Sydney CBD to permanently lose 206,565 sqm of secondary grade stock.
As a result of the Sydney Metro project together with the rising number of residential and hotel conversions, the Sydney CBD looks set to permanently lose 206,565sqm of secondary grade office stock, which has placed downward pressure on incentives, resulting in significant increases in effective rents across all grades.
Whilst rents increase and competition for space intensifies, tenants have seen an opportunity to upgrade their office accommodation as secondary rents surpass those of higher grades. According to data from the latest Colliers Radar report, this, assisted with speculatively fitted out suites, has certainly underpinned the ease with which tenants have moved into premium assets.
Never before has such an aggressive grade migration by tenants been witnessed, as rents continue to increase significantly in the secondary market and available space remains tight, says Cameron Williams, National Director, Office Leasing at Colliers International.
“Sydney’s CBD will receive an average of 21,256sqm of available space per year for the next five years (accounting for pre-committed space), but the office market is projected to remain tight as we forecast net absorption of 29,727sqm per annum over the same period.
“Total vacancy will increase only gradually (but remain under the 10-year historical average of 6.4 per cent) from 2.8 per cent in H2 2018 to 5.1 per cent in H1 2021, the timing of when the market is expected to experience significant positive net supply” he said.
The latest Colliers Radar report confirms that B grade assets have experienced the largest net effective rental growth increasing 33.7 per cent in the 12 months to September 2016, and more recently, have been reported to surpass A grade and in some cases premium net effective rents.
According to Kristina Mastrullo, Research Manager at Colliers International, our forecasts indicate that due to the high level of secondary withdrawals, B grade net effective rental growth will continue, gaining 27 per cent over the next 12 months on the back of constrained supply.
“This has allowed tenants to strike while the iron’s hot and act on opportunities to upgrade their office accommodation.
“Tenants that find themselves in the CBD office market have to cast a wider net to allow for premium and A grade assets, despite originally seeking secondary space. Now, a presence within a desirable precinct or particular prime grade building appears more feasible considering the lack of available and affordable secondary space” she said.
Rents aren’t the only variable triggering this tenant migration. Landlords such as DEXUS, Investa, Carlyle Group and GPT with buildings such as Grosvenor Place, Aurora Place and Chifley Tower have experienced successful take up of their turnkey suites i.e. carving up whole floors and speculatively fitting out spaces of 150sqm - 300sqm which incoming tenants can effortlessly move into.
By comparison, tenants seeking whole floor spaces of between 1,500sqm and 2,500sqm in these same premium buildings would typically enquire 12 - 18 months prior to lease execution. With a turnkey suite strategy, the landlord’s downtime (time without income flow) reduces and the impact on the building’s expiry profile decreases.
Mr Williams said in the six months to January 2017, premium vacancy in the Sydney CBD’s core precinct is expected to fall to 4.6 per cent, from 9.7 per cent in July 2016.
“For the last four years, vacancy for the precinct has hovered between 8 and 11 per cent, its prior low being 3.1 per cent in July 2011.
“Midtown is projected to experience a 450 basis points reduction in vacancy to 7.4 per cent from a previous vacancy rate of 11.9 per cent. Vacancy peaked last period (increasing by 10 per cent) as Ernst & Young relocated from 680 George Street to 200 George Street, leaving behind 25,500sqm of vacant space, however it is expected that approximately 10,000sqm is due to be absorbed by January 2017 and the balance is off the market” he said.
Mr Williams said that while office markets have always experienced an element of tenant upgrading, it has never occurred this quickly.
“The motives for this tenant shift has largely been brought about by a knock-on effect from permanent withdrawals of secondary stock having triggered a ‘value for money’ concept for premium grade or A Grade rather than organisational strategy. Needless to say this dynamic is not sustainable.
“Effective rents in the secondary market are likely to remain elevated but will correct to their usual rank where premium attracts a higher rate than the lower grades” he concluded.