Australian office markets after the boom

May 7, 2014 / By  

The resource boom over the past decade had a major impact on the Australian property market. The investment phase of the mining cycle has now peaked. Fortunately, for the health of the domestic economy, the RBA recently noted that there are encouraging signs that the handover from mining-led demand growth to broader private demand is beginning.

Office Vacancy rates for the resource-dependent markets of Perth and Brisbane reached a cyclical low (2.0% and 6.1%) at the beginning of 2012. Over the remainder of the year, as large scale resource projects moved from investment to production, the workload of engineering consulting firms and other professional services firms was scaled back. The contraction of these firms is illustrated in our net absorption and sub-lease availability figures and ultimately a rise in vacancy in both Brisbane (15.5%) and Perth (11.8%). In contrast, the service orientated markets (Melbourne and Sydney CBD) have shown less volatility on the demand side of the equation.

Investment markets both globally and locally are taking into account the divergence in the physical markets and pricing them accordingly. Comparing Sydney and Brisbane yields movements can offer insight into how investors are pricing the different markets.

Since the cyclical low in vacancy in the first quarter of 2012, yield compression at the tighter end for both Sydney and Brisbane has been recorded. The weight of capital for core product with strong covenants and latest in sustainability credentials has resulted in yield compression for Sydney (25 bps) and Brisbane (50bps). This is supported by transaction evidence from 1 William Street and 170 Eagle Street in Brisbane over the beginning of 2014. Both transactions showed pricing below 6.50%.  The Sydney CBD is also projected to record further tightening over the remainder of 2014 as benchmark assets are expect to trade below 6% due to competition for assets that is creating pricing tension.

In contrast, with Brisbane as an example, the downsizing resource sector and public sector job cuts mean that the growth outlook for this market is less positive. The corporate rationalising by occupiers is having a negative impact on vacancy levels in Brisbane. Further, 2016 is expected to be the second highest year on record for completions in the Brisbane office market. The inherent risk in the Brisbane market is reflected in transactional evidence. The AM 60 building in Brisbane reflects an 8.3% yield, indicative of the softening at the lower end of the JLL research prime yield range from 8.00% to 8.25%.

The 10 year average spread between the softer end of the prime grade yield range in Brisbane and Sydney is approximately 50 bps. In 1Q14, the spread moved out to 100 bps. This may provide an investment opportunity for counter-cyclical investors who can manage the occupancy risk in the Brisbane market. Over the medium-term, market pricing tends to mean revert. An investor with a higher risk tolerance could generate a higher return by moving up the risk curve, acquiring a well-positioned lower quality prime grade asset and waiting for yields to revert to historical averages.

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