Melbourne CBD and City Fringe Office Market - 2020 and Beyond

November, 2020

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Summary

There is approximately 338,000 square metres of new and refurbished supply forecast to be added to the Melbourne CBD over 2020-2022 with 149,000 square metres (44%) pre-committed.

Refurbishment space (fully and partially) under construction in Melbourne CBD totals 142,000 square metres, with additional backfill vacancy of 167,000 square metres likely to be withdrawn for refurbishment.

New supply under construction in Melbourne’s City Fringe totals approximately 241,000 square metres, with 68,000 square metres pre-committed.

There is estimated to be 115,000 square metres of available prime grade space in Melbourne’s City Fringe which has been refurbished and/or is under construction to be refurbished. New supply under construction in Melbourne’s City Fringe totals 241,000 square metres, with 68,000 square metres pre-committed.

Tenant demand in both the Melbourne CBD and City Fringe markets is being impacted negatively by stage 4 restrictions and sentiment driven by the COVID-19 health and economic crisis, which continues to unfold.

With a continued reduction in tenant demand likely, vacancy is expected to continue to rise which will result in continued negative effective rental growth in the short term.

Authors

Amita Mehra

National Director - Research, Marketing & Strategy

View Profile > VIC
Gary Longden

Director

View Profile > VIC
Niall Ashleigh

Associate Director

View Profile > VIC

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Supply & Demand Overview – Melbourne CBD

Supply

  • There are six new developments currently under construction which are expected to add approximately 195,750 square metres of office space to the market within the next three years. Around 76% of this space has already been pre-committed, leaving 46,000 square metres of non-committed new office space likely to reach the market over 2020-2022.
  • There are three buildings which are currently undergoing a full refurbishment which will add 95,000 square metres of office space within the next two years. Additionally, there are 47,000 square metres of space being partially refurbished that will come online in the next two years. From our knowledge, all this refurbishment space is available for lease.
  • The recent and upcoming development of new buildings has resulted in significant backfill vacancy, which we expect to total 166,862 square metres over the next three years. Majority of this space is expected to be withdrawn to be refurbished. Refer to our detailed report on Melbourne’s backfill vacancy for further details – https://m3property.com.au/publication/melbournecbd-office-market-2020-and-beyond/

 

 

Demand

Tenant demand has been significantly impacted by COVID-19, with the current restrictions resulting in increased indecision from tenants. Considering the high amount of supply/available stock for lease resulting from new developments, back-fill vacancy and refurbished stock, we expect the following implications on Melbourne CBD’s office market:

  • Incentives to rise significantly, with recent transactions and incentives on offer indicating an increase in nominal incentives of 10-15% from pre-COVID levels.
  • Great pressure to maintain face rents in buildings with large amounts of vacancy as supply in those buildings will significantly outweigh demand.
  • Effective rents will continue to fall throughout late 2020 and into 2021, which we expect to result in a flight to quality from secondary buildings into prime grade buildings.
  • Vacancy to rise to between 9.5% and 10.5% due to a significant increase in sublease vacancy, increases in backfill space and completed development space offered to the market and direct vacancy stemming from tenant contraction or insolvency.

 

While the most likely path for vacancy over the next five years is around the base case forecast, there is scope for the rate to range down to “Scenario 1” or up to “Scenario 2”. If demand quickly resumes and confidence returns to the economy and Melbourne office market, we would be likely to see forecast vacancy move towards “Scenario 1”. However, if the economic recession results in a financial crisis and delay in economic recovery, the outlook is likely to head up towards “Scenario 2”.

Melbourne CBD Vacancy Forecast Scenarios

As a result of COVID-19, high unemployment rates and economic uncertainty are expected to impact tenant demand over the next 12-18 months. Falling demand, combined with upcoming supply, is forecast to result in CBD vacancy increasing to 7.4% by the end of 2020, and reaching 9.4% in 2021, before reducing in 2022.

  • Given the uncertain economic conditions as a result of COVID–19, m3property have carried out a scenario analysis of the impact of net absorption adjustments on the Melbourne CBD office vacancy rate. We have developed three vacancy forecast scenarios for the market by considering potential variations in tenant demand and potential backfill space availability.
  • Base case forecasts – Net absorption forecasts are based on the current economic outlook, including the white-collar employment forecasts and current leasing market conditions. m3property is forecasting vacancy to peak at 9.4% by December 2021 and reaches a second peak of 10.19% in 2023.
  • Scenario 1 – Based on the long- term average net absorption being reached over 2020-2022. Under this scenario, the vacancy rate could rise to a peak of 9.11% by December 2021 and reach a second peak of 9.91% in December 2023.
  • Scenario 2 – Based on the previous historical downturn net absorption averages (early 90s recession, Tech Wreck and GFC). Under this scenario, the vacancy should continue to rise until the end of 2023 (reaching 11.21%) and is expected to decline by the end of 2023 at 10.77%.

 

m3property have identified 20 major developments that are currently under construction in the City Fringe. Of these developments, 241,000 square metres of space is scheduled to be completed by 2022 with approximately 28% (68,425 square metres) pre-committed, leaving 173,000 square metres (72%) available.

We also estimate there to be ~115,000 square metres of available prime grade refurbishment space available for lease across Melbourne’s fringe office markets. This space comprises areas which are currently undergoing or have recently completed refurbishment.

Considering the large amount of available Prime grade space, which totals approximately 356,000 square metres between new stock coming online and refurbished space within existing buildings, and the subdued leasing market we are entering as a result of COVID-19, we expect the following:

  • Significant increase in incentives on offer, which is already occurring in some recent transactions that have occurred (although minimal), resulting in negative effective rental growth.
  • Increased pressure on landlords / developers to maintain face rents, and we expect face rents in some City Fringe areas to decrease, however, this will be very location and asset-specific.
  • Extended vacancy periods for available space as supply will significantly outweigh demand in the short term.
  • Large increase in vacancy to be caused by a significant increase in sublease vacancy, tenants reducing their footprint and new supply entering the market largely vacant.

 

 

 

Approximately 241,000 square metres of space is under construction to be completed by 2022.

Outlook

  • Subdued Leasing Market – COVID-19 has resulted in increased indecision from tenants, weak tenant demand in the short term with rising vacancy, increasing incentives and rising pressure on maintaining face rents.
  • City Fringe Supply Pipeline – oversupply in the city fringe of both new development and refurbished space, will likely see a rental correction. Potential increased demand in the fringe and suburban markets from tenants looking to decentralise their operations from a “CBD-only” office presence.
  • Long – Term Outlook – difficulty in securing pre-commitments in a weak leasing market to lead to potential undersupply of prime stock in the long term, coinciding with white-collar employment growth.
  • Melbourne’s office rental rates are the most sustainable of all major capital cities and we note that Melbourne has the strongest long – term population growth forecasts.