Melbourne office market going from strength to strength: but BIS Oxford Economics issue warning

Melbourne office market going from strength to strength: but BIS Oxford Economics issue warning
Melbourne office market going from strength to strength: but BIS Oxford Economics issue warning

The Melbourne office market upswing is continuing strongly, according to BIS Oxford Economics.

They said net absorption was solid again in 2017 having been backed by strong economic and employment growth in Victoria.

Minimal net additions to stock in the year helped vacancy rates to contract in both CBD and non-CBD markets.

The metropolitan vacancy rate of around 5% is the lowest in almost a decade. Leasing incentives are being scaled back and rents are growing strongly, a recent BIS report found.

BIS did caution however that once rental growth stops – and reverses – yields are likely to correct sharply.

“As always, circumstances can change and there's a risk that yields soften sooner than we expect. Investors need to go into the market with their eyes wide open," senior project manager and report author Maria Lee said.

In the investment market, robust demand has pushed yields down – and prices up – further.

Some are concerned that the upswing in prices has run its course, however BIS suggest they do not share this view.

In the company’s latest Melbourne office market reports, it assesses prime grade CBD offices as being fairly valued (in relation to prospective returns) over a five-year horizon, while non-CBD assets are considerably undervalued.

“We’re looking at a prospective five-year IRR of around 10% on average across Melbourne’s non-CBD office markets” says Lee.

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Melbourne office market going from strength to strength: but BIS Oxford Economics issue warning

This forecast is based on a continued favourable demand/supply balance that will push vacancy rates lower and rents markedly higher over the next five years albeit BIS Oxford Economics expects a temporary hiccup in the leasing market around 2019 and 2020 as the wave of development currently under construction comes on stream.

The strong returns forecast comes despite the company’s expectation that rising bond rates will result in softening yields. The critical thing here is the timing.“Certainly, falling bond rates were a key factor in promoting investor interest in property and driving down investment yields” states Lee, acknowledging that “On the face of it, rising bond rates will put upwards pressure on yields.”

However, there are several factors that BIS Oxford Economics considers will offset this impact over the next few years; indeed, near term yields could firm further. Firstly, the extent and timing of rate rises is uncertain. Moreover, the company points to the healthy buffer between office yields and bond rates, and to the lag, historically, before changing bond rates affect yields.

“In addition, and importantly, bond rates aren’t everything," Lee says.

"Investors are not consistent in the importance they attach to bond rates. As we’ve seen in the past, strong rental growth can take over as the driver of firmer yields. That’s what we believe will happen in the early 2020s.”

BIS Oxford Economics cautioned that once rental growth stops – and reverses – yields are likely to correct sharply.

“As always, circumstances can change and there's a risk that yields soften sooner than we expect. Investors need to go into the market with their eyes wide open," Lee said.

 

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Melbourne Office Market

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