Authors: Ben Farquhar, Director - Core Commercial & Sam Lipshut, Head of Department - Middle Markets & Portfolio
The office market remains in a challenging position, with dragging demand and high vacancy rates across Australia. According to a recent KPMG report[1], institutional office assets are likely to experience further capital declines due to market and economic conditions.
Given the market fundamentals apply across all segments, the story in the sub-$15m office market is similar – albeit with a few more high notes thanks largely to the prevalence of owner-occupier buyers, as well as interest from high net worth individuals, private investors, syndicated investors, boutique fund managers and self-managed super funds.
Across the board, the office market has been affected by remote and flexible working practices, challenging economic conditions and softening yields. However, we see greater value resilience in the sub-$15m office property market where there is less property fund activity and greater demand by owner-occupiers, particularly those in the professional services and IT sectors. It is worth noting there remains some market volatility in this segment, some of which is caused by a lack of transparency in off-market transactions. As most buyers are owner occupiers, issues such as land tax and interest rate levels also remain in the background.
At both the institutional and sub-market levels there’s a trend of tenants downsizing their leasing footprints and moving to more ‘luxe’ accommodation to entice workers to spend more time in the office. While this is often a cost-neutral exercise for the tenant, the trend is impacting vacancy levels for some secondary assets.
Another developing trend is that the cost to develop new offices is driving people to existing assets, particularly in the sub-$15m market segment. While A-grade assets continue to be closely held, some secondary assets are benefiting from this investment outlook. For example, we have seen several old buildings acquired by medical specialist owner occupiers with conversion plans. Having said that, retrofitting existing buildings can be challenging in the context of some ESG and wellness requirements, including end-of-trip facilities.
The KPMG report highlights that Brisbane stands out as a relatively strong performer for institutional grade assets compared to other capital cities, including Melbourne and Sydney.
One of the reasons for Brisbane’s comparatively strong performance in the office sector is that there has been a limited supply coming on to the market in recent years. While Brisbane has had higher vacancy rates historically, the limited supply has led to an absorption of vacant space. This trend is expected to continue over the coming three years with limited new supply of uncommitted space expected to enter the market in the short-term.
According to the Property Council of Australia, office vacancy rates in Brisbane are now at the lowest point seen over the past 10 years, with CBD vacancy rates decreasing from 11.7% to 9.5% over the six months to July 2024. In its media release, the Property Council of Australia said: “The drop in vacancy was due to the combined factors of strong demand with 26,552sqm of net absorption as well as 40,338sqm of office stock being withdrawn from the market.” In turn, demand has lifted rents and improved yield over the past year.
Incentives in the Brisbane market, which have historically been high, are also starting to come down slightly. In the past, the market has seen heady mixes of up to 30-45% rent abatements combined with fit-out offerings. The complexity in the market is that many smaller leases in secondary assets, including good quality strata assets, achieve more modest face rents and comparatively low incentives, which are often below 10% and in the form of rent free periods or fit-out contributions, rather than abatement-free periods. While fit-out incentives continue to apply, speculatively fitted out secondary grade accommodation, which has seen comparatively strong demand in 2021-2023, is becoming over-supplied.
There have been very few A-grade sub-$15m office assets transacting recently, but those that have, have demonstrated the segment’s resilience. For example, three years ago (during a COVID impacted market) a redundant four-story asset in Spring Hill was purchased by a construction business servicing the office sector for $3,000sqm. The company then refurbished the asset with new services and a full speculative fit-out, which was sold in 2024 to an IT company for $8,000sqm.
Urban renewal and infrastructure projects are also boosting investor appetite, including in areas like the Queens Wharf area in the CBD, Fortitude Valley and Woolloongabba. For example, a serviceable but older asset in Woolloongabba near to the soon-to-be completed train station was recently bought by a professional services firm for $6,200sqm with an analysed market yield of 6.15%.
Suburban offices in the sub-$5m category that are in good locations near public transport, parking and social amenities are also performing solidly in the wider Brisbane metropolitan area.
[1] https://kpmg.com/au/en/home/insights/2024/07/commercial-property-market-update.html#:~:text=The%20KPMG%20Commercial%20Property%20Uncertainty,over%20the%20past%206%20months.
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