Over the past month, several new datasets have been published which has allowed us to gain a clearer picture of the performance of Australia’s office markets over the latter part of 2021 and, more broadly, where they are at after the impacts of the pandemic and what lies ahead.
The first set of indicators is the Property Council of Australia (PCA) Office Market Report which tracks vacancy levels and allows us to better understand current office occupancy and current office demand. The PCA data is complemented by the Colliers Office Demand Index (ODI), which tracks enquiry levels across the major office markets. The ODI can be used as a lead indicator for future office deal activity and what office occupancy might look like over 2022.
Firstly, what did the data show?
The latest PCA numbers at a National aggregate level show a stabilisation of office vacancy. Australia’s CBD vacancy rate increased by only 0.1 percentage point to 11.3% and Australia’s Non-CBD vacancy rate increased by only 0.4 percentage points to 13.9%. Despite the slight uptick in vacancy levels, both CBD and non-CBD vacancy rates have remained relatively stable over the course of 2021 and in another positive sign, both have recorded significant positive net absorption for the first time since the onset of the pandemic. We acknowledge that positive net absorption has been somewhat supported by committed new supply coming online within some markets, but this is a positive as new developments are entering the market with healthy pre-commitment levels.
We also acknowledge that there are differences in the recovery at a market and grade level. For example, Sydney CBD vacancy has remained stable over H2 2021 at 9.3% whereas Melbourne CBD has lagged Sydney due to more significant impacts from the pandemic and therefore recorded an uptick in vacancy to 11.9%. For this reason, we expect the Melbourne CBD may continue to lag with most occupiers, particularly large space occupiers, only now starting to return to the office in a more consistent manner and therefore still strategising on their space requirements.
If we delve a little deeper into the data at a building grade level, there is a clear thematic occurring within premium grade assets. All premium markets recorded a reduction in vacancy over H2 2021, highlighting the demand for high quality office space which I talk about further below. A-grade has recorded the highest increase in vacancy where the majority of larger sub-lease availabilities have come to market, as well as backfill space. However, within A-grade we know anecdotally that there is a two-tiered market with high-end A-grade assets still benefitting from the flight to quality from lower A/B-grade buildings.
Now looking to the Colliers Office Demand Index (ODI), it is clear that demand for office space is recovering with enquiry up significantly in 2021. Nationally Colliers recorded 3,781 enquiries for more than three million sqm which is a 13% increase on the number of enquiries and a 12% increase on the area enquired for when compared to 2020. Over the last two years, deal activity has been driven by small-to-medium sized businesses (or SME’s), but it is encouraging to see that when breaking the data down by size segments that the 3,000sqm + enquires recorded the largest increase at 53% when comparing H2 2021 to the same period of 2020.
Across the major cities, the level of enquiry recorded over the second half of 2021 was close to or at record levels since Colliers began tracking enquiry data (2009). Whilst some of this enquiry is attributed to pent up demand and also future briefs being brought forward, it is clear that occupiers are gaining confidence and starting to make decisions on their real estate needs.
Why the uptick in enquiry and demand?
We think there are a number of contributing factors to the current state of play. Firstly, the impacts to our economy and markets have been very different when compared to a financial crisis. The GFC hit the financial sector hard, one of the largest industry contributors to office occupancy in our major markets. The recovery out was slow with the macroeconomic environment effected for around five years post the initial impact. This meant that organisations took the opportunity to cut back on office space or delay expansion plans as their leases lapsed through the longer recovery period.
The impact from the pandemic has been very different in its behaviour, mostly putting businesses into a holding pattern and causing disruption to their operations as opposed to severely effecting their business fundamentally – although we acknowledge that lockdowns have impacted many face-to-face service-based operations.
The period of most uncertainty has been short and sharp, around 12-18 months, and has therefore not impacted leasing decisions over the long term; more placed them on hold and put more emphasis on the use of the office and what businesses want from the workplace moving forward.
Now almost two years on, there is more transparency and confidence of what ‘back to normal’ looks like, particularly with a high proportion of the population vaccinated and government mandates mostly lifted. Even though we are still dealing with COVID-19 in the community, there is a sense of wanting to move on and the initial knee jerk reaction to job losses has unravelled very quickly, particularly within the white-collar sector.
The National unemployment rate has dropped to 4.2% in December-2021, quicker than many commentators and the RBA expected, with 246,600 more people employed at the end of last year compared to March-2020. In addition, when looking at the ABS electronic payroll data, white collar industries are 4.9% above pre-pandemic levels, mainly driven by a strong recovery in jobs across the Finance, Admin and Support and Professional and Scientific and Technical Services sectors – all of which lease a large proportion of office space particularly in the Australian CBD markets.
An additional overlay to this is government support for SME’s through the pandemic. Data released by ASIC shows a 42% decrease in the number of companies entering external administration when comparing 2019/20 to 2020/21. Therefore, some of the natural attrition of businesses has not dragged on office enquiry or lease deal statistics.
Also, there is an element of opportunistic tenants in the market looking to take advantage of the current favourable terms on offer and the increase of options within the market. We may be experiencing a larger proportion of activity that would normally be spread over a five-year period brought forward over one to two years. Leasing activity is also being driven by a continued flight to quality theme by occupiers looking to not only upgrade their premises, but to attract and retain talent within such a competitive labour environment.
In summary - What does this mean for 2022 office demand?
The record level of enquiry recorded through the latter half of 2021 bodes well for deal activity through 2022 as more occupiers look to move ahead and lock in their future office space requirements. We expect this deal activity to be skewed towards the prime end of the market and new developments and therefore result in a wider divergence between prime and secondary vacancy. The question being will occupiers take more or less space and that question remains unanswered over the short term. What we may see is that occupiers will not lock in as much additional space for future growth and use flexible space, whether that be within a flex-space offering or flexible working utilising WFH, for future growth requirements.
Flexible work and the work environment are just some of the considerations an organisation will consider when looking at their office space requirements and are now just being viewed through a different lens. There is no one size fits all approach and space requirements will continue to be led by the individual needs of each organisation. The CBD will remain the activity hub supported by amenity and infrastructure.
Now that work-from-home orders have been effectively lifted in most states, and conditions are normalising, we can start to delink the return to the CBD/return to the office narrative from office demand. 2021 has proven that the office is still central to most organisations with strong levels of leasing activity - up 55% from 2020 and up 3.3% from 2019 across the major CBD and metro office markets (Source: Colliers Deal Activity Data), and as a result the impact to rents and incentives have started to taper off and will continue to do so through 2022.
Deal activity is being driven by the attractive terms on offer and a ‘Flight to Experience’ thematic whereby occupiers are not just looking for a higher quality of building and space, but the overall experience the location of their office has to offer; particularly with a longer-term view of retaining and attracting the best talent in a highly competitive labour market. A good example of this is tech companies who offer a highly flexible work arrangement for their employees but continue to commit to large amounts of office space within prime assets and in particular large pre-commitments to new developments.
The strong levels of enquiry and deal activity, rebound in white collar employment and a stabilisation of overall vacancy levels are all highlighting the resilience in office fundamentals.
The growing certainty around these fundamentals will underpin the continued recovery in office investment activity over 2022 after already reporting a 70% uplift in volumes over 2021. The flight to quality thematic will see more capital look to be placed towards high quality prime office buildings that offer talent attracting amenity and location and strong ESG credentials, but will put pressure on poorer quality, secondary assets. However, this will provide an opportunity for secondary asset owners or opportunistic investors who are willing to spend on refurbishment activity to position these assets as a competitive option within the grey area between upper-B grade and lower A-grade assets. Demand from global capital will continue to grow given the relative value of the Australian market and comparable yields in other global hubs.