Melbourne's Inner East office market has a supply squeeze: Colliers

From a demand perspective, Melbourne's Inner East is just as highly sought after as the City Fringe market, however, the opportunities for tenants to move around are limited, according to Colliers International’s latest Metro Office report.

“While our vacancy rate has increased in the six months to March 2017, from 4.15 per cent to 6.3 per cent, a number of the larger tenancies that have recently become vacant are currently in Heads of Agreement (HOA) stage, thus we expect the vacancy rate to quickly fall down again to 5.9 per cent by September 2017, and further to 4.7 per cent by this time next year," said the report.

One of the larger vacancies to be leased in late 2016 was 2 Luton Lane (above) to Swinburne University. This was a 5,660 sqm deal which was completed before the space even became vacant, hence is not reflected in our net absorption figures, Colliers said.

"Orora also renewed 4,000 sqm of space at 109 Burwood Road, Hawthorn. Again, this is a large tenant commitment to the Inner East market that is not reflected in net absorption,” the report stated.

Rents in the Inner East continue to increase despite increasing vacancy rates, Colliers says.

“Rents continued to increase in the Inner East, despite the increase in the vacancy rate, as the underlying demand not reflected in the figures has pushed landlords to increase face rents and reduce incentives.

"Face rents grew by 5.6 per cent in the year to March 2017, and coupled with a decline in average incentives from 18 per cent to 15 per cent, the overall increase in effective rents was 9.1 per cent.

"We are forecasting very similar (nine per cent) effective rental growth over the next 12 months, as continued tenant demand and no supply constrain tenant options.

"Despite good tenant demand in the Inner East, there is only one development in the pipeline for this precinct, following the completion of Vicinity’s new 13,650 sqm building adjacent to the shopping centre,” the report said.

Colliers says that net absorption will remain below averages in the long term.

A new development at 139-155 Camberwell Rd, Camberwell is expected to add 8,000 sqm of supply in late 2018.

Most development sites in the Inner East are still proposed as residential or student accommodation projects.

"For this reason, we expect that net absorption will remain below long-term averages over the next few years, as tenants are forced to look to other markets for accommodation.

"This is the continuation of a recent trend we have been seeing in the Inner East, which in the five years to 2015 absorbed an average of 15,000 sqm of space each year,” the report says.

Yields have compressed similar to the City Fringe market in Melbourne, Colliers says.

Since 2015, only 3,000 sqm of space has been absorbed on average in this precinct, a stark illustration of supply constraints impacting tenant activity.

A total of $240 million of commercial property was transacted over 2016, with Charter Hall’s $140.5 million purchase of a 50 per cent interest in 800 Toorak Rd, Hawthorn East accounting for the bulk of the transaction volume figure.

"Yields have compressed in line with the City Fringe market, at 100bps to average six per cent for A Grade assets as at March 2017,” the report stated.