• With investors remaining uncertain on the sector, across Melbourne’s office markets there have only been six major sales totalling $139 million in the first half of 2023, the lowest half-year result in 10 years;
• Urban Property is projecting 250,000sqm of new office projects to be completed in the metropolitan office market in 2023 and 2024 with much of the focus of the new development in the City Fringe;
• The total Melbourne CBD office vacancy has continued to rise, increasing to 13.8%, its highest level since January 1999.

Office Market Summary

With investors remaining uncertain on the sector, across Melbourne’s metropolitan office market there have only been three major sales in the Melbourne metropolitan office market totalling $83 million in the first half of 2023, the lowest half-year result in 10 years. In comparison to last year, the volume of sales across the Melbourne metropolitan office market totalled almost $1.0 billion in the first half of 2022. The lack of transactions and stubborn low occupancy levels continue to place downward pressure on values of office properties with falls of 15% to be expected to be realised through 2023.

Sales Volume / Yields

With investors remaining uncertain on the sector, across Melbourne’s metropolitan office market there have only been three major sales in the Melbourne metropolitan office market totalling $83 million in the first half of 2023, the lowest half-year result in 10 years. In comparison to last year, the volume of sales across the Melbourne metropolitan office market totalled almost $1.0 billion in the first half of 2022. While sales activity for the past nine consecutive years has surpassed $500 million, investment activity in coming years may be more constrained, adversely impacted by increased funding costs and soft tenant demand for space. Given the increased uncertainty, prime metropolitan office yields have continued to ease and now average 7.0% with secondary yields averaging 8.0%. While Urban Property expects investor interest for prime assets with solid income profiles to remain robust, the yield spread between secondary assets is likely to continue to widen as investors become more discerning.

Melbourne Office Investment Activity

Supply

Urban Property is projecting 250,000sqm of new office projects to be completed in the metropolitan office market in 2023 and 2024. Of all the total stock currently under construction in the metropolitan office market, 67% is already committed. Much of the focus of the new development remains focused on the City Fringe with the precinct accounting for 60% of all new metropolitan office stock projected to be completed in 2023 and 2024. With tenant demand strengthening and the level of new supply peaking in the Melbourne metropolitan office market in the short term, Urban Property projects that the vacancy rate has peaked and will trend down as tenants capitalise on the attractive leasing terms on offer to upgrade their office accommodation. Although the vacancy rate is anticipated to have peaked, with vacancy levels still elevated; looking ahead, the development pipeline is forecast to ease as funding requirements for new projects will constrain new supply for the medium term.

Tenant Demand

Over the past year, Victoria’s total employment has increased by 123,000 which has resulted in the state’s unemployment rate falling to 3.7% as at March 2023, down from 4.6% as at June 2021. Highlighting the growing business investment environment, as at June 2023, there were 71,700 jobs being advertised compared with the 10-year average of 46,500. Mirroring the employment growth, tenant enquiries and leasing activity continues to improve. While employment growth has been solid over the past year, office occupancy levels remain significantly below pre-COVID levels, albeit pleasingly levels have also recovered in the past six months. Latest office occupancy levels in Melbourne have risen to 47% compared with 15% a year earlier. While tenant demand has been positive over the past 12 months, take up of stock remains subdued with occupiers focused on A-grade space.

Annual Victorian Employment Growth

Vacancy / Rents

While the level of tenant demand improved, it was surpassed by the level of new completions and as such the vacancy rate of the Melbourne metropolitan office market rose slightly, increasing to 12.5% as at June 2023, still almost double the long-term average. Urban Property forecast that the vacancy rate of the metropolitan office market has peaked for the short term as the pipeline of new supply reduces in coming years. Reflecting the stabilising vacancy levels and improving leasing activity across the Melbourne metropolitan office market, prime rents continue to rise with both growth in net face rental levels while incentive levels stabilise. Looking ahead, Urban Property Australia forecasts that prime rents will continue to rise as tenant demand gathers momentum. In contrast, secondary office rents are projected to decline even more as occupiers seek to capitalise on better quality space which is highlighted from the recent trend of tenant moves.

CBD, St Kilda Road & Southbank Office Markets

The total Melbourne CBD office vacancy has continued to rise, increasing to 13.8% as at January 2023, its highest level since January 1999. Interestingly, having reached a 28-year high, sub-lease vacancy levels appear to have peaked in the short term, falling from 2.6% in July 2022 to 1.9% as at January 2023. Although tenant demand in the CBD office market over the six months to January 2023 was negative, the result was driven by tenants vacating secondary stock at the expense of prime grade office space. While rental incentives appear to have stabilised, prime office space recorded some marginal growth of face rents, resulting in a slight increase in net effective rents over the year. After recording all-time high transactional activity in the Melbourne CBD office market last year, only three transactions above $10 million have been recorded in the first half of 2023, Melbourne CBD’s slowest half-year of transactional activity in a decade. Urban Property Australia forecasts that prime CBD office net effective rents will remain stable in 2023 as occupancy levels struggle to rise.

Outside of the CBD, the vacancy rate of the Southbank office market fell to 14.6% as at January 2023, above its 10-year average. While the vacancy rate of the St Kilda Road office market rose to 21.6% as at January 2023, an all-time high. Although the vacancy rates of both the St Kilda Road and Southbank’s office markets are elevated; Urban Property Australia anticipates the addition the Anzac railway station in 2025 and the rejuvenation project of Southbank Boulevard will stimulate tenant demand for both markets in the medium term. Similar to Melbourne’s other office markets, transactional activity remains subdued in both Southbank and St Kilda Road office markets with no assets transacted in the first half of 2023.

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