Although the Melbourne metropolitan office vacancy rate marginally fell in the first half of 2014, vacancy remains above the 10-year average at around 7.6%.

Despite the elevated vacancy levels, the outlook for the metropolitan office market remains positive with the new supply pipeline limited coupled with increasing trend of converting proposed office development sites into residential use.

According to the Australian Bureau of Statistics, over year to August 2014 Victorian employment grew by 49,700 jobs. The growth of employment was driven by the education and retail sectors. In terms of traditional white collar employment sectors, the finance sector grew only modestly over the 12 months to August while employment in the professional services sector contracted in the year. In the year to August 2014, Victorian employment increased by 1.7%, modest in comparison to the past 10 years, but an improvement on the preceding year.

Supply of new office space continues to remain subdued across Melbourne. Within in the metropolitan office market specifically, new supply remains well below the long term average with new supply forecast to total 40,000 square metres in 2014. Looking ahead, Box Hill and Dandenong are both anticipated to face significant rises in vacancy over the next 12 months, impacted by relocations of the ATO into new buildings in both suburban office hubs.

In line with the soft employment growth, tenant demand has also been muted over the past two years. However with pre-commitment levels within the new development high, options for tenants seeking new accommodation remain limited which have stifled significant rises in vacancies and held rental levels steady.

The recent trends in job advertisements coupled with improvements in business confidence levels should transcend into uplift in leasing transaction activity over the next six months. Whilst Victoria in particular has been impacted the spate of planned manufacturing closures anecdotal estimates suggest that manufacturing tenants only account for 5% of metropolitan office, and thus unlikely to have a significant bearing on vacancy and rental levels.

In contrast to the subdued leasing conditions investment activity has been steadily improving since the trough recorded in 2008. While the majority of offices were purchased by syndicates and private investors in 2013; of interest has been the emergence of foreign capital into the metropolitan office market.

With significant investment activity and tightening yields in CBD office market, investors are looking towards other office markets as alternative investments and this trend has seen investor volumes reach new peaks. Institutional investors continue to be the largest purchaser group within Melbourne’s metropolitan office market as demonstrated by GPT Metropolitan Office Fund’s acquisition of 109 Burwood Road, Hawthorn for $63 million.

The attractive yields on offer within Melbourne’s office markets in comparison to global markets and Australia’s economic outlook has resulted in very strong offshore interest which is likely to continue to pressure current yield levels.