Commercial property from the March edition.
The insatiable demand for office space, especially in Perth and Brisbane, is completely out of step with supply. So expect steep rent hikes over the coming years.
When the good times roll quality office space is difficult to find and damned expensive. When loads of space is available and cheap, nobody wants it.
Nowhere is this more in evidence than in Perth and Brisbane. For some 15 years it just hasn’t been worth investing in or even contemplating building commercial property in these cities. Rents have been too low, with landlords forced to offer extremely generous incentives to seduce companies into filling their empty offices.
But now there is a property crunch. You can blame China’s hunger for Australia’s resources. In particular, it is caused by resources companies opening up new mine capacity to meet demand. Basically, when mining companies expand operations, they also need additional CBD office space to house the hundreds of extra financial and technical experts and their computers.
Dr Frank Gelber, chief economist at economic forecaster BIS Schrapnel, says: ‘The thing that employs a lot more people, the thing that drives demand for commercial office space, particularly in Brisbane and Perth, is the construction phase, i.e. investment in new capacity.’
John Sears, manager of forecasting services at property consultants Jones Lang LaSalle, says it’s very hard to find space in Brisbane and Perth at the moment. ‘The problem is, because the space is required for office accounting, they need relatively good space and air-conditioning systems for the computer networks,’ he says. ‘It can’t be [second-rate] building space.’
He believes companies will soon find the only offices available to them are ‘rats and mice space in the ‘c’ and ‘d-grade’ buildings’.
Says Sears: ‘Brisbane is basically effectively full. [It is] down to 3 per cent vacancy rate.’The executive director of the WA division of the Property Council of Australia, Joe Lenzo, said in a release:
‘The property sector is battling to keep up with demand for property due to the most acute period of stock shortage in WA in over 20 years. Not since the late 1980s have all sectors of the WA property market boomed at the same time.’
Gelber says there are good and bad sides to strong demand in Perth and Brisbane. ‘The good side is that they need a lot more project managers, designers, construction lawyers and accountants when that investment is going on,’ he explains. ‘When the investment stops, even when you are exporting, a lot more of those jobs go.
‘The real strength of the Perth and Brisbane markets depends critically on how long the investment boom will keep going.’
The first phase of the minerals investment boom began three years ago. Gelber says that capacity is only now coming on stream. The second round will sustain investment for at least another two and a half years.
This pressing need for space has come on the back of an extended period of weak demand for office space. Three years ago in Brisbane companies were offered two-and-a–half-year incentives (rent-free periods, free fit-outs, or a combination of both) to take space.
‘What happens now is we get caught short of office space because we haven’t built enough,’ Gelber says. ‘And particularly in Brisbane and Perth, they were remarkably reluctant to spec new buildings … You couldn’t underwrite the financial feasibility of a new project.’
Sears says the solution for many companies may be to move their offices to other Australian cities or even abroad to, for example, Singapore.
If mining facilities are scattered around WA it probably is more convenient to be based in Perth but with today’s electronic communications it is not essential. The same goes for Brisbane.
Figures for the fourth quarter of 2005 released at the start of last month showed rent for premium buildings in Brisbane is $361/sq m. In Perth it’s $345 /sq m, Sydney is $507, Canberra is $298 and Adelaide is $226.
Melbourne is about $330, making it a viable alternative location. ‘Because the space is relatively cheap there [in Melbourne] companies have been taking extra space and moving in from the suburbs,’ Sears notes. ‘It gives them a bit of an edge when you are comparing to Brisbane or Perth.’
Sears forecasts vacancy rates staying tight for the next three to four years. And while there are some new projects proposed in Brisbane, they are unlikely to go ahead unless firm tenants can be found.
The total amount of floor space in Perth, Sears notes, hasn’t increased for 10 years. That’s partly because overdeveloping in the late 1980s burnt so many developers. He says: ‘Developers are very reluctant to go ahead unless they have got a precommitment to a tenant, which will limit the boom/bust [cycle] we’ve seen in the past.’
However, according to the Property Council’s Lenzo there are at least two major commercial developments on the drawing board for Perth in 2006.
Yet with demand for space increasing and rents rising, new buildings can be justified – although there are few sites for new buildings in central Brisbane and Perth.
‘At this stage of proceedings, we are not going to get enough new space on to the market in the next two to probably three years to prevent much further tightening,’ Sears says.
Says Gelber: ‘In a year’s time the name of the game will be, ‘How the hell can we get space in this market?’ You can’t get any new space coming on. And there is strong demand for what there already is. All incentives have gone and rents will increase.
‘But – and this is the nightmare – now we will see strongly rising rents underwriting a round of new construction, which should come on stream just in time for the next recession because of the volatility of minerals investments,’ says Gelber, who believes the next recession will hit in 2008.
Over the next two years Gelber forecasts effective rents in Brisbane and Perth will increase by 50 per cent, with Sydney and Melbourne showing similar increases.
Sears says that gross effective rents (which exclude incentives) increased by 21 per cent for nine months to September 2005 in Perth. ‘A huge amount of that – over 16 per cent – came in the third quarter,’ he says.
‘That’s because Perth has gone to having one of the highest vacancy rates in the country to effectively being full. ‘Then the landlords realised they could raise their rents proportionally,’ Sears says.
Gelber says: ‘From the point of view of the tenant, the days of the extraordinary deals have gone. But the deals you do today are an awful lot better than the deals you are going to be doing in three years’ time.
‘What we are going to see now is a rapid absorption of excess space and very strong rises in effective rents as people recognise that there will be firming yields and rising property values. So here we go. This is it. Hang on to your hats for the next two and a half years. It’s going to be really strong.’