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CBD Benefit

Sydney CBD Office Market

The commercial office market in Sydney CBD will be the main player in 2008. There is likely to be a surge in leasing activity, with companies rethinking purchase selection as the cost of borrowing puts a strain on the bottom line. Strong tenant demand sets the stage for another round of construction, with several new speculative buildings now likely to go ahead.

The vacancy is likely to fall before new stock can hit the market. With strong demand and a lack of options available, the Sydney CBD market is expected to be a major beneficiary and standout player in 2008.

Strong demand from business growth and expansion has fueled demand, but the decline in inventory largely drove the tightening of vacancy rates. Total office inventory decreased by nearly 22,000 m² from January to June 2007, representing the largest drop in inventory levels in more than five years.

Continued solid growth in white-collar employment and healthy corporate earnings supported demand for office space in Sydney’s CBD in the second half of 2007, resulting in positive net absorption. Driven by this demand from tenants and decreasing available space, rental growth has accelerated. Sydney CBD’s prime core net face rent increased 11.6% in the second half of 2007, reaching $715 psm per year. Incentives offered by landlords continue to decline.

The total CBD office market took up 152,983 m² of office space during the 12 months to July 2007. Demand for A-class office space was particularly strong, with the A-class absorbing 102,472 m² off-market. Order in the premium office market has decreased significantly with a negative take-up of 575 m². By way of comparison: a year ago, the premium office market took up 109,107 m².

With negative net absorption and rising vacancy rates, the Sydney market struggled for five years between 2001 and 2005, when things started to change, but vacancy remained at a fairly high 9.4% until July 2006. Due to competition from Brisbane and, to a lesser extent Melbourne, it has been a real battle for the Sydney market in recent years. Still, the core strength shows the real result with probably the best and most solid performance indicators since 2001.

The Sydney office market currently registered the third highest vacancy rate at 5.6 percent compared to any other major office market in the capital. The highest vacancy rate increase for total office space across Australia was for Adelaide CBD, with a slight increase of 1.6 percent from 6.6 percent. Adelaide also registered the highest vacancy rate in all major capitals at 8.2 percent.

The city with the lowest vacancy rate was Perth’s commercial market, with a vacancy rate of 0.7 percent. Brisbane and Perth were among the better-performing CBDs with a sub-let vacancy rate of just 0.0 percent in terms of under-let vacancy. The vacancy could fall further in 2008, as the limited offices to be delivered over the next two years come from extensive office refurbishments, much of which has already been committed.

The market is going to get interesting at the end of this year. Assuming that the 80,000 square feet of new and refurbished sticks re-entered this year are absorbed, coupled with the minimal stick additions coming to market in 2009, vacancy rates and incentive levels will plummet.

The Sydney CBD office market has taken off in the past 12 months, with vacancy rates plummeting to 3.7%. This was accompanied by rental growth of up to 20% and a marked decrease in incentives in the corresponding period.

Strong business growth and expansion demand have fueled this trend (unemployment has fallen to 4%, the lowest level since December 1974). However, the decline in inventory has largely led to the tightening of vacancy rates over the next two years with limited space on the market.

Any assessment of future market conditions should not ignore some potential storm clouds on the horizon. If the US subprime crisis creates a liquidity problem in Australia, businesses and consumers will find debt more expensive and harder to get.

The Reserve Bank continues to raise rates to suppress inflation, which has caused the Australian dollar to rise and oil and food prices to continue to rise. A combination of all these factors could dampen the market in the future.

However, strong demand for Australian commodities has contributed to the Australian market remaining relatively undisturbed. The outlook for the office market in Sydney CBD remains positive. As supply is expected to be moderate in the coming years, vacancy rates for the nest will stay low for two years before increasing slightly.

Looking ahead to 2008, net demand is expected to fall to approximately 25,500 sqm, and new additions to supply are expected to reach 1,690 sqm, bringing vacancy rates down to about 4.6% in December 2008. Top rental growth is expected to remain strong in 2008. Premium Core net rental growth in 2008 is expected to be 8.8%, and Grade A-shares are likely to grow approximately 13.2% over the same period.

With this in mind, if demand continues as expected, the Sydney CBD office market should continue to benefit from rising rents due to the lack of existing stock or new stock on offer until at least 2010.

Tim Green is the Managing Director at Tim Green Commercial, a boutique commercial real estate agency based in Sydney, Australia.