Is there a silver lining to the Brisbane office downturn?

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Is there a silver lining to the Brisbane office downturn?

May 16, 2013 / By Peter Guevarra

The Brisbane CBD office market has endured a very turbulent 12 months. At the beginning of 2012, Brisbane was one of the strongest office markets in Australia. Twelve months later, the opposite is true. Brisbane is now the weakest CBD market nationally based on overall vacancy. Vacancy over Q1/2013 increased from 9.9% to 12.9%, while negative net absorption of 57,000 sqm was the largest decline on record for this market. What caused this market to turn from a bull to a bear so quickly, and what are the implications for developers and investors?

Falling demand from two key occupier groups – the public sector and the mining sector – caused the rapid market downturn. A newly elected state government initiated public sector downsizing in the order of around 14,000 full time positions. With the government previously occupying roughly 20% of all stock in the CBD, contraction in the government footprint by around a quarter is having a severe impact on the market. This is expected to continue in the short term.

Demand was also weakened by significant consolidation among resource sector tenants. As the peak of the investment phase of Australia’s mining boom nears, firms are focusing on cost containment, with real estate a non-core area where costs can be minimised. Coal mining firms in particular have been quick to cut costs given lower commodity prices and slowing demand. During Q1/2013, Rio Tinto and Xstrata Coal both relinquished a significant amount of space in the Brisbane CBD.

Surprisingly, despite the tougher leasing conditions, both the development and investment markets have remained relatively solid. Investment capital is still firmly focused on prime assets and two new large developments (480 Queen Street and 180 Ann Street) are likely to commence construction imminently. Along with the falling cost of debt and relatively high cap rates, a key to understanding this apparently contradictory dynamic is recognising the two-tiered nature of the market.

Government and mining sector tenants primarily withdrew from secondary space. Consequently, as the chart below shows, the secondary vacancy rate increased to 16.6% over the quarter and is now double the prime rate (8.3%). While overall demand conditions worsened, the prime end held up relatively well, illustrated by several large leasing mandates currently in the market. These leasing requirements, coupled with limited availability of prime contiguous space, have given developers confidence to proceed with existing schemes in spite of the higher overall vacancy, with the 58,000 sqm 180 Ann Street project completely speculative and the 55,000 sqm 480 Queen Street development 50% leased.

The stability at the prime end has also underpinned solid investment activity, with sustained capital focus on high quality real estate. Assets with long WALEs, strong lease covenants, and small capex requirements are key acquisition targets for the many institutional funds currently in the market, supporting prime yield compression of 25 basis points at the upper end of the range in Q1/2013. While we expect the prime end of the market to continue to hold up relatively well, a key question is what will become of secondary stock, particularly given the now higher pace of obsolescence?