Investa Inside Office Market Outlook - March 2019 - Investa Property Group
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Investa Inside
Office Market Outlook
March 2019
Australian Office Market Outlook In Three Charts
Chart A1: White Collar Productivity vs Other Industries Strong employment vs weak economic activity
Highlighted by the RBA as the ‘economic puzzle’,
Australia’s employment growth remains robust in contrast
to slowing economic activity. In 2018, the Australian
economy expanded by a modest 2.3% while adding a
robust 268,000 jobs, with 60% of these in white collar
industries. Despite the strong growth in white collar
employment over this period, economic output and labour
productivity from the white-collar sector has
outperformed. In comparison to other sectors, which have
produced 6.5% less output per employee over the past two
years, white collar labour productivity has only recently
Source: ABS & Investa Research declined by a negligible 0.45% in 2018.
Chart A2: Office Market Vacancy Rate Forecasts Leasing market conditions to converge
Tighter major capital city leasing markets have
reflected the combined impact of positive underlying
demand coupled with constrained supply. Office leasing
markets in Sydney and Melbourne CBD have continued to
perform strongly, as vacancy tightened to new
cyclical lows at the end of 2018. Coming off a higher base,
other capital city office markets also experienced tighter
office leasing conditions. Looking ahead, Australia’s CBD
office supply will increase strongly in the coming years
with Melbourne to bear the majority of this development.
We expect Melbourne’s CBD office vacancy to gradually
unwind over the next five years. In comparison, vacancy
Source: Property Council & Investa Research (forecasts)
in Sydney’s CBD office market is expected to remain in a
tight band.
Chart A3: Office Capitalisation Rates & US Yield Curve Capital markets to remain strong, but nuanced
Capital transaction activity remained strong across
Australia’s CBD office markets through the year with prime
office cap rates tightening to new all-time lows towards
the end of 2018. A-REITs and domestic wholesale funds
have been the dominant buyers in recent CBD office
capital transactions. However, foreign-sourced capital and
global financial market dynamics remain critical to the
outlook for Australian office capital markets. In particular,
the outlook for the US economy provides an important
indicator to the direction of Australian office cap rates.
Source: Federal Reserve, Property Council-MSCI & Investa Research Looking beyond the impact of global cyclical factors,
we expect Australian office cap rates will follow a more
market-specific defined path in the coming years with
Sydney, Melbourne, Brisbane and Perth cap rates reflecting
different market dynamics.
Investa Inside | March 2019 1.
Economic Outlook While business confidence and conditions have eased,
the underlying factors driving absorption of office space
in the major capital cities remain firmly in play. Population
Business services outperform
growth continues to run at a solid pace, supporting the
In line with an easing in economic activity and business significant infrastructure development pipeline and the
conditions at the end of 2018, the 2019 outlook for the associated demand for business services. Meanwhile,
Australian economy has softened. GDP growth has slowed the long-term structural shift to a ‘knowledge economy’ in
to 2.3%, with the main sources of weakness being related Australia remains supportive of continued investment and
to the household sector. In contrast, government growth across the business services sector.
expenditure and non-mining business investment have
provided a positive source of growth, both of which are Despite the strong growth in white collar employment over
important indicators for the pipeline of demand for office the past year and a half, economic output and labour
space in Australia’s major capital cities. productivity from the white-collar sector has
outperformed. In comparison to other sectors, which have
Highlighted by the RBA as the ‘economic puzzle’, produced 6.5% less output per employee over the past two
Australia’s employment growth remains robust in contrast years, white collar labour productivity has only recently
to slowing economic activity. The unemployment rate sits declined by a negligible 0.45% in 2018. (Chart 3).
at just 4.9%, with the Australian economy adding 268,000
jobs in 2018 – 60% of these in white collar industries Chart 3: White Collar Productivity vs Other Industries
(Chart 1). Looking ahead, we think the sharp gains in white
collar employment in 2018, largely reflecting a rebound in
government jobs, will revert to more moderate growth in
2019 (Chart 2).
Chart 1: White Collar vs Other Employment
Source: ABS & Investa Research
Economic risks building
A number of economic headwinds have gathered
momentum recently and we remain watchful of key
Source: ABS & Investa Research economic risks. Global trade policy and financial market
volatility continue to present potential downside to
Australia’s business sector. On the domestic front we see
Chart 2: White Collar Industry Employment
the main economic risks are related to the decline in
Australian residential property prices and the fallout from
this on household sector finance.
Recent attention has focused on the impact of the Hayne
Royal Commission to the business structure of
financial services. We think this factor in isolation will have
a moderate net positive impact on the office footprint of
the finance sector, particularly with increased demand
for risk and compliance functions within the banking and
finance sectors.
Source: ABS & Investa Research
Investa Inside | March 2019 2.
However, we see the greatest prevalent risk to financial
services demand for office space in Australia is the Chart 5: Office Market Vacancy Rate Forecasts
potential for further slowing in demand for credit,
particularly mortgage/housing credit.
Falling residential property prices, a sharp contraction in
housing construction and weak mortgage approvals in
combination have driven housing credit growth towards
all-time lows. This has yet to have any material impact on
finance sector office absorption levels. However, any
further significant slowing in housing credit growth could
add pressure on finance sector operating costs, including
their office footprint and rent, and drive finance sector
absorption lower (Chart 4).
Sources: Property Council & Investa Research (forecasts)
Reflecting the increased downside risks facing the Tighter major capital city leasing markets have reflected
Australian economy, combined with persistently weak the combined impact of positive underlying demand
inflation, market pricing of the RBA cash rate has shifted coupled with constrained supply. While the negative
to a moderately dovish view of monetary policy. While the weight on office stock of withdrawals for infrastructure
consensus view of the RBA cash rate remains unchanged development and office redevelopment has finally eased,
at 1.50% into 2020, some analysts have factored in 50bps new office completions in 2018 remained soft. A modest
of RBA rate cuts in 2019. 451,000 sqm of new office space completed across
Australia in 2018, 30% below the annual average over the
Chart 4: Credit Growth & Finance Sector Office Demand past 20 years.
Looking ahead, we expect office supply to increase
strongly in the coming years. The current development
pipeline is expected to deliver 2.3 million sqm of new office
space across Australia’s CBD markets by 2024 (Chart 6).
Chart 6: Australian CBD New Office Supply Forecasts
Source: RBA & Investa Research
Office Market Outlook
Leasing market conditions to converge
Office leasing markets in Sydney and Melbourne CBD
have continued to perform strongly, as vacancy tightened
to new cyclical lows at the end of 2018. While coming
Source: PCA & Investa Research
off a higher base, other capital city office markets also
experienced tighter office leasing conditions with vacancy
Major capitals to face supply challenge
across all other CBD office markets (excluding Sydney and
Melbourne) 2.8ppts lower in 2018. Over the year Brisbane
recorded the strongest contraction in vacancy across Accounting for 25% of Australia’s CBD office space,
Australia’s CBD office markets, driving 3.2ppts lower to Melbourne’s CBD will deliver almost 50% of the
reach its lowest vacancy rate (13.0%) since 2013. Australian CBD office development pipeline in the coming
Investa Inside | March 2019 3.
three years. Nonetheless, the outlook for Melbourne CBD competition to attract tenants to new office developments
office demand remains positive. Net absorption of office and the backfill space through the approaching upturn in
stock is expected to increase by an average of 90,000 sqm office supply will be the main factor driving this outlook.
per year over the next five years, driven by solid economic
growth, a diversified tenant base, strong population growth Consequently, a reversion in face rent growth combined
and relatively affordable office rents. With approximately with the negative impact of higher incentives, will dampen
80% of projects under construction already pre-committed, effective rent growth in Sydney and Melbourne compared
and considerable demand for the backfill space of to the strong gains in recent years (Chart 7).
upgrading tenants, we expect Melbourne’s CBD office
vacancy to gradually unwind over the next five years to a Chart 7: Prime Office Gross Effective Rent Forecasts
peak of 8.0-8.5%.
Sydney’s supply outlook is also positive (300,000 sqm
– 23% of the Australian CBD pipeline over the next three
years), albeit more orderly in comparison to Melbourne’s.
Only four new major office developments are expected to
complete over the next four years, starting with Investa’s
60 Martin Place to be completed in Q4 2019. Beyond this,
2023 provides the largest single year injection of new
office supply since Towers 1 and 3 completed at
Barangaroo in 2016, across four major projects including
Macquarie’s Metro Towers over station development.
Nonetheless, positive underlying demand for Sydney CBD
office space is expected to maintain vacancy in a tight 3.5-
5.5% band over the coming five years.
Across the other major CBD office markets the
development pipeline is more subdued, with only 165,000
sqm under construction across all other CBD markets
(80% of this is in Brisbane). Combined with both a positive
economic outlook and increasing absorption of vacant
office space, a soft supply outlook will support further
tightening in these office leasing markets. In particular, we Sources: JLL Research & Investa Research (forecasts)
expect the CBD office vacancy rate in Brisbane and Perth
to decrease by 2ppts and 5ppts respectively to 2024. In contrast to Sydney and Melbourne, prime office rents in
both Brisbane and Perth CBD markets have some
Rental reversion to reflect leasing market cycle ample headroom and will face increasing upward pressure
through the upturn in office leasing market conditions.
Tight leasing market conditions have supported strong Following the soft market conditions in both Brisbane and
growth in both Sydney and Melbourne CBD face rents in Perth of recent years, face rents are already rebounding
recent years. However, despite continued tight leasing while incentives are under downward pressure on tighter
market conditions across both of these major capital city vacancy. In particular, the combination of lower vacancy
markets and continued increases in rents to new all-time and a subdued development pipeline in both of these
highs, more moderate face rent gains and stable markets will drive prime office market effective rental
incentives have slowed effective rent growth (allowing for growth above long-run average (Chart 7).
rent-free incentives).
Cap rates to follow nuanced path
We expect market conditions will remain tight in both
Sydney and Melbourne CBD in the coming years, Despite some easing in the Australian economic outlook
supporting further (albeit more moderate) growth in face combined with both higher global interest rates and lower
rents through this period. However, we think incentives global fiscal stimulus, capital transactions in Australian
– having remained stubbornly entrenched at historically CBD office markets remained elevated through 2018. The
elevated levels despite strong leasing market conditions – strength of transactions has been reflected in further
have reached a low point in the cycle and will move tightening in prime office cap rates towards the end of
moderately higher in the coming years. Increased 2018.
Investa Inside | March 2019 4.
Chart 8: Office Capitalisation Rates & US Yield Curve
Sources: Federal Reserve, Property Council-MSCI & Investa Research
A-REITs and domestic wholesale funds have been the
dominant buyers in recent CBD office capital transactions.
However, foreign-sourced capital and global financial
market dynamics remain critical to the outlook for
Australian office capital markets. In particular, the outlook
for the US economy provides an important indicator to the
direction of Australian office cap rates (Chart 8).
While cyclical factors remain broadly supportive of
ongoing Australian office capital market strength, solid
foreign demand for Australian office assets continues to
reflect an underlying appetite to diversify portfolio
allocations to the Australian office market. In addition, a
low and stable AUD is expected to provide further support
to foreign capital inflows.
Nonetheless, we expect Australian office cap rates will
follow a more market-specific defined path in the
coming cycle. While we see all major office markets have
hit the low-point in the cap rate compression cycle, Sydney,
Brisbane and Perth’s prime office market are likely to
remain around current cap rate levels until mid-2020
before moderately easing. In comparison, Melbourne’s
surge in new office completions is expected to trigger an
easing in Melbourne prime office cap rates through the
second half of 2019.
Beyond 2020, we expect yield-seeking investors will see
value in total returns in the strengthening Brisbane and
Perth CBD markets. Consequently, we see the current
spread between prime CBD cap rates in Brisbane and
Perth to the Sydney benchmark (currently 70bps and
150bps respectively) to tighten over the coming 5 years.
Investa Inside | March 2019 5.Further information About Investa Research About Investa
Investa Research focuses on understanding Investa is a leading Australian real estate
the drivers and analysing the movements and company managing more than A$11 billion of
trends within the Australian commercial office quality office real estate. As a specialist office
market. The research function is fundamental manager of commercial office buildings Investa
in guiding group investment strategy and manages more than 37 assets in the key Aus-
decision making, as well as providing a tralian CBD markets on behalf of ICPF, Oxford
competitive advantage through insightful Investa Property Partners (OIPP) and private
analyses and forecasting. mandates. Its end-to-end real estate platform
incorporates funds, asset, property and
The research team publishes regular updates facilities management, development,
David Cannington sustainability, capital transactions and
on the performance of the major Australian
Head of Research & Strategy research.
office markets, as well as occasional papers
T +61 3 8600 9209
and reports examining a broader scope of
dcannington@investa.com.au Investa strives to create Australia’s most valued
topics that may be of interest to investors and
other Investa stakeholders. working places be the first choice in Australian
office, by delivering consistent outperformance
for its investors and exceeding the expectations
of its tenants and staff, while remaining an
industry leader in sustainable building
management and responsible property
investment.
Rose Cooper
Senior Research Analyst
T +61 2 8226 9921
rcooper@investa.com.au
The information contained in this Report is intended to provide general information only. While every effort is made to provide accurate and complete information, Investa does not warrant or
represent that the information in this Report is free from errors or omissions.
You should be aware that any forecasts or other forward looking statements contained in this Report may involve significant elements of subjective judgment and assumptions as to future
events which may or may not be correct. There may be differences between forecast, projected and actual results because events or actual circumstances frequently do not occur as forecast or
projected and that these differences may be material.
No person, including Investa or any related entity or any of its employees, accepts any responsibility for any loss or damage however so occurring resulting from the use or reliance on the
information contained in this Report.
This Report has been prepared by Investa without taking into account of your objectives, financial situation or needs. You should consider the appropriateness of its contents having regard to
your own objectives, financial situation and needs before making any investment decision. Past performance is not a reliable indicator of future performance and no guarantee of future returns is
implied or given. You should rely on your own judgment before making any investment decision.
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