BIS Shrapnel observes that the drop in Melbourne CBD office vacancy rate is not indicative of the market being in recovery mode yet.

Melbourne’s CBD office vacancy rate fell from 9.8% mid-year to 8.7% in December 2013, which many saw as a sure sign that the market was on the road to recovery after a challenging couple of years.

BIS Shrapnel’s just-released Melbourne Commercial Property Prospects 2014 to 2024 report disputes this, saying that market recovery is still at least 18 months away.

Maria Lee, Senior Project Manager and report author explained that the reduction in vacancy rate in December 2013 was due to an unusually high level of withdrawal from stock. Had it not been for those withdrawals, the vacancy rate would have increased because net absorption was very weak.

According to Lee, the market will have trouble absorbing the quantum of floorspace due for completion this year and next. That said, due to the lumpy nature of completions it’s quite possible that the vacancy rate will fall temporarily in June 2014.

BIS Shrapnel expects net absorption to remain fairly moderate in the near term, though it should pick up from the 10-year low recorded in calendar 2013. Lee explains that the key reason is a sustained soft patch in the Victoria economy where residential building activity is falling, non-residential building is subdued, cuts in government investment are a drag on growth, and the high Australian dollar over the past few years has hit the state’s key trade-exposed industries, namely agriculture, manufacturing, finance and business services, international student education, and tourism.

BIS Shrapnel’s report sets out several reasons why the weakness in the Victorian economy is likely to continue for at least the next year before stronger fundamentals begin to reassert themselves. These include: Total building activity is likely to be soft for some time, dragged down by the residential sector despite the inner city apartment boom underway; New public investment is expected to continue to trend downwards over the near-term as the state government attempts to consolidate the budget; Engineering construction work done has further to fall due to the lack of major projects (apart from East West Link); and the A$ is not yet weak enough to significantly boost the competitiveness of the state’s trade exposed sectors.

Overall, BIS Shrapnel anticipates that Victoria’s pace of economic growth will underperform against the national average for a few more years. For landlords and tenants, that means leasing incentives are likely to remain high for some time yet, continuing to affect owners but affording tenants a great opportunity to lock in low rents and/or upgrade to better quality accommodation.

On the upside, Lee notes the economy is fundamentally strong with key drivers that underpinned the strength of the Victorian economy last decade still in place. Consequently, the report forecasts a strong rebound in Melbourne’s office market in the second half of this decade.