Our latest commercial real estate update provides a snapshot of the Australian CBD office leasing markets. We base our insights on the latest market data and our experience on the ground.
According to the PCA, the vacancy rate in Sydney's CBD is sitting at 11.5%, slightly up from the 11.3% recorded in Q1. However, we believe this figure could be much higher once you consider subleasing opportunities, backfill spaces and shadow vacancy.
This slower Q-o-Q increase may be attributed to the low supply of new and refurbished stock in the second half of 2023, which has been limited to smaller developments such as 121 Castlereagh Street (11,500 sqm) and 32-36 York Street (8,366 sqm).
Looking ahead to 2024, approximately 357,000 sqm of stock is expected to come online, with notable developments to include:
Though pre-commitment levels look good, movements from major tenants into these assets will increase the amount of backfill space available, adding to vacancy pressure.
Many agencies remain upbeat about the market's recovery. However, we're confident it will stay a tenant's market for the foreseeable future. Here's why:
In February 2023, Sydney CBD's office occupancy rate was 61%. The PCA has since stopped publishing these figures, however some market reports are indicating that this figure now sits at 75%. Opal data also shows that there's been a rise in the number of people travelling to the CBD between 8-9 am on weekdays, increasing from 1,500,000 in April to 1,900,000 in October, which correlates with this figure.
We also know that more companies are pushing for their employees to return to the office five days a week, providing incentives for being on-site or implementing return-to-office mandates with policies around designated in-office days.
Despite this, a significant portion of office-based employees still work remotely, with a LinkedIn survey showing that people work an average of 2-3 days per week from home and approximately 30% of job listings mentioning the option.
For this reason, office occupancy poses an ongoing challenge and we’re seeing many of our clients giving back excess space on expiry to help reduce their leasing costs.
Office values have continued to be a key talking point in Q3, with documented falls across assets and Barrenjoey analysts predicting a further decrease of 20% for ASX-listed landlords. Their prediction is based on high interest rates and the working-from-home trend, both of which have negatively impacted the office sector.
Despite this, face and effective rents continue to increase to counteract surging construction and fit-out costs and artificially maintain property values. However, this rise is offset by high lease incentives (36% and above).
A tangible fall in valuations and transaction prices could cause landlords to reconsider face rents, potentially triggering a long-anticipated reset. However, we cannot see this knock-on effect happening until valuations of commercial properties fall across the board. Coupled with the flight to quality, we expect B and C-grade assets will be the most impacted.
Many tenants are downsizing and signing new leases on significantly shorter terms. In 2019, the average office lease term was 41 months (3.5 years). However, in Q1 2023 they had reportedly dropped to 29 months (2.5 years).
Previously, landlords would prefer to wait for a tenant that they could lock in on a longer lease. However, market conditions are forcing office landlords to offer shorter leases and high incentives to retain or attract tenants and maintain their portfolio values.
Demand for space in the Sydney CBD continues to be driven by Financial (27%) and Professional Services (24%).
Prior to 2022, the tech industry was the biggest driver of leasing demand. However, this has since declined due to staff cutbacks and the remote work trend.
Decreased demand in this sector has not only impacted the Australian office. It has also been felt in other countries. For instance, Meta recently paid approximately $181 million (the equivalent of seven years of rent) to relinquish their office space in Central London to cut costs in light of their ongoing adoption of hybrid work.
As businesses look for ways to attract and retain talent and lure staff back to the office, there's a growing interest in quality fitted spaces that have now become more affordable. This trend has crushed the demand for lower-grade buildings, increasing B-grade vacancy to 12.4%. Though this figure is high, it has stabilised over the last quarter due to the permanent withdrawal of stock (approx. 52,000sqm), which will be used to make way for the Hunter Street Metro Station.
In a bid to maintain property values, gross face rents have continued to increase across all grades Q-o-Q, with Premium rising from $1,690 to $1,700, A-grade from $1,380 to $1,390 and B-grade from $1,100 to $1,130. High incentives averaging between 30-39% offset these increases, with additional savings in the form of early access etc. also on offer.
Effective rents across all grades have also increased off the back of face rent increases and inflationary pressures.
The Sydney CBD has seen an uptick in sublease space, with sublease availability as a percentage of total stock sitting at 2.7% (approx. 139,000 sqm), up from 2.4% in Q2 2023.
One of the key drivers of this increase has been larger tenant. This is particularly true for banking and finance (33%) and tech tenants (19%) who are rethinking their property requirements as they implement more permanent hybrid work arrangements. According to CBRE, hybrid working and contraction are the reasons behind 54% of all subleasing occurrences.
The best deals in the market are subleases, where businesses are offering excess space at heavily discounted rates. The savings are so good that it's starting to impact the traditional landlord market. So much so that we're witnessing a shift in behaviour as more institutional landlords reclaim their properties through solid surrenders, preferring them to sit vacant at market rates rather than be subleased at 50% of the market rate.
Melbourne CBD’s overall vacancy rate remains elevated, increasing from 12.9% in Q3 2022 to 15% in Q3 2023. Q-o-Q vacancy increased across all grades, except for B-Grade, which saw a decline after three buildings were withdrawn for redevelopment.
Approximately 44,000 sqm is expected to come online by the end of 2023, thanks to the 500 Bourke Street refurbishment, of which 70% has been pre-committed.
While some new stock is set to enter the market over the next few years (including 68,000 sqm at Melbourne Quarter Tower 1 in 2024), injections won't match the levels seen across 2020-2022.
Coupled with positive demand for higher-grade assets, many agents claim that this will help fast-track the market's road to recovery. However, we expect vacancy will continue to increase for at least another 2-3 years due to the following factors:
Melbourne-based companies have embraced hybrid work models (even more so than in Sydney), with many larger companies making a permanent shift and downsizing their footprint, including:
These relocations will leave a large amount of backfill space in buildings that will require refurbishment and division to be filled, further contributing to vacancy pressure.
The flight-to-quality trend is particularly pronounced in Melbourne's CBD since it has the country’s lowest return-to-office rate.
Recent market reports have revealed a noticeable shift in demand for premium and A-grade spaces over their B, C, and D-grade counterparts. The divide is also clearly illustrated in the city's overall vacancy rate, which climbed to 15%, with much of the increase concentrated in the secondary market.
We're also finding that businesses are signing on for shorter lease terms, opting for less space at a higher rental rate if the premises will help attract their staff back into the office. So, to remain relevant and profitable, owners of lower-grade buildings will need to explore refurbishing or repurposing their assets.
With so many companies embracing hybrid work models, Melbourne's average office occupancy rates have fallen well below pre-COVID levels, with some market reports showing that it's currently sitting at 56%. That means there's more underutilised space in the market today than there was just a few years ago.
Most of this excess space is unlikely to be sublet for one reason or another. So, many businesses have been left paying for space that they will eventually shed when their leases expire.
Over the past few years, more and more landlords have undertaken speculative fit-outs and building upgrades to make this flight to quality more attractive. However, it's caused a divide between new/refurbished buildings and lower-grade buildings where owners are unwilling to spend the capital upfront.
We're also finding that the construction of spec suites is slowing down as several existing spaces sit vacant, failing to attract tenants. For this reason, we expect the spec suite market to become even more competitive through 2023-24, with 10-20% incentives becoming increasingly available on top of new fit-outs.
Some economists are forecasting the value of Melbourne’s prime CBD office towers could drop by as much as 21.5%. For example, late last year, REST Super tried to sell its Melbourne Docklands office building at 717 Bourke Street for circa $490 million. However, the sale was abandoned when bids started rolling in at 15% below the book value.
In June of this year, Mirvac also hoped to finalise the sale of 367 Collins Street (aka the Optus centre) for a market value of $365 million – a 12% decline in the book value from December 2022. This was Mirvac’s second attempt to offload the tower after the previous year's sale stalled over valuation disagreements. Despite reports of the new marketing campaign gaining interest from buyers, there’s been no further update on the sale of this asset.
A widespread drop in property values will pressure landlords to reduce face rents, which, like Sydney, are currently being artificially propped up by high incentives.
Face rents remain elevated in an attempt to maintain declining property values. However, they're being capped by higher incentives, which have increased year on year, with Premium rising from 38% to 41.5% and A & B grades from 40% to 42% (all as compared to the Net rent, whereas Sydney is compared to the Gross rent).
Effective rents remain stable off the back of the high incentives currently being offered by landlords.
We expect incentives to stay elevated as long as high vacancy rates persist (at least until 2026). However, a decline in property values may mean we eventually see face rents come down again.
In June, Melbourne CBD's sublease availability was reported at 2.2% of total stock. Though these numbers have not yet been updated, we're finding that many larger companies are still looking to sublease their excess space, offering large floorplates and high-quality fit-outs at relatively low rents and on long lease tails. High subleasing availability is expected to remain throughout 2023-24.
According to the PCA, Brisbane's overall CBD vacancy rate decreased from 12.9% to 11.6% in 2023 due to strong demand and limited new supply.
Premium vacancy softened slightly over the last quarter (+0.17%), with some backfill space becoming available. It now sits at 4.4%.
A-grade vacancy remains the highest of all grades. However, the level has dropped since the start of 2023 from 17.9% to 15.8%. Behind professional services, the government is the largest sector driving this demand, with the Queensland Government's search for additional space reported to make up 18% of tenant take-up in 2023. Tenant upgrades from B to A-grade space and withdrawal of stock for refurbishment will further reduce vacancy levels in this grade.
Though B-grade vacancy has remained below 10%, it has increased since Q1 2023 from 9.5% to 9.9%, fuelled by the flight-to-quality trend. Another driving factor is the drop in demand from smaller tenants. Tenants in the sub 250sqm range who could suddenly afford B-grade space in the CBD represented 20+% of leasing activity during 2020-2022 and now make up less than 10% of the total area leased.
Since the completion of 80 Ann Street in 2022, there has been a lack of new construction in the Brisbane market. Over the next three years, less than 100,000 sqm of office space is expected to come online, including:
With limited supply, higher demand from SMEs and A-grade vacancy tightening, there’s potential for an under-supply in premium-quality accommodation. We anticipate that Brisbane’s Premium vacancy will drop to the very low single digits and the overall vacancy rate to fall to under 10% in 2024.
However, from there, an injection of new supply and refurbished space could push the Brisbane CBD vacancy rate back into low double digits until 2027.
Owners eager to activate their B-grade assets increasingly turn to speculative fit-outs, with 17,500 sqm of a total of 20,000 sqm concentrated in the Secondary market.
This has created an oversupply problem. Tenant demand for spec-fit-outs in this grade also remains subdued, which poses a dilemma for B-grade owners who have previously relied on them.
In contrast, repurposed existing fit-outs and 2nd gen spec fit-outs are drumming up more interest amongst cost-conscious B-grade tenants, particularly when accompanied by high incentives.
The war on talent and return-to-office are two big-ticket objectives fuelling the ongoing flight-to-quality. We’re seeing an appetite for higher-grade buildings in good locations with efficient floorplates, quality spec fit-outs and premium amenities. This is eradicating the demand for lower-grade assets that are poorly located or positioned. Coupled with rising construction costs and demand for refurbished fit-outs, many secondary landlords are adopting new strategies to attract tenants and reduce their outlay.
Over the next two years, smaller buildings, such as 41 George Street, 150 Charlotte Street and 140 Elizabeth Street, may be withdrawn for refurbishment or potential redevelopment, placing downward pressure on Brisbane's tightening vacancy rate.
Over the past year, tenant demand has diversified, with increased activity from larger tenants who have finally settled on their long-term real estate plans. However, smaller tenants remain at the core of Brisbane's leasing market, accounting for 31% of leases by location.
Given limited supply and strong demand, Gross Face and Effective Rents have increased Q-o-Q. Significant movement can be seen for Premium and A-Grade assets, where Premium Gross Effective Rent increased from $605 to $635 and $445 to $465, respectively. B-grade effective rent also saw an increase from $370 to $380.
Though incentives remain elevated to encourage tenant relocations, they have seen slight decreases Q-o-Q, now sitting between 39-45%, depending on the grade and location.
Where incentives have seen even more of a decrease, however, is in spaces with existing fit-outs. This is due to tenants using their incentive to discount their rent instead of constructing a new fit-out. Over the next decade, we anticipate that rents will increase while incentives will decrease as Brisbane reaps the benefits of interstate migration and the Olympics.
Sublease space in Brisbane remains the lowest in the country. This is due to strong leasing activity and the city's limited exposure to financial and tech companies, the main drivers of subleasing nationwide.
However, over the last year, the amount of sublease space in Brisbane has ticked up by +28,821sqm, with 324 Queen Street contributing 3,769sqm, 545 Queen Street 2,020sqm and 111 Eagle Street contributing 2,968qm.
The reason behind this trend is not immediately apparent. However, we will continue monitoring reports to gain a better understanding of the underlying causes.
It’s a tenant’s market and will be for the foreseeable future. Landlords are competing to secure quality occupants on long leases and are more flexible than they have been in years. Opportunistic tenants are taking advantage of favourable market conditions by renegotiating terms in their existing space or relocating to a better building.
To secure the best terms, tenants need only find the soft spots in the market and develop their strategy around landlord motivators.
But the landscape is challenging to navigate alone. Even in a favourable market, there's more to negotiate, and tenants need access to the whole market to get the best deal.
Tenant CS is an independent tenant advisory firm that exclusively represents tenants in commercial negotiations to secure favourable lease terms and savings. We cater to companies across Australia, Singapore and the greater Asia-Pacific region and have offices at the heart of the Sydney CBD, Melbourne and Singapore.
Book a discovery call to find out how we can help you with your next lease negotiation or relocation project.