Out with the old – the other side of the construction cycle

December 7, 2011 / By

As they inch along Sydney’s congested roads during their weekday journey into the CBD, commuters have plenty of time to ponder their surroundings. What they see along the roads that snake towards the city centre are rows of shops, mainly constructed between 1890 and 1920. In Melbourne the “strip” shops are even more prolific, although the traffic may move a fraction faster.

These strip shops typically consist of two stories. The ground floor is a retail establishment – restaurant, dry cleaner, pharmacy, news agent and the like. The upper floor is more problematic: small legal and accounting practices, tailors, tattoo artists and, rarely these days, the living quarters of the retailer who operates the business on the ground floor. But many of these upper floors are simply empty.

Technology has changed, modes of transport have changed and lifestyles have changed. Many of the businesses that used to operate from these buildings have simply vanished. Technology, demography and rising household wealth have made a whole swathe of commercial real estate obsolete.

Obsolescence is talked about a lot but analysed seldom. And it’s big enough to matter. In the Sydney CBD over the past 20 years for every one hundred square meters of office space added to the market, forty-six square meters has been withdrawn. In the Australian residential market we measure very precisely the new dwellings constructed. In the year to June 2011 it was 155,730. But we have only the vaguest idea of the number of dwellings (probably around 35,000) that were knocked.

What drives obsolescence and demolition? It’s certainly a range of factors, some of which may be contradictory. If office rents are low, and expected to remain so, the incentive is to withdraw office stock for conversion – to hotels or residential uses, for example. Conversely, high or rising office rents provide an incentive to withdraw old buildings to be replaced by larger, newer buildings.

Overlaying these forces are extraneous drivers such as new technology, which encourages open plan office working and hastens the demise of older office buildings. The drive for security and environmentally sustainable buildings is also likely to reduce the economically useful lives of existing office buildings. Conversely, today’s low interest rates should, at least in theory, extend the life of existing buildings and lead to the construction of buildings with longer pay-back periods.

Obsolescence lacks the sex appeal of new construction and attracts much less attention from researchers and government statisticians. But over the next few years, as a spin-off from the Global Financial Crisis, new construction is likely to be low in many markets. So the economic impact of withdrawals, for demolition, refurbishment or conversion, is potentially significant. As Sydney’s strip shops show, whole categories of real estate can fall into disuse: wanted; a handy algorithm to predict the obsolescence and demolition cycle.

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