Sydney, NSW, Australia

Vacancy levels across Australia’s major CBD office markets are in most cases likely to remain tight in the short to medium term despite the slowdown in the leasing markets as increased construction costs, the credit squeeze and declining confidence combine to delay the delivery of new stock, according to Colliers International’s latest national CBD office market research.

The CBD Office Market Indicators Reports: Spring 2008, which included research from Adelaide, Brisbane, Canberra, the Gold Coast, Melbourne, Perth and Sydney, revealed little change in the official PCA vacancy data released in June.

The research also revealed the extent of the decline in investment market activity with only 23 major sales ($10 million plus) to date nationally or less than half the total for the same period in 2007. In Sydney there have been no major sales this year while in Melbourne, which has seen eight major sales, total sales value is less half of the 2007 figure. Sales also dropped significantly in Perth while Adelaide and Brisbane have been steady.

According to Colliers International’s Director Commercial Research (NSW), Felice Spark, the impact of the credit crisis was now being keenly felt, particularly in Sydney’s CBD where investment sales activity had been brought to a ``crunching halt’’.

"The decline in investment markets and in particular the zero sales in Sydney’s CBD is a harsh reflection of the impact of the credit crisis, especially when you consider the Emerald City’s average of 20-25 sales per year in previous years,’’ Ms Spark said.  

She said with little or no sales evidence available, tracking the changes in yields and values was challenging, but there was evidence that yields had softened substantially over the course of 2008 after peaking in late 2007.

"With the full extent of the credit crisis likely to have further to run, there may be additional softening in yields still to come,’’ Ms Spark said.

However despite the slowdown in leasing and investment, the states, with few exceptions, reported that solid fundamentals, especially in the resource rich states, continued to underpin the markets. An estimated 250,000sqm of additional office space is needed within Brisbane’s CBD and fringe areas during the next five years to accommodate the predicted growth in white-collar employment. 

Sydney
Four consecutive years of positive net absorption and limited new supply to come on line over the next two years is expected to see Sydney’s CBD office market vacancy bottom out at under 3% by 2010.

The Sydney CBD Office Market Indicators Report: Spring 2008 also found gross face rents had grown by 2 to 3% on average in the six months to September, however much of the growth could be attributed to refurbished stock, while some increase in incentives reflected a softer leasing market in 2008.

The report suggested yields may have softened by 50 to 75 basis points for prime grade property and by as much as 100-200 basis points for secondary grade property, however with no major investment sales to date it was difficult to be sure of the extent of any movement in yields or capital values.

State Director Commercial Research, Felice Spark, said while the overall vacancy rate at 4.3 % was only marginally above the record-low of 3.7% in January 2008, a slowing in white collar employment growth and the increased cost of funding developments, if indeed funding could be found, would limit new construction and keep the vacancy rate low in the medium term.

National Director Office Leasing, Cameron Williams, said while average gross face rents had increased by 2% to 3% during the six months to September - taking the average annual rental growth to approximately 6% - rental growth had actually slowed as a result of the softening in demand and the higher amount of space coming back into the market.

Mr Williams said with limited supply and development timelines continuing to be pushed back as well as continuing instability in the financial market, he expected to see continued rental growth in the order of 4 - 7% per annum across Sydney’s CBD over the next two years.

"This growth will soften from 2012 onwards when more supply is expected to come to the market,’’ Mr Williams said.

National Director Investments, Vince Kernahan, said the fundamentals in the market were generally strong with the leasing marketing having low vacancy and buildings providing strong cash flows. He said new development was also slowing because of higher interest rates thus limiting potential oversupply.

"However cash flows in the next one to two years will be strained. The leasing market is presently inactive and there are signs of an increase in incentives and sub-lease space thus putting pressure on cash flows.

"Add to this the cost of debt and some owners, particularly those that do not have the necessary capital expenditure, are needing to sell. Their valuation levels which often dictate their ability to sell are generally above the level of offers currently being made and hence no sales have taken place,’’ Mr Kernahan said.

Melbourne
With a record low vacancy rate (3.1%), limited new supply in the short term, and employment growth rates expected to remain steady over the next 24 months, the competition for office accommodation in Melbourne’s CBD is expected to intensify over the next few years. 

The Melbourne CBD Office Market Indicators Report: Spring 2008 also found the low vacancy rate, reasonable tenant demand and supply constraints had driven growth in net effective rents over the last six months and were expected to drive further rental growth across Melbourne’s CBD over the next six months.

On the investment front the report found the total sales ($10m plus) figure of $319 million was down by more than half compared with the same period last year however, according to Colliers International’s State Director Investment Sales, Pat Burke, foreign funds as well as local and international private investors attracted by record low vacancies rates, rental growth potential and low capital values (compared to other Australian capital cities), had made several purchases and were likely to continue to figure prominently over the next twelve months.

Colliers International’s National Director Office Leasing, Andrew Tracey said that although 100,000sqm of office space was due to come online during the next six months the vast majority was already committed and the CBD should see only a marginal increase in vacancy levels over the next six months.

"The big question for the next six months, is to what extent, the global credit crisis will slow tenant demand.  Many companies are now implementing capital expenditure freezes and this is translating to slightly reduced demand although there are still a lot of transactions going on and options are limited. Stock availability is at its lowest level since 1990 and tenant options in the short term are limited, so despite this weakening in demand we still expect the market to perform strongly for the remainder of 2008 and to continue into 2009,’’ Mr Tracey said.

Brisbane 
An estimated 250,000sqm of additional office space is needed within Brisbane’s CBD and fringe areas during the next five years to accommodate the predicted growth in white collar employment.

The Brisbane CBD Office Market Indicators Report: Spring 2008 suggests white collar employment for the CBD and outer areas will increase by 17,054 employees over the next five years. Assuming an average office space ratio of 15sqm per employee, almost 255,810sqm of office space would be needed for both the CBD and fringe areas to cater for the projected growth.

According to the   Commercial Research Manager (Qld), Helen Swanson, said that after a sizzling 2007, the leasing market had shown signs of slowing during the first half of 2008 with rents hitting resistance levels and the threat of upcoming supply resulting in incentives becoming increasingly featured for most grade of product.

"While record levels of rental growth were achieved during 2007, it is now expected that more moderate growth of between 8 per cent and 10 per cent will prevail this year,’’ Ms Swanson said

State Director Office Leasing, Matt Kearney, said market activity across the board had slowed.

"US sub prime crisis concerns, turmoil in the equities markets, tightening credit conditions, rising borrowing costs along with a decline in business sentiment have seen a change in the market dynamic over the first half of 2008,” Mr Kearney said.

"Despite this the leasing market has been kept buoyant by a spread of mining, engineering and construction firms that continue to target Brisbane’s CBD for suitable office space.

"Gross face rents for new A-grade buildings in the CBD have increased and we’re still seeing a healthy level of enquiry for office leasing – particularly for good quality stock,” Mr Kearney said.

Adelaide 
Strong white collar employment growth, record immigration, and expansion in the mining/resource and defence sectors are likely to see the Adelaide CBD vacancy fall below 2% within two years.

TheAdelaide CBD Office Market Indicators Report: Spring 2008 also found sustained demand would maintain upward pressure on rents and see incentive levels continue to fall, while on the investment front a reduction in sales activity had resulted in a softening of yields and yet only a slight fall in capital values given the rental growth.

According to Commercial Research Analyst, Katy Dean, the Adelaide office market is well equipped to perform above average over the short, medium and long term.

"The record levels of absorption are clear evidence of a high level of demand with almost 60,000sqm of office space taken up in the 12 months to July against an historical average of just 19,000sqm,’’ Ms Dean said.

Ms Dean said while projections for white-collar employment were positive, the resources and defence sectors would continue to underpin a solid market. She said a cautious construction sector would help to maintain the low vacancy rate and upward pressure on rents.

"The subprime disaster and the oversupply speculative development caused in the early 90s, has engendered a more cautious approach amongst developers with the result that some speculative development has now been postponed.

"It is this type of sentiment that will keep new buildings close to full occupancy leading Adelaide towards very tight market conditions over the next couple of years,’’ Ms Dean said

State Director Investment Sales, Alistair Mackie said the impact of the credit squeeze had been felt with just four sales over $10 million this year, yields softening by 50 to 100 basis points, and a slight fall in capital values.

Mr Mackie said institutional investors had been conspicuous by their absence with the four properties having sold to private investors, the group – including many from interstate and overseas - which had been responsible for much of the recent enquiry.

He said it was likely private investors would continue to figure prominently in the market as institutions, especially highly geared players, looked more towards divesting non-core assets than purchasing.

"While there is no doubt the investment market has flattened off with sales down and yields easing, the strong fundamentals of the South Australian economy reflected in record low vacancies, potentially strong rental growth, and consistent white collar employment growth, will ensure that Adelaide remains on the national investors radar screen.” Mr Mackie said.

Perth
Perth’s CBD office market looks set to face a continued low vacancy rate in the short to medium term, with the effects of the credit crunch throwing a serious question mark over almost one third of the city’s proposed new developments.

The Perth CBD Office Market Indicators Report: Spring 2008, cast doubt over an estimated 131,000sq m of the more than 413,000sq m of proposed new office supply expected to come online between 2009 and 2012, with several developers now being pushed to secure pre-commitments in the face of tightening finance requirements.

Research Consultancy Manager Erwin Edlinger, said the potential reduction in new supply would have major ramifications for Perth’s record low vacancy rate, which had been predicted to go as high as double figures by 2012.

"The industry had been expecting to see vacancy rates return to a more normal range of between 10 per cent and 12 per cent thanks to the addition of new stock and the emergence of backfill space, created by tenants leaving office premises to take up residence in new developments,’’ Mr Edlinger said. 

He said while credit constraints had already acted to put an effective supply ceiling on development in the suburban and fringe office markets, risk-averse financiers were now showing caution towards major CBD development proposals and insisting on substantial pre-commitments before giving the green light.

That is going to have an impact on development activity, and the general consensus is the vacancy rate is more likely to sit at somewhere between 6 per cent and 8 per cent at the peak of the supply cycle – and while that’s still a big improvement on our current situation, it does mean the impact of the supply cycle isn’t going to be as significant as previously anticipated,” Mr Edlinger said.

The report revealed sustained rental growth looked set to continue until at least late 2009 with the continued squeeze on vacancies and strong demand expected to see an average rental growth of between 10 per cent and 15 per cent over the coming year.

Premium Grade office rents have climbed by an estimated 40% in the 12 months between June 2007 and June 2008, bringing the net face rental rate up to an average of $875sqm and a high of approximately $900sqm – however, further growth is expected to see premium rents top $1000sqm by early 2009.

The report found the effects of the credit crunch had also filtered through to the investment sales sector with just three sales in the first six months of 2008 totalling approximately $94.3 million. Capital value growth is believed to have slowed, and yields to have shifted towards historical averages.

Director of Investment Sales Ian Mickle said WA’s strong economic fundamentals, low vacancies and softening yields continued to make Perth assets an attractive investment option.

"Tighter credit conditions have clearly had an impact, as has an element of caution regarding what was expected to be a significant amount of new supply coming to the market – however, if a significant portion of that new supply doesn’t eventuate, we may well see buyers become more active over the coming year,’’ Mr Mickle said.

Canberra
Canberra’s office vacancy rate is expected to rise over the next few years, as supply exceeds demand, with a concomitant rise in incentives and slowing in rental growth.

The Canberra Office Market Indicators Report: Spring 2008 found the strong demand evident from 2003-2007 had eased significantly in recent months to the point where developments underway were likely to result in an oversupply from 2010 assuming no increase in the rate of demand. 

On the investment front the report found diminished sales activity in 2008, driven by global economic uncertainty, was likely to have resulted in a softening of yields by 50 to 75 basis points.

According to report author, Valuer Consultancy & Valuation, Tim Mutton, the Canberra market has traditionally been less volatile than other capital markets with relatively low vacancy levels and relative equilibrium of demand and supply, however a spike in demand from 2003 to 2007 had reduced incentives and caused vacancy levels to retract to record lows.

"The market response has been to provide record supply growth with the initial delivery of new accommodation being pre-leased. Of the 385,000 sqm new supply currently under construction or recently delivered, such as new space at the Airport, approximately 45% does not have the 100% pre lease commitment and vacancy levels are starting to rise.

"We therefore expect incentives to become more a feature of the Canberra market over the next three to five years as existing tenants take advantage of their stronger bargaining position,’’ Mr Mutton said.

The report found overall vacancy had increased to 6.12% (up from 2.16%) due largely to a significant increase in new supply at Canberra International Airport Business Parks. However the vacancy level would start to trend upwards over the next few years as new supply continued to be delivered, Mr Mutton said.

"There is a strong likelihood of an oversupply from 2010 assuming no further increase in the rate of demand growth,’’ he said.

According to State Chief Executive, Paul Powderly the sale of Tuggeranong Office Park in early 2008 for $166 million was one of few major investment sales in Australia in 2008 despite an increase in the volume of properties for sale.

He said large institutions such as Listed Property Trusts (LPTs) and Superannuation Funds had shown little interest in the increasing level of stock now available for sale.

"This situation has caused sellers to adjust price expectations downward and yields have softened as a result. Our analysis of limited market evidence and general market conditions and sentiment indicates yields have softened by 50 to 75 basis points across the city over the last six months,’’ he said.

Gold Coast
With a large number of office developments in advanced stages of construction the Gold Coast vacancy rate, currently at 8.1%, looks set to enter double figures by the start of 2009.

The Gold Coast Office Market Indicators Report: Spring 2008 found 44,169sqm of new office space was to be completed by the end of the year bringing the total amount of available space to nearly 75,897sqm.

According to Director Commercial Agency, Leonie Smith, the major challenge now for the city’s office market is to rebalance supply with demand. She said part of the solution may be in the attraction of tenants from the extremely tight Brisbane market.

"An increased supply of high quality buildings, coupled with Brisbane’s exceedingly low vacancy rates, may see some tenants from Brisbane relocate to Gold Coast premises in search of lower rent and high incentives,” she said.

According to Commercial Research Analyst Kim Sowry, net absorption was 10,485sqm over the last 12 months however that has slowed to just 2039sqm in the last six months.

She said the oversupply would see an increase in incentives and a decline in rents which could last until 2010 or beyond. The report revealed A-grade office space was achieving rental rates between $400-$450sqm with incentives between 10 and 15 percent. It also found less activity in the investment market had seen capital values starting to fall and yields soften.

About Colliers International

Colliers International is a global affiliation of independently owned commercial real estate firms. The organization's 10,092 employees span the world in 267 offices in 57 countries. On a worldwide basis, Colliers manages 672,945,918 square feet, and has revenue of $US 1,620,958,349.

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