Melbourne’s office market vacancy lowest since 2012, but slowdown likely: BIS Oxford Economics

Melbourne CBD’s office market is on an upswing, with vacancy rate at its lowest in five years, but a pause is likely before the second leg kicks in at the turn of the decade, according to BIS Oxford Economics.

The Victorian capital’s office market posted impressive results through 2016. The CBD vacancy rate fell by 140 bps to 6.4%—its lowest level since 2012—net effective rents increased by 14% and capital values surged almost 20% higher. 

The positive momentum is continuing this year and the trend is far from over, says the forecaster. However, it won’t be all smooth sailing and a looming slowdown in demand lies ahead coinciding with a spike in new supply, it said.

A similar trend was witnessed in the city fringe market as well, with vacancy rate dropping to 3.47 percent in March from 4.96 percent in September 2016, according to a separate report by Colliers International.

“This is the lowest vacancy rate that Colliers International has ever recorded for the City Fringe market, and is the outcome of strong demand and very low levels of supply," said the Colliers report.

Last year’s strong run in the CBD market meant average prime net effective rents rose nearly 20% above post-GFC lows, while aggressive yield compression pushed values a 90% higher, said BIS Oxford Economics. That puts average prime values around 50% above pre- GFC peak levels. 

After a high like this, one might expect a muted outlook for the market. But BIS Oxford Economics expects further gains of more than 60% in prime net effective rents and almost 50% growth in values to a peak in the early 2020s. 

However, senior project manager and report author Maria Lee has a caveat.

“It won’t be smooth sailing through the upswing. In particular, Victoria faces several headwinds that are likely to cause economic growth to slow over the next few years, with a negative impact on the demand for office space,” Lee said. 

This slowdown in demand is likely to coincide with a substantial quantum of new supply coming on to the market. 

Six major towers are currently under construction in the CBD, with work on two more likely to begin shortly. These will be completed from the second half of 2018. 

Although substantially pre-committed, there is an as-yet uncommitted component which will result in considerable back-fill space becoming available, according to the forecaster.

The impact of these coming changes to the demand/supply balance would be more like a pause in the upswing rather than an end to the trend. 

“Melbourne retains a key affordability advantage over its northern neighbour and competitor, Sydney. This will help to insulate Melbourne somewhat from the negative impacts of the closure of the Hazelwood power station, the end of car manufacturing and a coming downturn in residential construction. For a national company looking to expand its back-office functions, the scales are tipped in Melbourne’s favour,” Lee said. 

The rental differential with Sydney is only set to increase over the next few years, according to BIS Oxford Economics, with Sydney’s CBD rents set to surge as the vacancy rate gets extremely tight for an extended period. 

Once Victoria has emerged from the challenges of the next few years, BIS Oxford Economics expects that Melbourne’s inherent advantages of plenty of skilled labour, a cheap and plentiful supply of land for residential, industrial and commercial building, and lower rents will come to the fore and support the second leg of the upswing. 

“Any near-term weakness should not discourage market participants from the longer term prize” concludes Lee.