Introduction
The DAE Business Outlook forecasts economic growth in Victoria to be the strongest of the mainland states in 2019-20 and the strongest among all the states in 2020-21.
Victoria’s gross state product is forecast to grow by 2.5 % in 2019-20 and by 2.9 % in 2020-21.
Government infrastructure investment, business investment and household consumption are expected to be the major drivers of State’s growth in 2019-20.
Business investment in Victoria will be supported by a large amount of engineering construction activity. Private engineering and commercial construction are forecast to increase by 4.6 % in 2020-21.
There is currently AUD 31 billion worth of transport projects under construction in Victoria, including the Melbourne Metro Rail Project, with a further AUD 53 billion across various projects in planning stages.
Strong employment growth has been recorded in recent years, which has driven demand for office space in both the Melbourne CBD and Melbourne’s metropolitan markets. While Deloitte Access Economics are forecasting employment growth in 2020 to be softer than previous years, it is expected to remain quite strong at 2.1%, before falling to 1.5% in 2021 and 2022.
The evolving coronavirus outbreak clearly poses significant downside risks for the global and Australian economy. In Australia, the initial growth impact is being felt primarily through services exports such as tourism and education. While the impact on office-based employment is likely to be more limited occupier demand may slow in the near term because of the spill-over effects from a weaker economic climate.
Melbourne Office Market Overview
While growth will inevitably slow in 2020, Melbourne will remain a key driver of the national economy and continue to experience faster rates of growth underpinned by population growth, urbanisation and the clustering of key service industries. Coupled with a tight occupier market, this long-term growth trajectory will ensure demand from investors and developers remains resilient.
A very strong office net absorption rate averaging 115,900 sqm annually from 2015-18, and a delayed development pipeline has led to Melbourne being the tightest CBD office market in the country.
Demand has been driven by a range of sectors, but much of the take up has been driven by four particular sectors: the professional services, finance & insurance services, public administration & health care services, and co-working & real estate sectors.
While employment growth is tipped to slow post 2020, office employment in Melbourne is nonetheless forecast to grow by a healthy 12% over the next 5 years (2019-2023). This translates to more than 25,000 new white-collar jobs which will need to be housed in office accommodation, ensuring robust tenant demand and office development over the medium term. Office employment growth is expected to be driven by the professional and public administration sectors.
Vacancy
The Melbourne CBD office market has virtually run out of office space. In the second half of 2019 CY vacancy declined again to now reach 3.2%. This is the equal lowest level of vacancy recorded for over 10 years.
With significant supply imminent, it is anticipated that vacancy will trend upward over the next two years. However virtually all of the 2020 new development pipeline is pre-committed which speaks to the pent-up nature of demand within the CBD market. Tight conditions have proven favourable for the fringe and metropolitan office markets.
Tight conditions have proven favourable for the fringe and metropolitan office markets.
Supply
The pipeline of new office development that is expected to land in Melbourne’s CBD over the next 2 years will result in backfill vacancy as CBD based tenants relocate to new office space within the CBD.
Between 2020-21, in excess of 310,000 sqm of backfill space is expected to hit the CBD market. All of the 2020/21 backfill stock is set to be Premium or A grade quality, and with the recent flight-to-quality trend dictating demand rests with premium stock, much of the CBD’s forthcoming backfill stock is tipped to be absorbed promptly, once any refurbishments are completed.
Vacancy compression is also furthered by no supply additions in St Kilda Road, over the past 12 months and positive net absorption over the last two years.
The lack of available space has constrained net absorption, leading to higher rental growth and lower incentives. It has also pushed tenants to other nearby office markets such as the CBD, Southbank and Metropolitan markets.
Leasing Activity & Demand for Office Space
Given the amount of backfill space due to hit the market in the coming 2 years, the CBD office leasing market is tipped to become competitive.
In response to this we are already seeing a number of landlords investing in refurbishments in a bid to reposition their assets to maximise their leasing potential.
Price Trends & Rental Incentives
Melbourne CBD office rents continue to grow at a rapid rate with double-digit growth evident for both prime and secondary rents over the last CY. Sustained tenant demand and high occupancy of CBD office stock has accelerated rental growth for landlords.
The strength of the increase in CBD rents over the past 3 years has been such that a flow-on effect has been felt in the office fringe market, especially within the inner east where net rents have risen by 88% in Cremorne and 81% in Richmond over the last 4 years to July 2019.
Prime net face rents have risen for both the St Kilda Road and Southbank precincts over the last 12 months. Along St Kilda Road rents are up by 8.4% to now sit at AUD 450, whereas along Southbank rents are up by 5.0% to now sit at AUD 575. Rents in both precincts have grown considerably since 2018.
Thus tenants are likely to opt for lease renewals on favourable terms or alternative space in the Melbourne Metropolitan regions.
Outlook
Global economic conditions remain mixed. Although trade tensions have eased somewhat, downside risks stemming from the COVID-19 outbreak have escalated, leading to volatility in the financial markets and the Australian dollar weakening to around an 11-year low.
Economic growth has slowed recently, and September GDP results were the weakest in over a decade. However, growth is forecast to increase to average 2.4% over the following five years.
On a positive note, the residential housing market is improving (particularly in Melbourne and Sydney), and the broader economy is being supported by record low interest rates, tax cuts, infrastructure development and solid employment growth.
Assuming the virus outbreak peaks in the coming months, growth is expected to mount a strong recovery later in the year as lower interest rates, fiscal stimulus and a return to confidence all combine to boost activity. At this stage, NAB and Oxford Economics expect GDP growth to recover strongly in 2021 to an above-trend pace of 2.8% and 3% respectively.
Melbourne office demand will remain robust in the medium to long term underpinned by population growth, urbanisation and the clustering of key service industries.
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