The case for Sydney suburban office funds

August 6, 2013 / By  

Investor appetite for office assets continues to grow under the impact of demand from domestic and overseas REITs, superannuation funds and managed funds. However, the tightening yields and scarcity of investment opportunities within the Sydney CBD office market has led investors to look further up the risk curve, towards Sydney’s suburban office markets to satisfy investment mandates.

There is significant depth in Sydney’s ‘non-core’ office market. There are nine suburban office markets (Sydney Fringe, South Sydney, North Sydney, Chatswood, St Leonards, Parramatta, Macquarie Park, Norwest, Homebush/Rhodes) with a combined commercial footprint of 4.39 million sqm. Jones Lang LaSalle has assessed the market value within these suburban markets at $19.5 billion, encompassing 190 A-Grade assets.

There are four fundamental criteria that support the argument for investment in the non-CBD office markets: tenant demand and vacancy levels, rental growth, incentive levels and the yield spread between CBD and non-CBD markets.

Tenant demand for suburban office space has been buoyant in the 12 months to June 2013, with gross take up totaling 140,700 sqm. Prime net absorption of a modest 2,000 sqm was recorded over the same period. But over the same period the Sydney CBD prime office market recorded negative net absorption of 20,700 sqm. The suburban markets of Homebush/Rhodes, Macquarie Park and Parramatta recorded significant positive net absorption over the same period (47,300 sqm) with North Sydney, Sydney Fringe and Sydney South reporting negative net absorption of 81,400 sqm. The number of tenant briefs for space has increased in the majority of the suburban markets as prospective tenants look to take advantage of the modern amenities and lower gross effective rents.

The average gross effective rent for the nine Sydney suburban office markets is AUD 341 per sqm p.a. The lower gross effective rent for the suburban office markets compared to the Sydney CBD (AUD 608 psm p.a.) makes the suburban market attractive for tenants despite the stronger rental growth (4.2%) against the Sydney CBD (-2.5%) year-on-year.

Prime vacancy across the nine suburban markets sits below the CBD vacancy level, at 9.2% and 11.3% respectively. Quality supply is scarce in the Sydney suburban office markets and little supply is forecast to come on stream in 2013 and 2014, which should see a tightening in the vacancy rate as was recorded in Parramatta, Macquarie Park and Homebush/Rhodes in Q2/2013.

Sydney Suburban office markets provide a greater yield spread than the Sydney CBD market. Sydney Suburban upper yields range from 7.25% to 9.00% compared to 6.00% to 7.50% for the Sydney CBD. Jones Lang LaSalle forecasts the yields will compress in the North Sydney and Parramatta markets in 2013 and 2014. The greater income together with the opportunity of repositioning older, lower grade stock in some suburban markets makes suburban markets attractive to investors.

A number of institutional investors are preparing to raise capital for non-CBD office funds as these markets offer a combination of high yielding assets together with strong income streams. As a result, the demand for non-CBD product is likely to increase over the next 12-36 months.

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