchanged this quarter. Incentives are expected to hold steady at circa 30%.
The majority of capital is looking for core investments. The largest Q2 14 transaction was the acquisition of the AXA Headquarters at 750 Collins Street, Media House at 655 Collins Street and 2 Southbank Boulevard, Southbank for a combined $548.4 million. The acquisition follows GPT Wholesale Office Fund exercising its option which stems from the CPPIB/DEXUS partnering to acquire the CPA portfolio.
Secondary stock conversion is evident in both the CBD and St Kilda Road office market, in line with the solid investor appetite for inner city residential.
Indicative prime office yields in the Melbourne CBD currently average 6.60%, a firming of 20 basis points over Q2 2014. The limited supply of good quality investment stock, higher yields compared to competing international markets and a favourable financing environment remain supportive factors. This is likely to be tempered, however, by a limited rental growth trajectory and rising bond yields as global sentiment improve
Development stock gaining further traction in Brisbane
The move of the Queensland economy away from its resource engineering investment focus to a broader base of drivers is proving slow. CBRE forecasts just a 0.5% increase in Brisbane CBD white collar employment over 2014-15. This suggests a sustained turnaround in office occupier demand is still some time away.
Despite this, the next wave of development stock in the CBD gained further tenant traction during Q2 2014. PricewaterhouseCoopers committed to 6,900 sqm at 480 Queen Street and will relocate from around 8,700 sqm in the Riverside Centre. The building is due for completion in early 2016 and is now 62% pre-committed. At 180 Brisbane, due for completion as early as late 2015, the Commonwealth Bank of Australia is believed to be close to committing to around 12,000 sqm, relocating from a similar amount of space at 240 Queen Street. If confirmed, the commitment would be the first for 180 Brisbane.
Together with 1 William Street, 183,000 sqm of new supply will be added over the course of twelve months. Whilst likely to be offset to a degree by withdrawals of older secondary stock for redevelopment or conversion to other uses, predominantly residential, the net result will still see a significant spike in vacancy during 2016 to over 18.0%.
Despite the weak occupier market, investor appetite for prime Brisbane assets remains strong, with domestic and offshore capital still competing for opportunities.
Following record activity in 2013, sales volume in 2014 is lower which is largely due to a more limited availability of stock. Just one major CBD asset transacted in Q2 when Central Plaza Three was acquired by Pembroke Real Estate for $122 million, on an initial yield of 6.4%.
Investors looking for value add opportunities in Perth
Market conditions in Western Australia remain weak, with a more widespread downturn in business confidence spreading from the resources sector to professional service industries.
Perth CBD vacancy at January 2014 was 9.0%, although according to CBRE’s latest CBD office stock count, vacancy was closer to 12.7% as of June. The availability of sublease space has impacted market fundamentals, offering quality office space at cheaper rates compared with direct vacancies.
Recent demand has been driven by tenants in the market to consolidate and downsize. CITIC Pacific Mining has agreed to relocate to 45 St George’s Terrace taking 3,200 sqm and leaving 5,000 sqm at 99 St George’s Terrace.
The next major supply wave has become 2015 centric, with eight new buildings potentially completing. Currently, 174,829 sqm of new office space is under construction, with 86% comprising new builds of which 62% is pre-committed. Some of the tenant underpinning the new developments have committed to larger amounts of space than previously occupied and are moving from peripheral locations of the CBD. While market vacancy is set to rise on the back of the strong supply cycle, the impact on vacancy from backfill may be less significant than seen in other CBD markets. Further out, Woodside have announced its pre-commitment to 55,000 sq m at Capital Square owned by AAIG (Malaysian based investors) which is likely to enter the market in late 2018.
The investment market in the Perth CBD remains robust as domestic and international investors continue to target prime office buildings with long term leases in place and minimal CAPEX requirements.
Whilst current market fundamentals are weak when compared nationally and across Asia Pacific, Western Australia remains an attractive destination for investment. Investors normally take a long term view and are enticed by the strong long term growth fundamentals entrenched in Western Australian economy.
There were four transactions totalling $196.1 million over the first half of 2014 in the Perth CBD, including 130 Stirling Street for $90 million and Septimus Roe, 141 Adelaide Terrace for $91 million to Singaporean Investment funds Hiap Hoe and Far East Organisation.
Investors continue to search the market for value add opportunities. At present, 220 St. George’s Terrace, 125 Murray Street and a 50% share in Exchange Plaza, 2 The Esplanade all sit on the market. Each asset offers opportunities to add value over the long term.
Flight to quality impacting market via backfill in Adelaide
Despite a softening in South Australia’s economy, tenants are taking advantage of stable rents and historically high incentives to upgrade their office space footprint. Deals to PwC, Marsh Mercer, Southern Cross Austereo and the Department of Immigration & Border Protection, all of which are moving to 70 Flinders Street, are indicative of the continued interest in prime grade space. We don’t expect this flight to quality to subside.
CBRE’s assessment of vacancy at June 2014 was 13.8%, up from 12.4% in December 2013. This rise is largely as a result of large parcels of backfill space deriving from the ATO at 81-95 Waymouth Street (16,378 sq m) and 44-58 Rundle Mall (10,000 sq m). While there is also significant vacancy at 70 Flinders Street, a large portion has been committed to, although take up will not be recognised until later in the year.
The lack of sales activity has seen yields in the Adelaide CBD stabilise and average 8.1% (prime) and 9.5% (secondary) at June 2014.
There was one transaction during Q2 2014. The National Australia Banks’ headquarters at 22 King William Street sold for $41.8 million to Adelaide-based syndicator Southern Cross Equity Group Pty Ltd on an initial yield of 8.58%.This is the most significant commercial office sale in over 12 months.
Uncertainty continues to plague the Canberra office market
Employment cuts across several government agencies (the main occupiers of space in Canberra) were outlined in the most recent Federal budget. The main impact on the property market stems from uncertainty, with occupiers unwilling to sign long term leases and commit to more office space in an environment further complicated by changing floor space requirements per employee.
CBRE forecasts total market vacancy to move to 13.5% by the end of 2014. Prime grade vacancy is expected to be slightly higher (15%) with the secondary market supported by withdrawals.
Despite the weak occupier market, Canberra remains an attractive place for investors, highlighted by the sale of the Manning Clark Building, which transacted for $25.8 million on a yield of 7.8%. CBRE expects yields for prime assets to remain in this range as the strong investment fundamentals of government tenants and long WALE’s continue to interest investors.
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About CBRE Group, Inc.
CBRE Group, Inc. (NYSE:CBG), a Fortune 500 and S&P 500 company headquartered in Los Angeles, is the world’s largest commercial real estate services and investment firm (in terms of 2013 revenue). The Company has approximately 44,000 employees (excluding affiliates), and serves real estate owners, investors and occupiers through more than 350 offices (excluding affiliates) worldwide. CBRE offers strategic advice and execution for property sales and leasing; corporate services; property, facilities and project management; mortgage banking; appraisal and valuation; development services; investment management; and research and consulting. Please visit our website atwww.cbre.com.au.