2015 was a big year for Melbourne’s CBD leasing market, with 128,500 sqm of net absorption recorded (the strongest year since 2007). Despite the strong reading on this metric, there were large sub-lease space options offered to the market that tapered the robustness of the headline net absorption number. Observing the activity of the sub-lease segment of the Melbourne CBD provides an interesting perspective on the state of the market.

What does the sub-lease vacancy rate tell us?

The sub-lease vacancy rate, currently at 1.9%, has been above the ten-year average since 2012. While the sub-lease vacancy rate has been above the long-term average, the overall trend has remained steady at around 2% since 2014.

A flat vacancy rate can suggest subdued activity. But charting the addition and removal of sub-lease space indicates that through 2015 the opposite has occurred. The area of sub-lease space coming to the market has been absorbed in roughly the same proportion (note that some of this is sub-lease space becoming direct vacancy and tenants taking space off the market). The amount of space additions on both sides of the ledger has been elevated and rising for most of 2015.

The results suggest a focus on cost management and reduction in some areas of Australian businesses. The market appears to be meeting the supply and demand of those firms wanting to keep a lid on their occupancy cost and potential tenants that are looking to secure a discount on market rents.

Drilling down into the takers and contractors provides a clearer picture of the Melbourne leasing market. Contracting tenants offering space include resources and energy firms as well as banks. This is not surprising as in the Melbourne CBD the headcount for the mining sector has contracted by circa 37% over the last two years (Deloitte Access Economics 2015).

On the other hand, takers of sub-lease space have come from the technology, government and education sectors. While education headcount in the Melbourne CBD has been flat in the short-term, Deloitte forecasts that the sector will receive a 6% increase in headcount over the next two years.

What does all this mean?

Sub-lease vacancy can be used as lead-indicator for overall vacancy, providing a preview of the types of tenants that may contract upon lease expiry. The takers and contractors have been reflective of the long-flagged transition of the Australian economy from resource led growth to a broader based recovery.

Recovery rates on sub-lease space are anecdotally around 65%-70% of net face rent. While there is an above average amount of sub-lease space being offered at a discount by the market, the potential for significant increases in rents is diminished. Should the amount of sub-lease space entering the market slow, and remaining space be absorbed, building owners could reasonably expect an uplift in rents above the level experienced in 2015. The sub-lease segment is a metric to watch over 2016.

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