Finding extra value in Australia's office market

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In Sydney, companies in the central business district have to think twice before relocating to another workplace in Australia’s largest office market.

That’s because there has been an office supply drought in the CBD that has seen the vacancy rate fall to 4.1% as of January this year, the lowest it has been in over a decade.

Head south to the country’s second largest office market, Melbourne CBD, and the vacancy rate is even lower at 3.2%.

Sydney, Australia

While the workspace shortages have proven challenging for businesses looking for new digs nearby, the high occupancy rates have accelerated rental growth for landlords in recent years.

Prime net effective rents in the Sydney and Melbourne CBD’s increased 17.5% and 15% respectively during the year to end-January 2019, according to advisor Knight Frank.

Years of significant rental gains have enticed real estate investors from near and far, driving a 13% increase in Sydney CBD office market investments to A$7.17bn in 2018, reported advisor Colliers.

And the heightened appetite for assets in both locations have pushed down premium yields to 4.8% in the Sydney CBD and 4.7% in Melbourne’s CBD.

“Yields in Melbourne and Sydney are very tight and there’s a perception that people are buying at tight yields for the opportunity for further rental growth,” Grant Nichols, fund manager of Centuria Metropolitan REIT, told APAC Real Estate.

“There is some very strong rental growth happening through these markets, so arguably you can pay 5% yields and in a couple of years you get the running yield back up to something more palatable because the rental growth has been so strong.”

Last year, Japanese real estate firm Daibiru Corporation bought the 275 George Street prime office development in Sydney’s CBD for A$240m, reflecting a 4.5% yield.

Charter Hall Prime Office Fund’s A$804m acquisition of 10 & 12 Shelley Street was reportedly completed at a similar yield.

While limited new supply across both markets will keep the pressure on available space and rents, investors will have to keep an eye on rental growth to ensure some of these deals deliver.

“If you did go hard in the Sydney or Melbourne market, you have to ask what sort of rental growth you intend to achieve because if you’ve paid a very tight yield and you don’t get that rental growth, you’re stuck with a fairly low returning asset for quite some time,” Nichols said.

After years of growth and yield compression in Australia’s major office markets, offices markets beyond the CBD and in other cities are gaining attention.

Beyond the CBD

Infrastructure and amenities are raising the profile of certain metropolitan and suburban office markets in Sydney and Melbourne.

Take the metro office market of Chatswood, 10km north of Sydney’s CBD, where Centuria Metropolitan REIT owns a 9,395 sq.m. office and a quarter stake in another building.

Chatswood prime asset yields range between 5.5%-6.25%, while its prime vacancy rate currently sits below 4%, according to advisor JLL.

However, the most exciting development for Chatswood is the $8.3bn newly-opened Sydney Metro Northwest rail project that will connect the city’s booming north-western suburbs with trains running every four minutes at peak times.

The new rail project is the first stage of the larger Sydney Metro project, which will link up Chatswood to underground stations throughout the CBD and beyond to the southwest by 2024.

It will have driverless trains, the first in the country, and has a target capacity of 40,000 passengers per hour, similar to other metro rail systems worldwide.

Melbourne is also boosting its public transport infrastructure, with the construction of the A$11bn Metro Tunnel that will run high capacity trains from the outer west suburbs to the outer southeast via new inner-city underground stations.

While Melbourne has other long-term infrastructure projects in the planning stages, occupiers are gravitating to metro office markets like Richmond and nearby Cremorne for other reasons.

Just a few kilometres southeast of the CBD, Richmond and Cremorne have become innovation hubs, attracting tech companies such as online jobs board SEEK, online real estate portal REA Group and

Centuria’s Nichols said companies were drawn to the retail amenities on offer in those areas as a way to attract and retain the best talent.

Secondary cities

Go further afield and there is growing investor interest in Australia’s next biggest office markets, Brisbane and Perth.

These secondary markets are starting to see the green shoots of an office recovery story after vacancy rates spiked at 23% in Perth CBD and 16% in Brisbane CBD in 2016 and 2017, respectively, according to UBS Asset Management – Real Estate & Private Markets.

In a research note, UBS AM-REPM’s Adeline Chan said vacancy rates were now starting to trend downwards, with rents expected to reverse their contractionary course.

“All things considered, Brisbane’s macro story has more legs to stand on than Perth given the strong population growth expected as well as the diversified economic growth drivers, although Perth appears more attractive from a yield and capital value perspective,” Chan wrote.

However, investors should be mindful of that the lack of depth and liquidity across the smaller markets in Brisbane and Perth do make them a riskier proposition than Sydney and Melbourne.

The secondary cities will best suit investors chasing a greater risk tolerance with the ability to ride through cycles, while Sydney and Melbourne, though in the late stages of the cycle, will remain attractive options for investors with a more stable risk profile, Chan said.

The other market to keep in mind is Adelaide. While the South Australian capital has low rents and a CBD vacancy rate at 13.5%, the city is home to the Australian government’s A$90bn naval shipbuilding program.

Centuria’s Nichols, who has been keeping a close eye on the Adelaide market after his fund bought a 50% stake in the Bendigo & Adelaide Bank headquarters for A$92.3m last year, said the economic flow-on effects of the program were yet to be truly seen in the city. Finally, Australia’s official capital city, Canberra, has also drawn local and overseas investor interest in recent months.

Singapore-based SC Capital Partners bought the 28,519 sq.m. Finlay Crisp Centre in the capital’s civic CBD for A$62m in mid-May, with plans for a A$50m refurbishment. The Centuria Diversified Property Fund then purchased the 6,709 sq.m. Optus Centre building in the CBD for A$35m in late May.