Melbourne landlords with poor-quality office space placed on notice: Charter Keck Cramer

By Larry Schlesinger
Wednesday, 06 February 2013

Melbourne office landlords with better quality floor space are best positioned to weather what is expected to be a softer office rental market over the next two years.

Consultants Charter Keck Cramer (CKC) are anticipating weaker demand for office rentals in the Melbourne CBD and Docklands markets over 2013 and 2014, with not yet fully committed new supply adding to the pool of available space.

“Melbourne’s central city office market (CBD and Docklands primarily) have been holding up well in the context of the numerous headwinds that have buffeted the economy and global property markets,” writes CKC director Robert Papaleo in a new commentary piece.

“Although central city office rents are not growing and vacancy rates are trending up, new supply has continued and investors have keenly sought prime assets at lower yields.

“The softening demand environment and other indicators clearly signal however that conditions in 2013 and 2014 will shift in favour of tenants in an increasingly competitive marketplace where better quality floor space will become more cost-effective,” he says.

Papaleo says there now a “clear window of opportunity” for both landlords and tenants to respond proactively to the reality of this emerging situation.

“Owners that act early and decisively will cap their exposure to the downside risk of further weakening in the rental market.

“Tenants that properly understand their own requirements (and lease obligations) relating to their accommodation will be best placed to take advantage of changing market conditions and the inevitable opportunities as they arise,” he says.

A further indication of weaker demand conditions going forward is a rise rental incentives being offered by landlords.

These can include such things as a certain number of rent free months or contributions made by the landlord to the cost of office fit-outs.

Papaleo says rent incentives have been a “notable feature of office lease negotiations since 2009 in response to GFC induced fears”.

These incentives eased through 2011 due to a brighter outlook, but rose again through the second half of 2012.

“The market is implicitly recognising, through higher incentives, that the impending new supply is expected to have a detrimental effect on vacancies.

“Firstly, there is a relatively high level of uncommitted floor space in some new buildings under construction which will be compounded by vacant floor space being left behind by those tenants moving into the new buildings.

“This situation is in contrast to what happened in the last supply cycle (2002 – 2008).

“In the last cycle, demand from anchor tenants was so strong that it was able to (almost completely) underwrite new floor space prior to its completion whilst other tenants were expanding to absorb much of the space being left behind which prevented extended vacancy.

“Strong market conditions also implied that it was viable for owners to withdraw vacant backfill floor space for upgrading and refurbishment.

“The weakening rental scenario this time around however will not afford owners the luxury of withdrawing space through 2013 and 2014 which will leave owners fully exposed to vacant floor space,” he says.