Sydney CBD Office Market

August, 2018

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Vacancy low, but expected to rise as next supply cycle starts

Sydney CBD Office Booming

The Sydney CBD office market continued to outperform other markets over the first half of 2018 with strong rental growth, positive tenant demand, low vacancy rates, solid investment demand and further yield compression.

According to the latest Property Council of Australia Office Market Report, positive net absorption levels at 9,489 square metres were recorded over the twelve-month period to July 2018. Specifically, prime stock recorded strong net absorption levels at 44,931 square metres whilst secondary stock recorded negative net absorption levels (-35,442 square metres).

Vacancy rates have recorded a ten-year low at 4.6%, decreasing further from 6.0% over the twelve months to July 2018.  This is predominantly due to continued positive net absorption and high levels of stock withdrawals.  There is around 220,010 square metres due to be removed from the market over 2018 and 2019 for refurbishment and redevelopment.

Completions over the first half of 2018 totaled 45,251 square metres.  This is expected to be supplemented with 34,851 square metres of new gross supply over the second half of 2018, which will include the completion of 151 Clarence Street (20,795 square metres), the office component of Central Park, 100 Broadway (5,447 square metres) and  222 Clarence Street (1,829 square metres).

Looking forward, the supply pipeline will increase significantly from a number of large redevelopment projects that will be undertaken over the next few years.

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Strong Demand Rising Rents

Leasing demand continues to be strong and as a result, gross face rents in the Sydney CBD have increased over the year to June 2018 at 4.7% for prime office space and 5.5% for secondary office space.

According to m3property Research, prime gross face rents are ranging between $930 and $1,650 per square metre, and secondary gross face rents are ranging between $800 and $1,125 per square metre.

Incentives have fallen in the Sydney CBD over the year to June 2018 to range from 17.0% to 21.0% for prime stock and from 10.0% to 16.0% for secondary.

According to m3property Research, strong rental growth is projected for both grades over the next two years, due to forecast low vacancy and continued positive demand.

Solid Sales Growth

Transaction activity has continued to be solid over 2018 with approximately $2.9 billion of sales recorded over the first seven months of 2018 and a number of buildings currently on the market.

Unlisted trusts (30.7%) and foreign investors (22.6%) accounted for the majority of sales activity over the year to June quarter 2018, with sales reaching $6.18 billion.

Larger sales recorded over 2018 were 275 Kent Street for circa $860 million, 231 Elizabeth Street for  $342 million and 1 York Street for $205 million.

Yields Tighten Further

Yields across prime and secondary offices continued to tighten over the year to June 2018 driven by improving market fundamentals and strong investor demand.

Prime yields tightened by 38 basis points over the 12 months to June 2018, to range between 4.38% and 5.00%.  Over the same time frame, secondary yields tightened by around 50 basis points to range from 4.75% to 5.75%.

The Outlook is Positive

  • According to m3property Research, vacancy rates are expected to decrease further over the next two years. Positive demand should result in pre-lease activity rising over the next few years, driving new development completions in 2020 and 2021. Forecast development activity in this period is expected to result in an increase in vacancy over those years.
  • Net absorption is forecast to be moderate over the next few years, in part due to the lack of available contiguous space. This is likely to pressure some tenants to consider fringe and suburban markets for larger and back office space requirements.
  • Prime gross face rents are forecast to increase around 5.7% over the next 12 months. Secondary space is expected to see similar growth over the year. Incentive levels are also likely to reduce across both grades over the same period.
  • According to m3property Research, yields are expected to remain low due to strong rental growth. This should drive continued investment demand in the Sydney market. However the rate of firming has already slowed and this is expected to continue to be the case over the short-term with the 10-year bond rate rising.