Melbourne office investors should forgo long lease deals for rental growth, agents say

Savills’ Victorian state director for office leasing Mark Rasmussen said Melbourne was going to see substantial rent growth in the next two years.

“If you buy a building that’s got a 10-year lease, or a long WALE (weighted average lease expiry), you will not have the ability to access that rental growth until the lease is finished because most leases have fixed rental increases over the term and not market rent reviews,” he said.

“If you have a market increase where the value of your building is reflected by the rental return, if you can access that rental return, then you can obviously access the capital increase of the building.”

Tenants have called dibs on more than half of the Melbourne CBD’s new office supply in the next three years. (Photo by Darrian Traynor/Fairfax Media)

As tenants will have fewer choices of where to relocate in a market with lower vacancy rates, landlords will be able to put rents up after covenants expire, Mr Rasmussen said.

“Rental increase will be substantial and that will mean substantial capital value increases if you can access that rental growth,” he said.

He acknowledged that not everyone would be jumping at the idea of shorter WALEs but that it was something to consider in this market.

“There would be some investors who would take the view that they still want to take a long WALE because of the security but what I’m saying is some of these people may be well-advised to look at it again.”

Melbourne’s vacancy rate has dropped from 5.9 per cent to 4.6 per cent in the six months to January 2018, Property Council of Australia’s Office Market Report released on Thursday shows.

“Melbourne has experienced the largest drop among Australian CBDs and now boasts the equal-lowest vacancy rate amongst all of Australia’s CBDs,” the council’s Victorian executive director Sally Capp said.

More than 450,000 square metres of office space will be added to the Melbourne CBD supply in the next three years, but 54 per cent of this was already pre-committed.

The developments in the pipeline will be delivered in 2020, which Mr Rasmussen expects to slow rental growth, but he noted the supply cycle before then was locked in and that would see demand escalate.

“The economy is doing well, the government is taking up more space and (in) the private sector, almost all people taking new leases are building in growth, which they haven’t done in some years,” he said, adding that businesses were committing to more space than they needed, to allow for growth.

 “The stars have aligned for the landlords and the tenants should be planning for rental growth because it’s going to happen.”

Mr Rasmussen said that the Melbourne rental market had plenty of room to grow as it was coming off a low base.

“Melbourne is so far behind Sydney on rentals; if you compare the rents that Sydney gets at Barangaroo compared to what we would get at Docklands in Melbourne, it’s about half.”

Sydney at record low vacancies

Need a full floor of prime office space? There’s only 68 in the entire Sydney CBD. Photo: Supplied

The Sydney CBD office market has the lowest vacancy rate in nearly 10 years, dropping from 5.8 to 4.6 per cent in the past six months, the PCA’s report shows.

Savills’ national head of office leasing Rob Dickins said Sydney had passed Melbourne’s cycle and vacancies were at a record low, with only 68 full floors of prime office space available immediately in the Sydney CBD – the lowest since the global financial crisis.

Tenants seeking prime options bigger than 5000 square metres have just six to choose from in the next 12 months. Meanwhile the only new development to be completed in 2018 is Barrack Place, which is 60 per cent pre-committed with a further 28 per cent under preliminary agreements.

“It’s well and truly the lowest level since 2008,” Mr Dickins said.

“It’s a pretty scary number but it’s a good number for owners certainly and the encouraging part of it from an owner’s side is that it’s only going to get stronger, or fewer (options), in the next 12 months.”

He predicted that the vacancy in the Sydney CBD market would dip below 3 per cent by the end of the year or early next year.

“(It’s) because there are no buildings being built in the CBD except for one in Barrack Place in Clarence Street,” Mr Dickins said.

“We’re now just absorbing what’s out there now (until) the next cycle of development in the end of 2019 which is 19, 20 months away, so it (the vacancy) can only go further south in the interim.”