‘Underlying issues’ flagged in secondary office markets

The latest CBRE ViewPoint report has examined current activity in Australian capital cities’ secondary markets — a broad term used to describe B, C and D grade office buildings.

According to the report, secondary office markets in the central business districts of Perth, Brisbane, Adelaide and Canberra are suffering high vacancy levels, with many buildings being rendered obsolete.

Further, the research found that over the past few years, these four markets have recorded either zero or negative net effective rental growth.

Oppositely, Sydney and Melbourne are reporting positive activity when it comes to secondary office markets.

“The secondary markets in Sydney and Melbourne have performed well because of strong economic fundamentals, low vacancy rates and increased demand for office space in conjunction with strong white-collar employment growth,” explained CBRE senior research analyst Aiden Bresolin.

“However, in Perth, Brisbane, Adelaide and Canberra, it is a different story. Some secondary buildings in these locations are now virtually untenable or have a high vacancy of 40 per cent [or over] and require extensive refurbishment to be brought up to a modern standard.”

Perth

Breaking down the cities, CBRE noted secondary vacancy is currently nearing 26.7 per cent. Despite this, however, the report predicts there will be some improvement in the WA capital in the medium term.

“In the six months to 1 July 2019, B grade vacancy rates fell by 3.3 per cent, which is the largest B grade vacancy fall since the second half of 2011 and a surprising result with the magnitude of the reduction,” said CBRE’s senior director, office leasing, Andrew Denny.

“It is also only the second time in eight years that B grade vacancy has fallen.”

Mr Denny added in the past 18 months, owners of B grade building have started to undertake significant building refurbishments, including aggressive speculative fitout programs.

“However, most C grade assets do not meet the requirements of tenants and are difficult to lease,” he said, noting that common issues in Perth include “ownership by high-net-worth investors, who are under little pressure to upgrade or sell and can service debt at such low rates”.

Brisbane

In terms of Brisbane, the report found vacancy spread between prime and secondary stock peaked in 2017 at a high of 10.9 per cent and currently sits at 6.8 per cent.

Secondary stock that has been bolstered with end-of-trip facilities, lobby and speculative fitouts are becoming a common occurrence, as well as lift and façade upgrades.

CBRE state director, office leasing, Chris Butters explained the attention to these details are more likely to attract tenants in a market that still has a high level of B grade vacancy.

“A niche example now under construction is Brisbane’s Midtown Centre which will link to existing C grade assets into one A grade building once completed,” Mr Butters said.

“The new tower will offer floor plates from 1,800sqm up to 2,500sqm with practical completion due for mid-2021. Midtown Centre will offer best-in-class amenity, services and workplace opportunities.”

Adelaide

Describing the market as a “quiet achiever”, the CBRE report said investor interest in Adelaide’s B grade stock has remained buoyant, with interest from funds seeking to capitalise on investment returns.

“Vacancy at an asset level allows for refurbishments to be conducted within a short time from purchase, adding immediate value and attracting and retaining tenants,” said CBRE senior director, office leasing, Andrew Bahr.

“However, there are C and D grade buildings in Adelaide that are simply untenable. Landlords not fully understanding the dynamics of the market, and the belief that finding a tenant first and then providing a tailored fitout is an option in an ‘impressions first’ market, are contributing factors to the decline in popularity of these buildings.”

Canberra

When it comes to Australia’s capital city, CBRE’s state director, office leasing, Zoe Ferrari, noted she “had never seen a secondary/prime vacancy spread as large as [one that] exists today”, at 10.8 per cent.

“The public sector accounts for around one-third of white-collar employment in Canberra and, with the trend for these public bodies to move into A grade space, vacancy in secondary stock is expected to remain high and possibly expand over time,” she said.

“Secondary buildings are ageing and losing appeal in the market as government requirements such as high NABERs ratings have contributed to a transition from secondary buildings to prime buildings.

“However, owners of secondary buildings who are proactively investing in refurbishments are continuing to experience solid tenant demand.”

In addition, Ms Ferrari said many C grade assets in Canberra have issues with noise, employee density, natural light, and lift and mechanical issues.

“With demand for this type of stock continuing to deteriorate, demolition and replacement would be the best strategy for optimum returns in the long run, albeit it’s not an easy strategy for owners to execute,” she said.