2017 tipped to be the year of the office landlord

Falling vacancies and lower incentives are promising a windfall for landlords across the country, according to Colliers International’s latest CBD Office research and forecast report.

The report projects that positive net-effective rent conditions from net face growth will continue to drive tenant demand throughout 2017 on the back of suite strategies, such as that in Chifley Tower in Sydney, and pre-commitment to new developments, such as the new ANZ building in Docklands.

Despite office investment volumes being down in Sydney and Brisbane, and plateauing in Melbourne thoughout 2016, an increase is expected in 2017, as domestic and offshore building owners trade out of their profitable assets.

“The landlord’s market is in full swing in Sydney and Melbourne,” John Marasco, Colliers International’s chief executive for Victoria, said.

“Enquiry levels are still strong, with the majority coming from business services, health and community services, IT and finance, which is resulting in a more positive environment than what has been experienced in the past few years.

“With large players, both domestic and offshore, striving to achieve access and scale, we expect more capital partnering, like what was witnessed between Charter Hall and Morgan Stanley last year for 1 Shelley Street in Sydney, and possibly more merger-and-acquisition opportunities to emerge in 2017.”

Daniel Lees, Colliers International’s research director, said that with the reduction of office supply continuing in Sydney and Melbourne, significant increases in rent and reduction on incentives would be experienced.

“We predict the low supply pipeline will see vacancy rates well below long-term averages in Sydney and Melbourne, beginning to fall in Brisbane, Adelaide and Canberra, and stabilising in Perth,” he said.

Colliers International’s mangaging director for valuations, Dwight Hillier, said the report indicated that the total internal rate of returns would strengthen throughout 2017, prompted by strong effective rental growth in the Sydney and Melbourne CBD office markets.

“Yield compression is forecast for the Sydney metropolitan office market in particular, as purchasers are forced to hunt for initial yield and total return beyond the CBD,” he said.

Sydney’s vacancy is anticipated to trend lower to 3.7% in early 2020, before rising to 5.7% by mid-2022.

“Sydney will enjoy a brief period of respite from negative net supply during the next six months as refurbishments come online.

But negative net supply will quickly return for the subsequent 18 months,” Simon Hunt, Colliers International’s managing director for office leasing, said.

“It won’t be until the first half of 2019, when withdrawals subside and the first building of the next Sydney supply cycle – 60 Martin Place – is complete, that Sydney finally starts a period of positive net supply.”

Vacancy in the Melbourne CBD is declining and will continue to do so during the next few years, with the total vacancy forecast to hit 4.3% in July 2021, due to the lack of supply.

“Melbourne’s supply levels have been far less sporadic than Sydney’s and accompanied by stable absorption,” Hunt said.

“We expect that healthy levels of demand will be sustained throughout the next two years, resulting in vacancy falling to 4.2% by the end of 2018, before the next supply cycle kicks in in 2019.”

Brisbane’s prime vacancy is also expected to continue falling during the next two years as tenants upgrade office space, enticed by incentives and competitive effective rents.

Office vacancy is likely to have peaked in Adelaide, as the construction cycle comes to an end this year and there is limited new supply in the pipeline in the short- to medium-term.

Sales activity remains strong as investors stake their claims in new builds, contributing to a volume of more than $453 million for 2016.

“This cap on new development supply and limited existing additions will help reduce the overall national vacancy from record levels to more historic 10-year averages,” Hunt said.

A-grade vacancy is also declining in Canberra, spurring effective rents to rise on the back of dwindling supplies.

Vacancy in the Perth CBD is stabilising, with major supply likely to be limited to new developments during the next two years.

Smaller tenants are most active, joining the office sector’s “flight to quality” movement to secure the best affordable stock.

The report highlights the increasing demand for suites across the country, with premium landlords carving up whole floors to cater to smaller tenants’ needs and boost effective rent values.

“We anticipate that a lack of whole floor space availability will see 2017’s leasing activity weighted to suites,” Hunt said.

While most grades across the CBD are seeing an increase in face-effective rents, the real story is in the sub-500 square metre B-grade market in fitted-out options, the report said.

Landlords are taking advantage of this demand and building new fitouts in these smaller suites or refurbishing suites with existing fitouts.

"Flexible spaces and the activation of areas for work are rapidly rising and filling the needs of tenants looking for lease flexibility," opined Hunt.

"Even though small businesses and start-ups have favoured flexible space, we should start to see larger businesses taking up more space in 2017, as the preference for flexible lease structures permeates through the market.”