Sydney CBD Office m3property Insight

June, 2019

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The Sydney CBD office supply and demand fundamentals have been positive over the past 12 months and are expected to remain that way over the next year.

Low vacancy continues

The Sydney CBD office supply and demand fundamentals have been positive over the past 12 months and are expected to remain that way over the next year.

Office withdrawals for various projects have led to a shortage of office space in the market. This has reduced the vacancy rate, which as at January 2019 was recording a ten-year low of 4.1%. This has worked well for landlords in the Sydney CBD as tenant demand remains positive and rents continue to rise.

The latest Property Council of Australia Office Market Report indicated positive net absorption levels at 10,443m² over the twelve-month period to January 2019. This was due to positive prime net absorption of 53,333m² more than accounting for the negative secondary grade net absorption of -42,890m². This grade has been significantly impacted by stock withdrawals from the market.

Vacancy is forecast to continue to decrease up until late 2020. This is due to expected positive net absorption and high levels of stock withdrawals from the market over 2019/2020 for refurbishment and redevelopment.

The downward trend in vacancy is likely to reverse in 2021 as large supply projects in the pipeline start to complete leaving backfill space across the CBD.


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Rental growth positive, but slowing

Tenant demand and low vacancy along with minimal new office supply and stock withdrawals have driven rental growth within the Sydney CBD.

Gross face rents in the CBD increased over the year to March 2019, with growth of 1.18% recorded for prime and 2.67% for secondary office space.

Incentives stabilised for prime and decreased for secondary space over the year to March 2019. The low vacancy is putting downward pressure on incentives but this is being offset in the prime market by future supply, which is already competing for tenants.

m3property Research forecasts rents to continue to grow from 2019 to late-2020, before moderating when backfill space and new stock enters the market increasing vacancy from 2021 onwards.

Have yields reached their peak?

Sales activity is expected to remain solid over 2019 due to positive market fundamentals. Domestic and foreign investors consider the Sydney CBD to be an attractive market due to its transparency and capability to attain higher returns than many other global cities.

Transaction activity was strong over the year to March 2019 with approximately $6.4 billion of sales recorded, representing an increase of 5.0% compared to the same time the year prior. However, we note that the number of transactions have decreased over the same period of time.

Yields across prime and secondary offices continued to firm over the year, driven by solid market fundamentals and strong investor demand.

Unlisted property funds, A-REITs and foreign investors accounted for the majority of sales recorded over the year.

It is expected that yields will remain low over 2019 due to low vacancy and rental growth, which should continue to drive investment demand. However, yields are considered to have reached their peak and it is likely that they will stabilise over the short-term.

The recent cut to the official interest rates is unlikely to have any significant impact on yields in Sydney CBD.

Market set to turn with upcoming supply

As vacancy rates are expected to decrease further over the short-term affordability of office space within the Sydney CBD is likely to become an issue for tenants.

The relocation of some tenants or parts of businesses from the Sydney CBD to more affordable fringe and other metropolitan locations is likely due to rental increases.

New projects forecast to be delivered to the market from 2021 will provide more alternatives for tenants in terms of additional options for lease, and a slowdown of rental growth, particularly in the secondary market.

Investor demand within the Sydney CBD will continue to be solid as new projects lift the quality profile of the market.

Yields are expected to stabilise across both prime and secondary markets over the short-term.