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Market Insights

22.05.2019

Melbourne Office Owners Sitting Pretty, But How Long will the Party Last?

As Melbourne experiences some of the strongest conditions for office landlords experienced in over a decade, most owners aren’t popping the champagne just yet. Whilst most buildings in the CBD and City Fringe have seen strong tenant uptake and growth in rentals, other concerns are starting to surface which may impact on their returns.

A recent CBRE annual office forum luncheon saw the “who’s who” of the property industry attend an invite-only event, where approximately 250 private and institutional office owners actively debated about the current state of the Melbourne office market.

According to CBRE, Victoria recorded the highest growth in State Final Demand in the country at 5.2%, whilst White Collar Employment growth, which grew 4.4% last year, continues to exceed the long-term average and underpins strong demand for office space in Melbourne. Melbourne’s prime and secondary net effective rents recorded growth of 2.3% and 1.4% respectively, with incentives remaining steady, while the office vacancy rate reached a record low of 3.2%.

Over the course of 2019, office supply will remain at a muted level and office vacancy is expected to remain tight. This will help support continued effective rent growth throughout this year, which is forecast at approximately 7%. However with the bulk of new office supply due to complete in 2020-2021, vacancy rates and incentives are expected to increase, leading to a softer projection of effective rent growth until 2023.

One major issue causing owners grief is rising occupancy costs, particularly due to increases in land tax and other statutory outgoings. Whilst in most cases, this cost can be passed onto the tenant, the overall cost of occupancy may see some office buildings become very uncompetitive or generate unacceptably low returns for the owner. “If rents can be sustained at these new levels, then it’s possible that landlords will be able to ride out these increases in outgoings, but if we do see a fall in rental levels and an increase in incentives, then this could create some pain for owners”.

One presentation revealed that transaction volumes for offices were significantly down in 2019, whilst capital values continue on an upward trajectory, consistently breaking the magical $10,000/sqm mark over the past 12 months.

“Whilst several transactions in the first half of the year have indicated that confidence is at all time highs for the office sector, the supply of opportunities, particularly in the $20-$120 million space has been well below the 5-year average”.

“What this means is that every time a property comes to market for sale, we are seeing a great deal of pent up demand where up to 10 or 12 offers are put forward by a range of domestic and international players looking to grow their office portfolio in Melbourne”

It was noted that there had also been several interruptions to the first half of 2019, with extended public holidays and government elections making it difficult for the market to gain true momentum off the back of a record-breaking 2018 period.

“Traditionally, we have seen transaction volumes increase markedly after a federal or state election, and we expect this to be the case as owners gain a level of certainty on where the market is heading. However it will be interesting to observe whether proposed legislative changes to the tax regime for property have a major impact on this activity”

Mr Lewis Tong, CBRE’s Asian inbound capital lead, said that whilst Chinese capital flows had slowed, they were still the largest international purchaser of office assets over the past 6 months. “For all of the reduced activity in the Chinese buyer segment, we are now seeing an uptick in activity from Hong Kong and Macau, which means we continue to trade over half of our office assets to international buyers”

The prevalence of fund-through transactions was also a topic of hot debate, as investors look to fill the capital void for developers looking to deliver office projects in Melbourne. “If the banks won’t come to the table, then developers need to consider either second-tier lenders or fund-through arrangements with investors who are looking to grow their exposure to the office market by owning the asset at completion”

With a number of industry leaders in the room, such as Hacer Group’s Vin Sammartino who spoke on a panel of experts, there were some concerns about the cost of raw materials blowing out construction estimates. The slowdown in the residential sector has been offset by the ongoing demand from large infrastructure projects, which will put continual pressure on development feasibilities for developers looking to deliver office or mixed use projects in Melbourne.

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