The Sun Shines On Office
UBS | Aug 04, 2017 14:32
Originally published by UBS Asset Management
This week saw the bi-annual release of the Property Council of Australia Office Market Report, which reviews the supply and demand dynamics of around 5,300 office buildings in 25 office markets. The country's economic fortunes are mirrored in the data, with NSW and Victoria benefitting from positive business confidence and jobs growth, while Perth and Brisbane are relatively weak but seem to have turned the corner. I worked on these reports in the early 1990's and can assure you there's much rigour to produce what seems a simple set of numbers.
The key number that we tend to focus upon is the vacancy rate, which is simply the proportion of vacant space in a building or market (or space with no rent collected). If it's 10% then it means 1 floor out of 10 is empty. The theory is that the lower the vacancy rate, the more pressure on rents to rise and vice-versa. So if a vacancy rate is at 5% (Sydney) then rental growth will be strong with landlords having pricing power and if it's high like Perth (20%) then rents should be falling as tenants have the power.
The good news is that in the past six months there's been positive demand for all CBD markets except Brisbane, and while Perth and Adelaide have relatively high vacancy rates, they appear to be improving. As the chart below shows, Sydney and Melbourne are the two tightest CBD markets.
Sydney has benefitted immensely from the new metro line that has seen office buildings resumed and tenants displaced, and rents in the past year have risen by an estimated 30% (net effective). With little supply expected in the next couple of years, rents are expected to rise even further. This has led to some decentralisation, with many of the suburban markets tightening. Parramatta has reported strong demand with Government and professional services competing for space, as evidenced by Western Sydney University's new HQ and Water NSW relocating from Penrith.
Melbourne is also strong, with the chart below (produced by Dexus) showing Victoria recorded the best jobs growth of any state. Rents there have risen by an estimated 20% in the past year and like Sydney, there's limited new supply expected so conditions should stay positive.
Given Federal Government budget constraints, demand in Canberra has been lackluster albeit quality space is keenly sought and has seen moderate rental growth in prime assets. Conditions in the Brisbane office market weakened in the first six months of the year, due to the loss of state and federal government tenants. Not helping the situation is the ~50,000m2 of new space expected in 2019 via the speculatively developed 300 George Street tower. The good news for REITs with quality properties is that declining rents tend to attract tenants from the suburbs and from lower quality buildings in a "flight to quality". Perth's severe office market downturn looks to have troughed but it will take some time for the market to recover. The reporting period marks the first time in nearly five years that rents have not dropped. Adelaide CBD is challenged with supply outpacing demand from firms associated with the $50bn naval contract (submarines).
In terms of REIT exposures, most are focused on the Sydney and Melbourne markets, with pure office sector REITs like Investa Office Fund (AX:IOF) and Dexus Property Group (AX:DXS) offering the best exposure. Diversfied REITs like Mirvac Group (AX:MGR) and GPT Group (AX:GPT) also have sizeable office assets with their earnings mix impacted by their respective residential and retail exposures. Growthpoint Properties Australia (AX:GOZ), Australian Unity Office Fund (AX:AOF) and Centuria Metropolitan REIT (AX:CMA) offer exposure to the suburban office markets. In the PSF Fund we are overweight Investa Office and Mirvac.
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