This blog has spent a lot of time highlighting the looming oversupply of apartments facing Melbourne. Well, it appears that the office market is facing similar conditions, with Morgan Stanley today releasing research pointing to a big ramp-up in office construction and office vacancy rates over the next couple of years:
Melbourne has been one of the better performing gateway cities in Australian office markets over the past five years, with vacancy remaining low and effective rents remaining defensive. However, Melbourne’s supply pipeline has well and truly picked up in the past 12 months, with close to 327,000sqm of committed supply forecast to come online between now and 2015. Importantly, a lot of this supply is in fact pre-committed (~240,500, or 74%)…
However, without a pick up in office demand, this new supply is likely to result in a higher level of backfill and sublease space re-entering the market…
Supply likely to outstrip demand for some time. Demand in Melbourne over the past 12 months has been negative (circa 40,000-45,000sqm). More recent anecdotes suggest demand has stabilised but there are few signs of corporates growing their tenancies at this stage. Even if Melbourne reverted to its longer-term annual average demand of circa. 70,000sqm, it is likely that it would take ~4.6 years of average demand to absorb current supply, or the backfill space left over. Of course, this can change pretty quickly, but it highlights the challenges for the Melbourne CBD and Docklands office markets in the near and medium-term.
Higher relative vacancy profile places continued pressure on effective rents. Our forecasts suggest risks to vacancies in the short-to-medium term is to the upside, and expect Melbourne’s office market vacancy will peak around 11.4% this year, from ~8.0-8.5% currently. This is an environment where tenants typically have the upper hand in rental negotiations, and more recent market feedback would suggest that incentives in Melbourne are quickly approaching Sydney, where they are moving toward the 25-30% range. With weaker relative demand, and a relatively large development pipeline, we expect landlords will favour filling space and offering higher incentives, rather than waiting for a better deal, placing further pressure on effective rents. We forecast relatively subdued effective rental growth in the next three years, with a 5-year CAGR of just ~1.6%.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
