[+] Scramble for Survival as Office Gloom Drags On

Depending on who you ask, offices are either dead—or they’re just hibernating. The Property Council of Australia this week attempted to instill confidence after more than a year of plummeting office valuations, nose-diving transaction volumes and the stalling of new office developments. But MSCI head of real assets research for the Pacific Benjamin Martin-Henry says it is evident that Australia isn’t weathering the office downturn well. “It shouldn’t come as a surprise that the office sector was the worst performer for the year, and transaction volumes were down 60 per cent,” he says. “It’s normal to see a cyclical impact, but is going through structural change at the same time and it’s still up in the air: do we need more or less space?” ▲ Full-floor offices at Fortis’s Lawton Hurley-designed Double Bay commercial project will average at $3 million. Developer Silverstone has bucked the trend in 2023, filing plans for a 24-storey office tower on Brisbane’s city fringe , but acknowledged the downturn, identifying interest rates increased to 4.35 per cen as a key driver. “This represents a 15 to 20 per cent reduction in intrinsic value if this increase is passed straight onto cap rates,” Silverstone development director Wade Fraser says. “Construction prices remain historically high. This, coupled with softer market values, is resulting in developers hitting the brakes.” Fortis general manager for Victoria Tim Mills, which started construction on its Double Bay offices last year , summed up the nuances in the market. “Although many commercial valuations fell in 2023, this was by no means a uniform change, but varied according to location and the building itself,” says Mills. “Typically, valuation reductions were lesser for premium buildings and greater for older, less well-presented stock.” Adding value to assets Dexus’ asset report showed that vacancy was unevenly spread, and according to JLL Research just 10 per cent of buildings account for around two-thirds of the total vacancy in CBD markets. As such, office owners have scrambled to offload, upgrade or convert underperforming assets. Conversions to other asset uses, such as 133 Liverpool Street and 39-41 York Street in Sydney, have helped insulate the CBD from a year of negative net absorption, but the practice is often cost prohibitive, says Martin-Henry. ‘I’m an advocate of looking at smaller, B and C grade offices, buying them for cheap and then fixing into premium grade in smaller assets. “People are downsizing not downgrading. They don’t want 50,000sq m footplates, but they want the same finishes and quality.” ▲ End-of-trip facilities, pools, rooftop communal areas and more are part of developers’ moves to upgrade assets like ultra-luxe Ruby House. Fraser says that owners who purchased at very tight yields will have to rely on rental growth from reviews and long WALEs to get growth out of their assets. “Having a solid balance sheet and the ability to deploy equity into the asset for upgrades, incentives, or reducing debt levels is critical,” says Fraser. Speaking at a Property Council of Australia event in Brisbane this week, Dexus fund manager for office partnership Brad Collier says it is both a flight to quality and a flight to locations playing out in CBDs. “End-of-trip facilities was what everyone was looking at 5 or 10 years ago, and older buildings were being retrofitted. It’s now about having that third space. Third space is the next end-of-trip facilities.” ▲ There are still opportunities in the megabrand space, including Adidas’s Dover House site (pictured) and the redevelopment of Canva's Sydney HQ. Fortis has heavily invested in amenities, especially at its Dover Street Cremorne site, the new head office for Adidas. “Techniques to manage cap rate pressure will remain the same, including superior location, design and amenity,” says Ed Eve, Fortis’ general manager for development in NSW. “Quality tenants will continue to be attracted by design aesthetics, fitness and wellness facilities, smart building technologies and digital infrastructure, outdoor spaces and activated rooftops.” The rise of other markets Of course, not every market or asset can be painted with the same brush, and demand for offices will be different across the county in 2024. National CBD vacancy rates, the PCA said, had increased to 13.5 per cent, however, Brisbane vacancy rates remained stable, with estimates around 11.7 per cent from the PCA and 11.1 per cent from JLL—tighter than before the pandemic. Sublease availability declined in Brisbane by 17.2 per cent, according to CBRE, second only to Perth at 23.4 per cent. “Each market has their own pressures, they prove the point of how Covid has impacted certain offices. You can tell that in Brisbane, everyone went to work,” says Martin-Henry. “Melbourne was one of the worst with occupancy rates the lowest in the country, and it had a lot of stock come into the market at the worst possible timing.” Office sector performance by city ▲ Source: JLL Research The contraction in the forward supply pipeline, exacerbated not only by a decline in demand but by high construction costs and interest rates will help protect existing stock from supply risk going forward, Dexus’s report found. This will be true of places such as Brisbane, offering opportunities for developers in the medium to long term. At the Property Council event, Knight Frank partner of research and consulting in Queensland Jennelle Wilson said the main challenge in the Brisbane office market was a lack of capital to develop, and a lack of capital to buy. “That will be the stumbling block for the market, not now, but in two to three years when we realise we haven’t made the most of the strong net absorption in Brisbane.” Looking to the future Generally, though, developers are optimistic about planning for the future of office development. “Despite the headwinds, we still believe there are opportunities in the market if you remain open to new ideas and get in at the right price,” says Fraser. ▲ Silverstone’s Milton office project is planned for 299 Coronation Drive, a site the developer bought for $13.3 million in 2022. “With interest rates stabilising, general market confidence should shore up and we will see cashed up buyers ready to deploy capital on asset trading at lower values. “Theory also tells us that there is only so long that cash-poor owners can sit on development sites with high debt costs before pressure requires them to sell. This should result in more transactions.” While there is a turning point in sight, erring on the site of caution is our best bet, says Martin-Henry. “It’s hard to predict the bottom of the trough, but don’t expect a turnaround this year. “Office performance may bottom out in six months at the premium end, but secondary offices won’t for at least 12 to 18 months. “The only thing certain is that everything is uncertain.” You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. Click here to learn more.

[+] Scramble for Survival as Office Gloom Drags On

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