City office markets ill, but not dead yet

Speculation about the demise of CBD commercial office markets is understandable, as legions of workers take shelter around the world and, on a specific local level, in Melbourne and Sydney.

But while those CBDs might not be in the best of health right now, predictions of their demise appear somewhat premature.

Leasing enquiry levels are a sturdy indicator of business’ longer term intentions, and have remained healthy in most Australian capital city markets since the COVID-19 outbreak, although further lockdowns may affect this.

Speaking to Australian Property Investor Magazine, CBRE’s Pacific head of office leasing, Mark Curtain, said listing enquiries were 50 per cent below normal levels but had risen across all markets. 

Data released this week showed office rents had fallen in all capitals except Perth and Canberra in the second quarter of 2020. 

Despite an uptick in business confidence, and predictions that the impact of COVID-19 may not be as severe as originally forecast, the east coast markets were most affected because of their large financial services sectors.

Sydney recorded the largest fall in effective rents at more than 6 per cent, followed by Brisbane and Melbourne. Demand and rents remained steady in Adelaide.

But even during such extreme circumstances as a global pandemic and lockdowns, only Brisbane failed to avoid a net face rent decline. 

This positive result for other city centre markets was attributable to landlords offering incentives beyond rent reductions.

Working from home arrangements mean office tenants are being offered higher incentives for leases in a bid to lure them back to major east coast CBDs. 

“Slightly higher incentives are being offered across most markets, but I relate that to landlords trying to encourage tenants to act in a low transactional environment,” Mr Curtain said.

“Capital is generally tight for all businesses at the moment so using the landlord to fund fit-outs makes sense for most tenants, rather than taking a cut in rent receipts.”

Pulse reading

As businesses struggle with insipid economic conditions, some are seeking to downsize office space to reduce overheads. 

But just how will this play out in the longer term, should the coronavirus be subdued with the advent of a vaccine or other breakthrough?

“Yes, there will be change but I expect it to be less dramatic than the extreme views being circulated by some market commentators,” Mr Curtain said. 

“Some companies will leverage this opportunity to provide a completely different working model to reduce costs and offer more flexibility to staff but the great majority recognise that the office environment is a critical ingredient in maintaining a collaborative, connected team environment.”

A recent Swiss court ruling that employees working from home were entitled to receive a portion of their rent or mortgage from their employer also highlights how the landscape can change quickly, in this case back towards the traditional office.

In Perth, where the lockdown conditions have largely been lifted, there were signs of how a normalised office market may respond.

The Western Australian capital was hard hit in recent years as the mining industry waned and the CBD vacancy rate has now moved out to 20.1 per cent in the second quarter of 2020, up from 19.5 per cent in the previous quarter.

JLL WA head of leasing Nick Van Helden was insistent that Perth CBD enquiry levels and market activity were improving.

“JLL tracks inspection numbers by prospective office tenants and these inspection numbers do remain down on the corresponding 2019 period, however, the June monthly figures show a significant increase from April and May, indicating tenants are reverting back to a normal decision making pattern,” Mr Van Helden said.

JLL’s WA managing director John Williams said the workforce changes may be temporary.

“Global economic recovery will be driven by government stimulus focused on infrastructure projects and the mining sector will be an indirect beneficiary of this investment. 

“While short term impacts in the office sector is a given, it is possible recovery will be in the short to medium term albeit with reduced expectation on growth.”

Major developers across the nation remain understandably wary of large investments but opportunistic investors, particularly from overseas, are watching carefully for potential distress sales.

CBRE’s Mr Curtain said capital markets were waiting to see how the leasing markets settle before they actively trading again. 

“Of course, well leased assets with long WALE (weighted average lease expiry) and good tenants are still highly sought after.

“I think we will need another 12 months to fully understand the impact on capital values and how the market prices in the anticipated uptick in vacancy rates and softer demand.

“These are the changes that will impact values more so than substantial changes in core capitalisation rates, and interest rates are going to be low for some time to come.”

Australian CBDs are currently experiencing significant health issues but their ultimate longevity will owe much to the scientists working on a vaccine for the coronavirus that has infected big cities everywhere.