Brisbane fringe office market to improve later this year

Vacancy rates will fall and effective rents will strengthen from the second half of 2018, according to Knight Frank research

1 June 2018, Brisbane – VACANCY rates in the Brisbane fringe office market are expected to ease later this year as tenant demand lifts and new supply falls, according to research from Knight Frank.

The latest Brisbane Fringe Office Market Overview found total vacancy was expected to rise slightly from 14.1% to 14.8% to peak in mid 2018, before beginning to ease.

Knight Frank Senior Director – Office Leasing Andrew Carlton said total vacancy in the fringe was expected to show a sustained recovery from late 2018, along with an improvement in effective rents.

“Improved tenant activity will return to the market in an environment of no additional short term supply,” he said.

“Tenant requirements that are considering the fringe have lifted, with IT, media and engineering tenants all active.

“A total of 27,976sq m of secondary stock was withdrawn from the Brisbane fringe office market during 2017. There are only two new buildings – 900 Ann Street in Fortitude Valley and K5 at Showground Hill in Bowen Hills – that will provide new supply during 2018, but the remaining direct and sub-lease space in these projects is close to being leased.

“Beyond these buildings, while there are many proposals for new commercial towers in the fringe, there are no firm construction starts.

“We don’t believe any of the current development proposals would proceed without significant precommitment, and given the size of many projects, this would require pre-commitment from more than one tenant or downsizing of the project. It’s more likely there will be a staggered delivery of new product from 2020 to 2021.”

The Knight Frank report found supply in 2019 would be dominated by refurbished accommodation.

Knight Frank Queensland Senior Director of Research Jennelle Wilson said unlike the CBD, where there was a marked diversion between the vacancy rate for prime and secondary stock, the gap between fringe rates was relatively close.

“Recent deterioration in the prime market has taken the vacancy to 13.4%. In part this was due to two fringe buildings, previously with significant sub-lease space and partially occupied, transferring to direct vacancy at lease end, with a resultant gap in occupation.

“The secondary market vacancy has been assisted by the withdrawal of obsolete stock.”

While net absorption in the Brisbane fringe market was negative for 2017 and is expected to remain that way for the first half of 2018, from the second half of the year it was expected to return to positive, said Ms Wilson.

Mr Carlton said this would happen as the fringe regained some of its competitive rental advantage over the CBD market.

“Demand is showing sustained improvement in the CBD, and fringe effective rents remain plateaued as incentives reach new heights. Therefore, the competitive tension between the two markets is on the verge of changing.

“In line with more tenants across both markets showing a greater inclination to relocate, there is an encouraging number of tenants currently in the market for fringe space.”

These tenants are dominated by IT users, however media and engineering tenants are also prominent. Technology One has a 15,000sq m requirement, while other IT tenants understood to be active in the fringe market include DXC Technology (3,500sqm), Melbourne IT (2,500sqm) and Genie Solutions (1,500sqm).

Other larger tenants include WSP (5,500sqm), Goodstart Early Learning (4,500sqm), Downer (4,000sqm), AECOM (8,000sqm), Austereo (2,000sqm), WPP (1,500sqm) and APN (1,500sqm).

“While not all of these tenants will relocate, or may choose a location other than the fringe, this represents an increase in the level of activity. The current market conditions are likely to encourage relocation,” said Mr Carlton.

He added that the fringe would also gain traction in drawing tenants from suburban markets, given the space available and rental levels.

“Confidence is being enhanced by the recent strong population growth in Greater Brisbane, at two per cent, a significant pipeline of major construction and infrastructure, indications Queensland economic growth is heading back towards trend levels, and green shoots in the resources and energy sectors.”

With demand expected to pick up more strongly for prime space in the fringe, Ms Wilson said the prime vacancy was expected to show greater short-term improvement than secondary.

“With only a handful of top-tier prime buildings, the level of competition can quickly build for these assets,” she said.

“Increased tenant activity is anticipated to spur some growth in prime rents from late 2018. Forecasts for prime effective gross rents are 3.3% and 3.4% over the next two years.”

Knight Frank Senior Director – Institutional Sales Justin Bond said despite vacancy remaining elevated in the fringe, investor demand has remained strong with prime median yields firming 48 basis points over the past year.

A surge in offshore investor activity took 2017 turnover to record levels, with $1.098 billion in transactions (above $10 million) recorded, well ahead of $597.9 million in 2017 and exceeding the previous record of $799.6 million during 2014.

“Offshore investors dominated the market in 2017, accounting for 51% of transactions by value, but towards the end of the year and into 2018 we saw greater investment from domestic buyers in the fringe market,” said Mr Bond.

“After falling to a low of 38 basis points in mid-late 2017, the spread to Brisbane CBD prime yields has increased slightly to 43 basis points, but still remains closely aligned with the CBD.

“With a core of assets constructed within the past 10 years, generally having good tenant covenants, the fringe prime market has been well accepted by investors with only a limited risk premium applied compared to CBD investments.

“As the improvement in sentiment and activity extends from the CBD market and into the fringe, the level of investment demand is also expected to grow, attracting new investors and placing further downward pressure on yields.”

Knight Frank Senior Director, Head of Commercial Sales Christian Sandstrom said the suburban office investment market continued to experience solid demand from a range of local and offshore private investors, smaller syndicators and institutions in the $10-150 million range.

“Given the limited number of formal opportunities in 2018 compared to 2017, yields have tightened 50 basis points for prime median assets and 75 to 100 basis points for secondary assets,” he said.

“There continues to be an increased appetite for suburban assets in traditional office park locations including Eight Mile Plains, Cannon Hill and North Lakes.

“As the improvement in tenant demand takes hold towards the end of this year we anticipate investment demand to continue to grow, creating an opportune time for investors who have repositioned assets through leasing and refurbishment programs to benefit “