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Downsizing Appetite Remains High in CBD Markets

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The contrast between Melbourne and Sydney’s CBD subleasing market could hardly be starker, and it seems how the pandemic has been handled is at the heart of it.

Lockdowns in Victoria have taken their toll as companies actively look to sublease CBD office space.

Victorians have had four comprehensive lockdowns in the past 15 months and some businesses are struggling to survive.

“Currently, the subleasing availability for A-grade is approximately 120,000sq m, which is around 5 per cent of the 2.5 million sq m of total A-grade market,” Savills office leasing director Mathew Kent, said.

“Large tenants are typically reducing their current space and are subleasing part of their current commitments.

“Landlords are providing tenants large incentives, speculative fit-outs and delayed lease commencement dates.”

Kent said a combination of business uncertainty and employees hesitant to come back to the office CBD as reasons incentives will remain for some time.

“Tenants are trying to recover costs, hence the sublease market availability,” Kent said.

“When their leases expire, they are taking the opportunity of current market incentives to get a better deal and to bank incentives by staying put or to upgrade into better quality buildings and fit out. They are also seeking flexibility in lease terms.

“Leases have moved from 12 to 18 months while incentives have increased substantially.

“On the flip side, cap rates have compressed due to weight of capital and low interest rates.”

The impact on net migration has been significant too.

“Since Covid-19 and international borders shut and lockdowns, we have seen the negative impacts of net migration and that will cause greater vacancy,” Kent said.

“Victoria had the largest change in net migration in the nation, from -3700 people in the previous quarter to -6500 people in the December, 2020 quarter.

“This was a result of departures—17,100 to 25,000— increasing more than arrivals—13,400 to 18,500.”

While New South Wales has managed to keep business actively going throughout the pandemic, there was a rush of subleasing activity at the height of the pandemic.

“Sydney CBD subleasing exploded in the third quarter of 2020 but since then it has remained fairly stable and recently reduced to around the 120,000sq m mark,” Knight Frank national head of leasing Andrea Roberts said.

“The organisations listing space for sublease are the larger financial services business, many of whom are still working through what a return to the office looks like for their business, as well as revisiting flexible working policies.

“A-Grade makes up 43 per cent of the sublease availability and premium is approximately 38 per cent.”

As the vaccinations roll out across Australia, plus a lack of state-wide Covid-19-related shutdowns in NSW, subleasing activity has subsided, though incentives are still on offer.

“The recent reduction in the level of sublease availability shows that the initial reaction from some businesses has not extended into a wider market trend and that demand has since picked up,” Knight Frank chief economist Ben Burston said.

“Sentiment in the office market has improved, in keeping with Australia’s successful management of the pandemic, and the strong economic recovery has accelerated the deal flow as a result.”

The effect of lower interest rates had a powerful offsetting impact on valuations which have held up well during the pandemic and in most cases have returned to growth, while net absorption is expected to rise again.

“Higher sublease availability implies weaker demand and partly explains the negative net absorption experienced in Sydney during 2020, however, the recent reduction is an indicator that office demand and net absorption will improve this year,” Burston said.

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Article originally posted at: https://www.theurbandeveloper.com/articles/sub-leasing-melbourne-sydney-pandemic