Unwanted and empty space in Australia’s east coast offices is causing a serious rise in sublease vacancy, adding to uncertainty about the prospects for once-thriving city towers.
Pandemic-hit companies are dumping unused office floors on the subletting market, accelerating a spike in empty space across Sydney’s prime CBD office towers and pushing vacancy levels above the peak seen during the global financial crisis.
The race to downsize is adding fuel to concerns about rising unemployment, the looming wind-back of JobKeeper, rising office vacancy rates and falling net effective rents, prompting a bearish response from investors.
This week analysts at Morgan Stanley downgraded the $9.5 billion ASX-listed office landlord Dexus to “underweight”. They questioned whether the office party was over, a position not welcomed by all.
“We have gotten some pushbacks on this call and it seems like the market remains divided on how to be positioned in office stocks,” analysts Simon Chan and Lauren Berry said.
“We remain comfortable with our cautious view,” they said.
About 135,000 square metres, or 2.7 per cent of Sydney’s total CBD office stock, is for sublease, according to research from global agency JLL.
That figure is above levels seen during the GFC (2.2 per cent) but well below the record set during the 1990s “recession we had to have” when it hit 6.2 per cent.
Nearly half of the 123,000 sq m of sublease space JLL is tracking in Melbourne’s CBD (about 44 per cent) is directly related to the fallout from the COVID-19 pandemic, the agency estimates.
Additional sublease vacancy is likely to come online in both cities in the final quarter of this year as occupiers start to make critical decisions about how much space they need, research analyst Sam Craig said.
Until now businesses have been waiting to see what the “new normal” post-pandemic economy will look like.
Heavyweight office chiefs this week urged businesses and workers to stop working from home and return to city offices, with Dexus’ Darren Steinberg, Brookfield managing partner Sophie Fallman, Blackstone’s Chris Tynan, and WeWork’s Australian general manager Balder Tol leading the charge.
Two-thirds of Sydney’s sublease vacancy is concentrated in prime grade buildings, with the remainder largely in B-grade stock.
White-collar professional services (19 per cent), financial services (18 per cent) and insurance and technological sectors (14 per cent) are driving the contraction.
On the upside, though, large office landlords are reporting strong rent collection and stable book values compared with their retail counterparts.
Companies typically view office leases as a short-term fixed cost and long-term variable cost, and adjust their requirements broadly in line with the size or headcount of their business. As unemployment rises, so too does available sublease space.
A reasonable portion of subleases available in Melbourne are time constrained, restricted by firms’ desire to grow back into their offices once conditions improve, JLL’s Nick Drake said.
“While sublease availability will be attractive to some businesses, many organisations will continue to gravitate to direct lease opportunities,” he said. “A direct relationship with the landlord reduces risk and increases flexibility and tenure.”
Mr Chan and Ms Berry think tenants have yet to work out where they stand on the work-from-home issue. “A bounceback is unlikely in the next 12 months,” they said.
“We think the most pressing issue – and what will drive share price performance in the near term – is the cyclical pressures as Australia heads into a post-COVID recession.”