The new BIS Shrapnel Melbourne Commercial Property 2013-2023 report reveals sustained weakness in the Melbourne office market.

According to the report, the situation is set to get worse before it gets better. Since market participants may not be prepared, there is a risk of market ‘panic’ as the reality hits home.

Rising vacancy rates in Melbourne’s office market are pushing up leasing incentives and causing effective rents to retreat. Market participants who expect conditions to bounce back next year may need to wait longer, says BIS Shrapnel since the situation caused by weakness in the Victorian economy on several fronts, is more serious. Declining dwelling building activity, severe cuts to public sector investment, and the high Australian dollar, which is taking its toll on manufacturing and some service industries are all impacting factors, explains Maria Lee, Senior Project Manager and report author.

Vacancy rates are set to hit around 10% by the end of 2013 and remain elevated for another year or so, requiring landlords to preserve cash flows. Leasing incentives are expected to rise further, to an average of 34 months’ rent free equivalent in the prime market. On the other side, conditions are favourable to tenants.

BIS Shrapnel’s report highlights the risk of even higher leasing incentives being introduced if market participants react in a similar way to the early 2000s. Lee recalls that the market panicked after the negative net absorption of 2002 and early 2003, when vacancy rates hit around 10% and prime net effective rents fell by 30%. Market reaction this time around has been more measured to date.

Existing investors and those entering the market now need to be prepared for a sustained period of challenging conditions and plan their leasing strategies accordingly. The BIS Shrapnel report forecasts a strong rebound in the second half of this decade.