Melbourne office slump set to continue

Melbourne office slump set to continue
Published:06 May 2013 Author:Claire Chaffey Source:Property Week

The Melbourne office market is set to get worse before it gets better, potentially setting off market panic, according to the latest BIS Shrapnel report.

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The BIS Shrapnel Melbourne Commercial Property Prospects 2013 to 2023 report states that Melbourne’s office market is experiencing rising vacancy rates, in turn pushing up leasing incentives and causing effective rents to retreat.

And market participants who expect conditions to bounce back next year shouldn’t be so sure, according to BIS Shrapnel.

“This is a more severe setback, caused by weakness in the Victorian economy on several fronts,” says Maria Lee, senior project manager and report author.

“Dwelling building activity is declining, there are severe cuts to public sector investment, and the high Australian dollar is taking its toll on manufacturing and some service industries.”

Office vacancy rates are set to hit around 10 per cent by the end of 2013 and remain elevated for another year or so. In this environment, it will be important for landlords to preserve cash flows.

“We expect leasing incentives to rise further, to an average of 34 months’ rent free equivalent in the prime market,” says Lee.

The other side of the coin is that conditions are favourable to tenants.

“Tenants already hold the balance of power in leasing negotiations, and that will continue to be the case for some time,” says Lee. “There’s no need for tenants to rush their leasing decisions.”

BIS Shrapnel’s report highlights the risk of even higher leasing incentives being introduced if market participants react in a similar way to the early 2000s.

“The market panicked after the negative net absorption of 2002 and early 2003, when vacancy rates hit around 10 per cent, and prime net effective rents fell by 30 per cent,” says Lee.

“This time around, the market reaction has been more measured to date. Even so, incentives have already risen and effective rents have dropped by about 7 per cent. But we are concerned about what might happen in 2014 when the bounce-back anticipated by many fails to materialise.”

Existing investors and those entering the market now need to be prepared for a sustained period of challenging conditions and plan their leasing strategies accordingly. But BIS Shrapnel notes that nothing fundamental has changed—the conditions that drove the strength of the Victorian economy last decade are still in place. Consequently, the report forecasts a strong rebound in the second half of this decade.

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