In spite of office occupancy levels being at all time lows in the wake of lockdowns and restrictions, a report by Knight Frank Australia shows that despite the adversities brought by the pandemic and subsequent economic uncertainty, demand for prime office assets has grown Australia-wide.
The Knight Frank Australia research shows that prime office yields have compressed over the past 12 months across all major office markets in the country despite higher vacancy rates. Compression has been strongest in the smaller markets of Canberra and Adelaide, with both markets recording a yield compression of 50 and 80 basis points respectively, in comparison to the 10 basis points seen in both the Sydney and Melbourne markets. The changes in the market reflect strong pricing and robust investor demand for prime offices, with CBD office values returning to growth in the first half of the year in spite of higher vacancy rates.
The country’s economic recovery, which was faster than expected, boosted sentiment in office markets in the first half of the year. While lockdowns will drive a slowdown in leasing activity in the second half of the year, the end of lockdown in the coming months and a staged return to offices has reassured investors and will support pricing. $9.8 billion worth of office property has been traded in the year to date, with that number expected to climb to approximately $15 billion by the end of 2021 — nearly $4 billion higher than the 2020 total of $11.4 billion.
In Sydney, leasing volumes are 125 percent above the same time in 2020, reflecting the strong economic gains made in 2021 rebounding on office leasing activity. While there has been a shortage of office space in the harbour city over the past few years, this is no longer the case, with the supply of offices at its highest level since the completion of International Towers. In the six months to July 2021, office completions totalled 104,721sqm, taking the total office stock base to 5,140,548sqm. New supply was led by the completion of the Make Architects and Architectus-designed Brookfield Place, which has achieved near full occupancy.
$2.3 billion in transactions has been recorded in Sydney over the year to August 2021, already above the comparable volume of $900 million at the same time in 2020. Prime yields are holding firm between 4.25 and 4.75 percent after sustained compression prior to the pandemic. An additional 180,000sqm of office space is under construction, which will reach completion by the end of 2022.
Heading south to Melbourne, Knight Frank have found that CBD office vacancy continues to increase, rising from 8.4 percent in January 2021 to 10.4 percent in July 2021. Prior to the pandemic hitting Australian shores, vacancy sat at 3.2 percent in January 2020. Sub-lease vacancies have almost doubled over the past six months in the garden city, which is the highest recorded for the CBD office market since 1994.
While the market currently looks bleak in Melbourne with sales volume down in the first half of 2021 compared to last year, offshore demand remains strong and pent up demand signals the market will bounce back in the coming months. Demand in Melbourne’s office market is led by demand for sub-500sqm spaces, possibly evidencing the move to more flexible, agile working spaces post-pandemic. The number of sub-500sqm deals in H1 2021 had almost surpassed the total number recorded in 2020, and the average size of new leases in H12021 was 1,978sqm, noticeably below the average level of 3,312sqm in 2020. Melbourne’s office yields remain low, with yields for prime assets currently sitting between 4.35 percent and 4.85 percent.
Knight Frank Australia Chief Economist, Ben Burston, says he expects the office market to bounce back significantly in the back half of 2021 and throughout 2022.
“The return to yield compression in prime office markets is revealing in that it comes in spite of higher vacancy and continued movement restrictions. It speaks to the strength of the impact of lower interest rates and to the weight of investor demand, particularly from offshore capital, seeking to allocate into the Australian market.
“The fact that yields have compressed more in Adelaide and Canberra also indicates that investors are pricing across markets is shifting to a more equal footing. Prior to the pandemic, the stronger rental growth performance of Sydney and Melbourne was commanding a substantial premium in terms of lower yields. However, with the near-term rental outlook now more subdued there is less of a difference between the prospects of different cities and this is being reflected in office yields.
“Notwithstanding higher vacancy rates, clearly investors are optimistic about prospects for the office market beyond the pandemic. We expect that the current momentum will carry forward into 2022 with office yields likely to maintain a downward trajectory aided by economic recovery and the release of pent up demand in leasing markets.”
To read Knight Frank’s report in full, click here.