Sydney office market strongest but most vulnerable to recession: Morgan Stanley

The prime Sydney office market is forecast to deliver the strongest rental growth over the next two years but is also the most vulnerable if a recession hits, according to research by Morgan Stanley.

The investment bank forecasts effective rental growth of 7.2% and 10.4% in Sydney over 2012 and 2013. 

However, if a recession were to strike, Sydney would suffer a 5% to 6% drop in office demand, about three times greater than what occured in other capital cities during the last two recessions. 

This is due to Sydney’s heavy reliance on financial services demand and its 50% to 60% office A-REIT exposure.

Morgan Stanley says there is a 30% chance of Australia falling into recession. 

Barring a recession though, Sydney and Melbourne are forecast to yield the greatest office rental returns over the next three years. 

Melbourne is forecast to match Sydney’s effective rental growth of 7.2% in 2012 before tailing off to 6.7% in 2013. 

“Although there are still prime vacancies within the Sydney market, a subdued development pipeline and our assumption of steady, but below average recovery in demand, should see the market tighten and vacancies down to around 4.7% by 2013,” write Morgan Stanley analysts Lou Pirenc, Todd McFarlane and John Meredith. 

A moderation of historically high incentives is also expected to contribute to stronger rental growth in Sydney. 

Melbourne and Sydney are expected to benefit from tight vacancy levels in 2012 and 2013. 

Vacancies in Sydney are expected to decline to 5.5% in 2013 from the current level of 8% and from 5% to 4.4% in 2012 in Melbourne before increasing to 5.5% in 2013. 

In contrast, new office stock coming on board in Brisbane, Perth and Canberra is expected to result in limited rental growth over the next three years. 

“In Sydney and Melbourne, we expect supply will remain relatively contained for the next two years, until new projects can be brought on,” the report says.