Power to the tenant: Abundance of capital seeking investment in commercial property creating options for corporate occupiers beyond supply and demand fundamentals
The weight of capital seeking investment in Australia's commercial property market is creating its own dynamic and creating more opportunities for corporate occupiers in the current market than has been seen in recent times.
The findings are detailed in 'The Wrap', the latest Corporate Solutions report from global commercial property firm JLL, which explores the implications of this wall of money on tenant movements and highlights the best opportunities for corporate occupiers over the next 12 – 24 months.
JLL's Head of Integrated Portfolio Services for Australia, Tony Wyllie, said, "Business cycles and property cycles have never really run in parallel, with property traditionally lagging the economy into a downturn and following behind in any upswing. This places corporates at the mercy of supply and demand movements for accommodation opportunities that do not reflect the corporate cycle.
"However in the current market there is an abundance of capital seeking investment in the commercial property markets nationally. This weight of money is creating its own dynamic, which is also providing an alternate avenue for accommodation strategy for tenants beyond basic supply and demand.
"As this capital competes to find a home it is allowing developers to commence new development if they can secure pre commitments. This means there are opportunities for tenants to take advantage of the current conditions and upgrade their real estate to the new space, creating a workplace experience that will resonate with their people and their brand. At the same time this capital is often off-shore and is satisfied with a lower yield, which translates into a more competitive deal for the occupier. This is a unique situation where an occupier can secure new, purpose built premises at a market competitive rate in a market where multiple choices already exist."
Examples of tenants moving into new office spaces:
LinkedIn's new offices in 1 Martin Place.
DropBox moving to 5 Martin Place.
IAG leasing the space being vacated by Price Waterhouse Coopers at Darling Park.
Suncorp's commitment to 10 Shelley Street vacated by KPMG.
Examples of tenants pre-committing to new developments:
Mirvac and Ernst and Young to 200 George Street.
Lend Lease, Westpac and KPMG to Barangaroo South.
Pitcher Partners to 664 Collins Street.
KPMG and Maddocks moving to Collins Square.
AGL to 699 Bourke Street.
Corrs Chambers Westgarth and Leighton to 567 Collins Street.
JLL's Head of Tenant Representation – NSW and ACT, Gavin Martin said, "The choice tenants have in the market today is not only existing space, but new stock that has yet to be built. If these sites could secure a pre-commitment of 40% plus, we are likely to see them come into the market over the next three to five years. The developments have the potential add a further 272,000sqm to the Sydney CBD office stock over the medium to longer term."
Mr Martin said that in the short term there will be a rolling effect where space vacated by tenants moving to the Barangaroo South precinct will be refurbished and repositioned into the market to provide opportunities for tenants. "We have already seen IAG lease the space being vacated by Price Waterhouse Coopers at Darling Park and Suncorp's commitment to 10 Shelley Street vacated by KPMG. This will provide opportunities for tenants to upgrade from their existing space into newer, more efficient and more sustainable space on attractive terms, reflecting the 'tenant friendly' market and the willingness of landlords to back fill these vacancies."
Mr Martin added that, on the demand side, there are currently a number of requirements in the market including Atlassian, CBA, WeWork, Gadens, Expedia and NBN, some of which may pre-commit to a new building and trigger additional supply into the market.
Mr Martin said that the Sydney market in the short term will be active, with more interest from the smaller and medium size technology firms favouring the CBD over the suburbs. "Additional supply can only be created by large tenants pre-committing to future developments. The challenge is companies' ability to understand their future space requirements some three to five years out, against a backdrop of economic uncertainty. Demand will be consistent over the next 12 months, but real growth will be limited to the technology sector, with other corporate occupiers focused on "doing more with less" rather than creating an expansionary environment."
Investment demand for office stock in Melbourne is strong and has driven down investment yields, as well as provided impetus for developers to deliver new stock into the market. The majority of new development in Melbourne is concentrated in the Docklands area, where tenants are attracted by opportunities for larger floor plates, higher densities and space that lends itself to activity based working environments.
JLL's Head of Tenant Representation - VIC, Peter Walsh said residential has proven to be the highest and best use and delivered solid return on investment to developers. "Developers need a substantial pre-commitment in most cases over 20,000sqm in the CBD to make an office development viable and outside of the large banks, there are not a plethora of tenants of this size and scale in the CBD. Development opportunities that have existed in the suburbs have also evaporated over the last seven years as residential development has taken their place in areas such as Richmond, Camberwell and Hawthorn. So, whilst there are opportunities for tenants to access and stimulate new supply, these are concentrated in the Docklands area."
After nearly two years of negative net absorption, the last four quarters have shown increased tenant activity in the CBD. Mr Walsh said, "However, we believe Melbourne will continue to be a tenant's market into 2016 and early 2017 as the backfill space comes to market, made available through Docklands relocations. In particular, there are likely to be opportunities close to Parliament Station in the Telstra and superannuation precinct into 2016 and early 2017."
Incentive levels are likely to remain where they are at around the 30% mark, with minimal overall rental growth expected over the near term, apart from some uplift in certain precincts in the CBD.
"Corporates in Brisbane are facing a plethora of choice when considering new office locations - choice in both existing and new stock," said Michael Greene, JLL's Head of Tenant Representation – QLD.
"Despite the high vacancy of 14.5% in the CBD and 15.6% in the near city market, developers are willing to build new product with a strong pre-commitment given the strong investment demand for commercial assets."
Incentives currently range from 35–42% for existing stock and 25–35% in new developments. Mr Greene said, "In addition to the usual incentive of fit-out contribution and rent free/abatement, the market is seeing examples of developers taking over lease tails of tenants that are pre-committing to their buildings as well as delaying lease commencement dates. Many of the deals being done today have long lease tails meaning that demand is being brought forward and future demand is likely to be diminished unless there is significant organic growth from tenants."
Of the lease transactions taking place today, Mr Greene said there is a trend towards a smaller space requirement. "Tenants are adopting more agile work practices and many sectors have reduced headcount following the transition of the mining cycle from investment to production. So whilst there is movement in the market, in many cases it is not an expansionary move but a reduction in space."
Mr Greene said the average age of office buildings in the CBD is over 26 years old. "We estimate that approximately 100,000sqm of the current 325,000sqm of vacant stock is obsolete and should really be taken out of the market either for a major refurbishment or conversion to an alternate use. If this stock is taken out of the market it has the potential to bring vacancy down to a more normal level of around 10.8%. However, the Brisbane market has not shown the propensity to take stock out of the market in previous market lows.
"Even with 100,000sqm of obsolete stock, at JLL we see the market remaining in the tenants' favour at least until 2020 and if the 46,000sqm of potential new development at 300 George Street comes to fruition, equilibrium will not return until 2024 – a large and deep window of tenant opportunity."
"The Perth commercial property market is seeing unprecedented conditions that are creating real opportunities for tenants," said Andrew Campbell, JLL's Head of Tenant Representation – WA.
The CBD office market is experiencing vacancy of 19.6% (including sub-lease space available) which comparatively, is the highest peak since the early 1990s.
Mr Campbell said, "With the significant correction in the economy as the mining boom transitions from investment to production, corporates particularly in that sector, have contracted space at a rapid rate. Perth has experienced 12 successive quarters of negative net absorption, or three years of subdued demand against a backdrop of increasing supply. Yet at the same time, like all other Australian capital cities, there is a large pool of investment capital looking for good quality product with long-term leases, or new product with a substantial pre-commitment.
"There is a real opportunity for corporates with a footprint of 4,000sqm+ to take advantage of this investment cycle. Over the next 12 to 24 months, tenants will be able to secure new office premises with greater amenity, more efficient floor plates, increased transportation links and arguably a better location to what they are occupying today.
"Given Perth has one of the highest concentration of office buildings greater than 25 years old (61% of total stock), we predict even higher vacancy levels in secondary stock as companies seek to upgrade from old, obsolete office buildings."
Mr Campbell said that in addition, these new developments are offering competitive rental levels to secure pre-commitments – meaning that tenants are not only able to secure space that drives efficiencies and productivity in their business, but also save on total occupancy cost.
"It is almost the perfect storm for tenants with the weight of capital seeking quality office product, the government investing in development to drive growth and the highest level of vacancy the Perth market has seen since 1995. Normally in market conditions such as these, developers turn off the tap on supply and projects grind to a halt, yet with the unique nature of the investment market we are seeing projects that were approved in the upswing still going ahead," he said.
JLL's Head of Tenant Representation – NSW and ACT, Gavin Martin said the supply pipeline remains subdued with only 12,600sqm of new office space under construction (0.6% of the market). The vacancy rate in Canberra is currently sitting at 15.1% and incentives are 21% gross, which is the highest level seen since the late 1980s.
"The market conditions present an opportunity for tenants to re-structure or re-gear their lease and potentially upgrade to a better quality office building for a similar cost. However, a tenant of 5,000 - 10,000sqm looking for space in Canberra will find there are not many options for larger areas of space as the vacancies are spread right across the market, rather than concentrated into a small number of buildings.
"Rental growth has been subdued since 2008 and has remained flat into 2015. We are not expecting any significant uplift in the medium term."
"While the Commonwealth Government is expected to record limited growth over the 2015/2016 financial year, growth in the IT sector, as well as professional services, is expected to provide some organic growth for the market over the short to medium term," Mr Martin said.