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Sydney and Melbourne see growing demand for CBD offices

The Sydney CBD office market has seen office investment double in the past 12 months, as demand for office space in Melbourne also remained strong but steady.

The latest Knight Frank CBD Office Market Reports for Sydney and Melbourne show that investment volumes in Sydney doubled to $4.5 billion in 2021, while in Melbourne, investment remained steady at $2 billion, led by strong interest from overseas investors.

With the economy rebounding strongly, the unemployment rate has fallen to a 14-year low of 4.2 per cent and the improving economic conditions are translating into positive demand in Sydney and Melbourne CBDs, according to Knight Frank’s reports.

Across Sydney, lease deal volumes were significantly higher in 2021, with more than 300,000sq m leased compared to 90,000sq m in 2020, with tech and financial services accounting for 60 per cent of all deals.

The report notes that capital growth accelerated during Q4 to reach 4.4 per cent over the full year, with overall total returns in Sydney CBD reaching 8.9 per cent.

The vacancy rate remained steady at 9.3 per cent, while the sub-lease vacancy rate trended lower, from 1.6 per cent in January 2020 to 1 per cent in January 2021.

Demand for office space also rebounded in Melbourne in the second half of 2021, with net absorption rising by 45,560 sq m.

The demand in Melbourne was driven by financial services, professional services, and public administration, making up a combined 92 per cent of take-up in 2021. 

According to Knight Frank, the finance and insurance industry led the surge, accounting for just over half of office take-up in the CBD in 2021.

Across Melbourne, demand for the prime market is strong, with net absorption rising by 51,253sq m and 3501sq m in the A grade and premium segments respectively.

The precincts with the largest falls in net absorption during the pandemic saw the strongest rebound in the second half of 2021.

Chief Economist at Knight Frank Australia, Ben Burston, said sentiment is increasing in Sydney along with economic conditions

“The Sydney CBD office market has rebounded alongside business confidence,” Mr Burston said.

“This has prompted a surge in leasing activity and the strongest net absorption since 2015, in clear contrast to the prevailing narrative which would suggest that many businesses are downsizing.

“It will take time for business to adapt their workplace strategies and the ultimate impact on space needs will vary widely, but a recurring theme from occupiers is a heightened focus on quality, amenity and wellbeing.

“This is driving the remodelling of office workplace environments, with demand clearly weighted towards new buildings and higher-graded existing stock.”

Mr Burston said the negative impact on rents and incentives over the last two years has likely ended with sentiment and demand improving.

“Investors remain confident in the long-term outlook for CBD offices, with strong appetite for core assets driving the recovery of deal activity during 2021 regardless of lockdowns,” he said.

“During 2022 we expect a further acceleration in activity as investors look to position themselves ahead of the anticipated return to rental growth.”

Director, Research & Consulting at Knight Frank Australia, Chris Naughtin, said slowing development will put upward pressure on demand in Melbourne.

“The Melbourne CBD vacancy rate is anticipated to peak at 12.4 per cent in the middle of the year, before gradually declining to around 9 per cent over the next few years,” Mr Naughtin said.

“The increase in prime vacancy during 2021 was driven by the high level of new supply, with development completions bringing the Melbourne CBD total office stock to just over 5 million sq m. 

“Following the large influx in 2020 and 2021, new supplies are projected to slow significantly over the next few years, and we expect this lower level of new supply combined with stronger demand for office space will drive the recovery of the leasing market.”

Mr Naughtin said improving leasing market conditions, tightening vacancy and declining incentives will drive a rebound in effective rental growth in Melbourne.

“The recovery in effective rents will be led by the Eastern Core, where incentives are expected to begin a sustained decline from their current average of 35 per cent from this year onwards,” he said.

“By contrast, we expect average incentives in the Western Core to rise a little further from 40 per cent at the end of last year to 41 per cent at the end of this year and remain around 40 per cent in 2023. 

“By the end of 2026, we expect prime incentives to average 28 per cent and 35 per cent in the Eastern Core and Western Core respectively.”

“Prime net effective rental growth is forecast to be 4.9 per cent p.a. in the Eastern Core compared to 2.8 per cent per annum for the Western Core.”

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Rowan Crosby

Rowan Crosby is a freelance journalist specialising in finance and real estate.