May 2020 – Melbourne Office Market

  • Metropolitan office vacancy rate has risen to three-year highs predominately as a result of the recent completions;
  • Despite low vacancy rates and a lack of available new uncommitted new supply, CBD rents projected to decline in 2020, impacted by COVID-19;
  • Infrastructure investment and a lack of new supply in the CBD has maintained tenant demand for both the St Kilda Road and Southbank office precincts.

Office Market Summary

Despite the low vacancy levels across Melbourne’s office markets, the current uncertainty in the market as a result of COVID-19 is likely to result in tenants delaying leasing commitments. Similarly, investment activity is likely to be impacted by the pandemic with purchasers to have increased focus on income security and tenant covenants with projections of unemployment to double in the short term.

Melbourne Office Investment Activity

Sales Activity

Urban Property Australia has recorded $570 million of Melbourne metropolitan office sales in 2020 to date, already surpassing the 10-year annual average. Transactional volume of the metropolitan office market has been boosted by a number of major sales, highlighted by ARA’s purchase of 200 Victoria Parade in East Melbourne for $330 million. Much of the sales activity across the metropolitan office market in 2020 to date has been within the City Fringe with the precinct accounting for 95% of the sales volume this year.

While both prime and secondary metropolitan office yields remain at historical lows at 5.4% and 6.5% respectively, Urban Property expects that this will be the cyclical low of the yield compression cycle with yields having steadily compressed since 2013. Given the continued economic uncertainty resulting from COVID-19, we expect investors will have a greater focus on income security and tenant covenant and we expect prime and secondary yields to diverge in the medium term.

Tenant Demand

Although the full impact of COVID-19 is unknown, according to the ABS, between mid-March 2020 and mid-April 2020, job losses were heaviest of all Australian states in Victoria with almost 300,000 jobs lost. From an unemployment rate of 5.2% in March 2020, Victoria’s unemployment rate is projected to reach 11% by September 2020. Reflecting the softening business investment environment, job advertisements in Victoria fell by 36% over the year to March 2020, the greatest annual decline in job ads in 10 years.

Over the year to April 2020, leasing activity across the Melbourne metropolitan office market was relatively subdued with total volume of leases significantly below the 10-year average. Reflecting the focus of the new development, the vast majority of metropolitan office leasing was located in the City Fringe office precinct.

Demand for metropolitan office space is likely to be adversely impacted as a result of COVID-19 in the short term. Given the economic uncertainty globally, leasing decisions for tenants are expected to be put on hold, coupled with some tenant’s experiencing significant financial hardship potentially leading to an overall reduction of tenants.

New Supply

Motivated by the low levels of vacancy of the metropolitan office market in recent years, new supply is forecast to reach 10-year highs in 2020. Urban Property is currently tracking around 220,000sqm of new office space to be completed this year across the Melbourne metropolitan office market. In 2020 to date, more than 40,000sqm of new office stock has been delivered to the metropolitan office market, already surpassing the annual total of 21,800sqm completed in 2019. The bulk of new supply projected to be completed in the metropolitan office market in 2020 is located in the City Fringe precinct. The City Fringe precinct is expected to account for 63% of total new supply in 2020 with 140,000sqm forecast to be completed in the year across 18 developments.

Looking ahead, UPA expects that new supply in the metropolitan office market will peak in 2020 for the medium term with developments requiring significant tenant pre-commitment prior to commencing construction in light of the COVID-19 uncertainty.

Vacancy & Rents

Predominately as a result of the recent completions, the vacancy rate of the Melbourne metropolitan office market has increased to 5.5% as at April 2020, its highest level since 2018. Urban Property forecast that the vacancy rate of the metropolitan office market will continue to rise over 2020 given the significant amount of uncommitted new stock scheduled for completion this year. Reflecting the solid tenant demand and leasing activity in recent years, prime rents have grown over the year to April 2020 in the City Fringe and Inner East sub-markets, whereas prime rents fell over the year in the Outer East and South East sub-regions. Looking ahead, Urban Property Australia forecasts that prime rents will remain steady over the remainder of 2020 however secondary rents will ease due to the continued economic uncertainty and increase in unemployment as a result of the impact of the COVID-19 pandemic.

Prime Office Yields by Market

CBD, St Kilda Road & Southbank Office Markets

It remains too early to realise the impact of COVID-19 on the Melbourne CBD office market with its vacancy having fallen to its second lowest rate on record of 3.2% as at January 2020. The Melbourne CBD office continues to hold the lowest CBD vacancy rate in Australia compared to Sydney (3.9%), Brisbane (12.7%) and Perth (17.6%). Boosted by the low vacancy rates, both prime and secondary CBD office rents have grown by more 10% over the past 12 months for a second consecutive year. Despite the strong rental growth observed over the past two years, as a result of emergence of the pandemic, UPA projects that rents for both prime and secondary CBD office properties will decline over 2020, despite the low vacancy rate. While 97% of all supply scheduled for completion in 2020 is already pre-committed by tenants, the launching of new developments is expected to slow and/or be delayed as current market conditions will extend tenant leasing decisions.

Outside of the CBD, the vacancy rate of the St Kilda Road office market rose to 8.7%, as tenants moved into other office markets in search of prime office space. The prime office vacancy rate of the St Kilda Road office market is 4.1% as at January 2020. Looking ahead, with the Anzac railway station as part of the Metro Tunnel project coming online in 2025, Urban Property Australia expects that tenant demand will remain solid for prime quality office stock along St Kilda Road. Reflecting the shortage of quality accommodation, UPA has recorded solid growth of prime rents in the St Kilda Road office precinct over the past 12 months. The Southbank office precinct also has benefited from civil works, namely the Southbank Boulevard project, which will include five new public spaces, public art spaces and new bike lanes. Office vacancy in the Southbank precinct has fallen 9.7%, the decline marking Southbank’s lowest vacancy level for two years. The vacancy rate of Southbank remains inflated by one building – 12 Riverside Quay which is wholly vacant accounting for 20,000sqm.

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