In contrast to the subdued leasing activity, investment activity reached record levels in the Melbourne metropolitan office market in 2014.

Tenant Demand

White collar employment growth is forecast to continue to gather momentum across Victoria with employment in the suburbs projected to increase at a faster rate than the St Kilda Road office precinct, which should result in tenants continuing to seek office accommodation in the City Fringe and Inner Eastern office markets in particular.

Leasing activity below 1,000 square metres continues to be the main driver of activity in the metropolitan office market in 2014; however demand for good quality large opportunities is building, constrained by the limited development pipeline of the past five years

According to the Australian Bureau of Statistics, over 2014, Victorian employment growth was largely driven by the retail trade, transport & logistics and surprisingly manufacturing sectors. In terms of traditional white collar employment sectors, employment levels remain volatile with finance and professional services sectors contracting whereas public services employment grew in the 12 months to November 2014. In the year to November 2014, Victorian employment contracted by 0.3%, weak in comparison to pre-GFC levels.

While Australia’s unemployment rate remains elevated, recent trends in job advertisements are consistent with a gradual turnaround in the labour market. ANZ job ads are up 11% over the year to December 2014, recording their seventh consecutive monthly rise. Over the next three years, white collar employment in Melbourne’s suburban office market is forecast to increase on average by 1.7% per annum, driven by growth in the professional services, health care and education sectors.

New Supply

While the development pipeline in the metropolitan market continues to pick up since its trough of 2010, the level of completions remains 30% below its historical average. Interestingly, of new supply currently under construction, the majority of development is concentrated in the Outer Eastern and South East regions, typically pre-committed by government agencies, highlighted by the construction of two offices for the Australian Taxation Office.

Vacancy & Rents

Currently the Melbourne suburban office vacancy rate sits at 7.5% – its highest level since 2010. Notwithstanding this, the level of occupied stock in the Melbourne suburbs continued to increase over the past 12 months.

Despite vacancy reaching four-year highs and soft tenant demand, face rentals have been held up by a lack of options for larger suburban office tenants. With pre-commitment levels high in the new developments, there are limited options with vacancies in excess of 3,000 square metres.

Since 2012, net face rents across the suburban office market have largely remained stable, reflecting the subdued tenant demand environment. Whilst incentive levels on average have risen in the suburban office market, of interest are the differences in levels across the regions. In order to compete with the increasing leasing options in the CBD office market, incentives for City Fringe and Inner Eastern located offices typically range between 20% and 30%. In contrast, incentives across the other suburban office regions range between 10% and 20%.

Sales Activity

With investment competition remaining intense for prime, core assets, investors are increasingly seeking to expand their exposure to the Victorian office market with more investment into the metropolitan market. Investment sales activity has surpassed record levels in consecutive years with more than $500 million transacted in both 2013 and 2014.

Of interest has been the re-emergence of AREITs in the metropolitan office market who are increasingly delving into markets beyond the CBD office market as demonstrated with recent purchases made by the GPT Group, 360 Capital and Growthpoint.

Investor appetite for modern assets with long lease expiry profiles will continue to attract institutional interest as demonstrated by the transactions of 211 Wellington Road, Mulgrave and Botanicca 8 in Burnley. This strong investor demand has placed downward pressure on yields with prime office yields compressing by 75 basis points over the past two years to now range between 7.5% and 8.5%.

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