New research from Knight Frank indicates that the Melbourne CBD hit a total of $2 billion in office sales in 2021.

The data, released in the agency’s Melbourne CBD Office Market Report, outlines Victoria is undergoing a strong post pandemic recovery, with retail sales increasing 16 percent in the wake of COVID-19 restriction alterations in late 2021. 

It is predicted Melbourne will grow at a higher rate economically in the next few years, with a 4.5 percent rise in employment in the three months to January 2022 in comparison to the national average of 3.5 percent.

Improved economic conditions have seen the demand for office space increase, with total net absorption rising by 45,560 sqm in the second half of 2021. Knight Frank has recorded Melbourne’s office take-up sits at 92 percent. Demand for the prime market is high, with net absorption rising by 51,253 sqm and 3,501 sqm in the A grade and premium segments respectively. Despite this demand, higher supply has seen the Melbourne CBD’s office vacancy rate rise from 10.4 percent in July 2021 to 11.9 percent in January 2022.

“The Melbourne CBD vacancy rate is anticipated to peak at 12.4 percent in the middle of the year, before gradually declining to around 9 percent over the next few years,” says Chris Naughtin, Knight Frank Australia’s Director of Research & Consulting. 

“The increase in prime vacancy during 2021 was driven by the high level of new supply, with development completions bringing the Melbourne CBD total office stock to just over 5 million sqm. Following the large influx in 2020 and 2021, new supplies are projected to slow significantly over the next few years, and we expect this lower level of new supply combined with stronger demand for office space will drive the recovery of the leasing market.

“Another trend we’re seeing is a higher concentration of smaller and medium-size leasing deals with office space of less than 5,000 sqm accounting for a higher share of CBD office-take up; 52 percent of takeup in 2021 compared with 30 percent in the previous two years. On the other hand, activity in larger deal bands remains subdued with deals larger than 5,000 sqm falling from 70 percent in 2020 to 48 percent in 2021.”

The market report shows that prime net face rents have remained unchanged over the past two years, averaging $708/sqm in the CBD as of January 2022. Average prime incentives continue to rise, averaging 38 percent in January and are expected to decline in 2023. Lower incentives will drive a rebound in effective rental growth, with prime net effective rents expected to rise by 3.6 percent per annum from 2022 to 2026.

“The recovery in effective rents will be led by the Eastern Core, where incentives are expected to begin a sustained decline from their current average of 35 percent from this year onwards,” says Naughtin. 

“By contrast, we expect average incentives in the Western Core to rise a little further from 40 percent at the end of last year to 41 percent at the end of this year and remain around 40 percent in 2023. By the end of 2026, we expect prime incentives to average 28 percent and 35 percent in the Eastern Core and Western Core respectively. Prime net effective rental growth is forecast to be 4.9 percent p.a. in the Eastern Core compared to 2.8 percent p.a. for the Western Core.”

Despite Melbourne’s office sales totalling $2 billion, activity is still below pre-pandemic levels with investment volume 33 percent below the average over the five years to 2019. Offshore investors continue to drive activity, accounting for 68 percent of investment volume in 2021, proving income-producing office assets are clearly still firmly on the radar for investors. South Korea, Singapore, Germany, and the US are the greatest sources of capital inflow into the Melbourne CBD over 2020-21.