Victoria’s office markets are Australia’s best performing office markets. The vacancy rate of the Melbourne CBD is the lowest of all Australian CBDs while the St Kilda Road and City Fringe precincts recorded rental growth in excess of 20% over the year.

A Grade Office Yields by Market

Tenant Demand

Total employment in Victoria has grown by 72,000 or 2.2% over the year to May 2018. Importantly full-time employment has underpinned the growth of total employment in Victoria over the past two years, which has led to increased demand for office accommodation. This recent improvement in employment has seen the Victorian unemployment rate fall to 5.1% as at May 2018 – the lowest rate since February 2011.

According to the Australian Bureau of Statistics, over the year to May 2018, Victorian employment growth was led by expansion of the Professional services sector with Government and IT sectors also increasing employment over the year.

Over the past 12 months, many occupiers have relocated from the outer suburbs to the City Fringe precinct as it continues to attract tenants, with the next generation of employees preferring to live closer to places of work.

Looking forward, employment is forecast to grow by 2.0% in 2018/19, representing five consecutive years of above trend growth. The unemployment rate is anticipated to stabilise at 5.75% in 2018/19 before declining to 5.50% in 2019/20. A further 70,000 white collar jobs are expected to be created across Victoria in 2018 driven by growth in the Health Care, Professional Services and Education sectors.

New Supply

Despite vacancy falling to 10-year lows, new supply in the metropolitan office market is remains muted. Urban Property Australia research forecasts that new supply in the Melbourne metropolitan office market will total 35,000sqm in 2018, almost half the long-term annual average. Interestingly, the bulk of new supply scheduled for completion in 2018 is located in emerging precincts highlighted by Target’s new 13,000sqm office in Williams Landing and Noordenne Constructions’ speculatively developed 4,000sqm office in Bundoora. With vacancy in the CBD office market down to 10-year lows, development in the City Fringe is projected to increase significantly over the next three years. Between 2019 and 2021, new supply is expected to be focused in the City Fringe precinct with around 200,000sqm is projected to be built, an increase of approximately of 20% on current stock levels.

A Grade Office Annual Rental Growth by Market

Vacancy & Rents

Reflecting Victoria’s strong employment growth; total vacancy in the Melbourne metropolitan office market fell to 5.0% as at July 2018 – its lowest rate since 2008. Vacancy fell across all metropolitan sub-regions with the City Fringe precinct falling to an all-time low at 2.3%. In addition to tenants relocating closer to the CBD, many occupiers also upgraded their accommodation resulting with the metropolitan A-grade vacancy rate falling to four-year lows. Total vacancy in the Melbourne metropolitan office market is forecast to fall further to the end of 2019 with the supply pipeline constrained coupled with continued employment growth. With total suburban office vacancy having fallen to 10-year lows, prime metropolitan office net face rents increased for a seventh consecutive year, driven by the City Fringe. In fact, prime effective rents have grown in the City Fringe on an annualized rate of 15% over the past three years, the highest growth rate of all of Melbourne’s office markets over that period.

Sales Activity

Investment sales activity in the Melbourne metropolitan office market over 2017/18 totalled $836 million, its third highest level on record, with institutions increasingly more active purchasers in the metropolitan market. Annual financial year sales volume in the Melbourne metropolitan office market has now surpassed $700 million for a fourth consecutive year. By far, domestic investors were the largest purchasers of Melbourne metropolitan offices with A-REITs and unlisted funds acquiring the bulk of investment opportunities.

With prime yields in the CBD office market currently ranging between 4.75% and 5.25%, investors are increasingly seeking investment opportunities in other office markets offering superior returns, such as the metropolitan office market. Competition for limited quality assets resulted in both prime and secondary yields in the Melbourne metropolitan office market falling over the year to July 2018.

CBD, St Kilda Road & Southbank Office markets

The Melbourne CBD office market experienced the largest decrease in vacancy over the six months to January 2018 and now boasts the lowest vacancy rate across all Australian CBDs. The Melbourne CBD office market decreased to 4.6% as at January 2018, its lowest vacancy rate since July 2008. The CBD office market recorded 74,800 square metres of net absorption over 2017, more than any other Australian office market, and was the 15th consecutive calendar year of positive net tenant demand. As a result of vacancy falling to its lowest rate in nearly 10 years, prime CBD effective rents have reached unprecedented levels, growing 15% over 2017. Future supply is on par with historic averages over the next two years, with 240,500 square metres to be brought to market in 2018 and 2019. Boosted by several significant fund-through transactions, investment activity in 2017/18 within the Melbourne CBD office market totalled $3.19 billion, its highest level on record.

Outside of the CBD, the Southbank office market recorded its highest level of tenant demand in seven years; however, high levels of supply pushed vacancy up. With further office properties withdrawn for residential development, vacancy in the St Kilda Road office market fell to its lowest level since July 2008. Looking forward, prime rents are forecast to grow solidly through 2018 underpinned by the current low vacancy, lack of new supply and additional stock withdrawn. With prime Melbourne CBD office assets transacting below 5% yields, investors – particularly smaller unlisted funds, private investors and offshore groups – are looking to more ‘value add’ opportunities with higher cap rates in other office markets. Intense competition for CBD office properties in Melbourne created a surge of appetite across Melbourne’s other office markets. Investment activity in the St Kilda Road and Southbank office markets totalled $701 million in 2017/18, with offshore investors acquiring the majority of investment opportunities.

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