Early signs of new development cycle show in Perth

The Savills Blog

Early signs of new development cycle show in Perth

Perth’s office market has turned a corner with a new development cycle in its infancy and a return to growth being predicted.

Development hiatus begins to ease incentive and vacancy outlook

Savills Perth’s Managing Director Graham Postma said there had been a fundamental shift in the cycle recently, with declining vacancy and rising occupier demand, on the back of improvements in the leasing market.

 “This shift has buoyed developer confidence and the potential for new development projects in the coming years – the most recent being Chevron’s announcement that they are committed to building their new circa 52,000sq m tower at Elizabeth Quay,” he said. 

“The development hiatus in Perth’s CBD office market, which has run for past three years, has placed pressure on existing buildings to fulfil demand.”

Mr Postma went on to say that the demand or “flight to quality” had created a two-tiered market, where the gap between prime and secondary grade pricing indicators was increasing. 

“The market has already seen incentives in premium-grade space start to decline, as well as in higher quality A Grade buildings, where occupancy is normalising,” he said. 

“Effectively, the path of rental growth and vacancy rates are very different to secondary space or space in less competitive locations within the CBD. 

“As the availability of prime space is declining, this part of the market is heading towards a supply proposition, being the development of new buildings or the redevelopment of existing buildings in order to fulfil demand.” 

Clear signs of recovery as office vacancy rate starts to drop

According to Savills Australia forecasts, which have factored in Chevron’s circa 52,000sq m requirement, and the resultant backfill space created when the company consolidates offices and moves to its proposed building in Elizabeth Quay, the overall vacancy rate could decline from the 19 percent it is today, to close to 14 percent by 2022. 

“If the Perth market continues to maintain its current growth momentum, even with a conservative outlook taking into consideration historical absorption trends, future employment and supply, including potential backfill space, the vacancy rate could reach 14 percent by 2022,” Mr Postma said.

“However, if the pace of tenant demand gains some ground, and absorption levels climb to 10 percent more than today’s conservative average, the vacancy rate could drop below 13 percent. 

“If we inflate demand levels by 20 percent, the vacancy rate could reach circa 11.0 percent by 2022.”

Clear signs of recovery as office vacancy rate starts to drop

Office market experiences a cyclical upturn

Mr Postma said tenant appetite for prime space had been elevated and incentives were already starting to pull back for premium and A Grade space, returning net effective rental growth to the market for the first time since 2013.  

“We anticipate a gradual reduction in net incentives in premium and A Grade space that could look more like 30 percent on average, returning net effective growth for the same period,” he said.

Growth from non-resource sectors expected to buoy future office demand

Savills Australia’s Associate Director for Research & Consultancy, Katy Dean, said she expected to continue to see more of the value added by other sectors that have been growing through the past two to three years, including legal, education and, to some extent, start-up technology and shared or co-working space. 

“While an increase in tenant demand from these businesses is not likely to result in a major rise in absorption levels, relative to a major resource producer such as Chevron or BHP, the demand is providing some buffer for owners of those 10,000sq m to 20,000sq m buildings, where we traditionally see smaller floor plates,” she said. 

“There are more Australian Stock Exchange-listed companies based in Perth than any other Australian capital city, and while major mining and resource companies such as Rio, Chevron and BHP, to name a few, occupy a significant amount of floor space in the CBD, the other 60 percent of the market is occupied by property and business services, such as legal, recruitment and consultancy; finance and insurance; information technology; and government – it’s not just gas and iron ore.” 

Tenant preferences start to impact future demand

Mr Postma said throughout the past two to three years, tenants had been increasingly positioned favourably in regards to negotiations and choice in availability of space. 

“This saw many tenants upgrade to better, often higher-grade-quality space at often more cost-effective rates per square metre than they had been paying previously,” he said.

Savills research has found that the absorption rate for office buildings in Perth’s CBD is about 21,000sq m per annum for the past three years, which is close to the long-run average. 

“However, through the peak mining period when vacancy reached almost zero, there were three years of elevated absorption, with some 120,000sq m of net absorption in 2012 alone,” Ms Dean said.

“What we do know from our analysis is that through the past three years, the market has been demand-driven, a dynamic that bodes well for development plans and a decline in the vacancy rate moving forward.

“Tenant preferences have also been changing and this is noted in the number of new lease agreements where tenants have relocated to the CBD from either West Perth or other suburban locations, as well as relocating from non-competitive locations within the CBD to what were previously considered highly competitive zones – that being St Georges Terrace, mid- or west CBD locales.” 

Mr Postma said during the past couple of years, tenant activity had been characterised by increased opportunity to “fine tune occupancy costs”, either directly through rent or indirectly through building efficiency and better use of space by moving into a higher quality space. 

“Building owners have lowered their rent expectations and become more sophisticated in terms of the building’s add-ons – such as end-of-trip facilities, concierges, etc. – and generally speaking, tenants have benefited,” he said. 

Mining and resources still expected to add value to office market

Ms Dean said there were a number of dynamics to consider that would continue to impact office demand and take-up in Perth’s CBD office market moving forward, including workforce availability and the value added by the mining and resource sector, which was moving into more normalised market conditions.

“The resource sector is labour-intensive when in the construction phase and the attraction of potentially higher pay in some of those roles did impact workforce availability within other sectors in Perth through the boom period leading up to 2012,” she said.

Ms Dean said the previously high global iron ore prices and demand through the years to 2011/12 had stimulated new projects and expansion in the sector, which had led to the significant increases in Western Australia’s iron ore production outputs. 

“However, price declines from 2013/14 saw many of these producers respond by reducing costs, notably for labour, but also spending on exploration and new project investment, in turn taking some pressure off the break-even price benchmarks and giving some control back to the miners, and potentially their office space requirements,” she said.

Mr Postma said it appeared that most of the major miners had now extracted as much value as possible from their cost-cutting initiatives so the only option to achieve their growth targets was through expansion.  

“This is evidenced by the recent announcements made by Rio Tinto, BHP and Fortescue Metals Group, with more than $11 billion of new or expansion projects committed and resulting in a number of immediate project requirements coming to market,” he said.

BHP and its joint venture partners recently announced an investment of circa $4.7 billion to develop the South Flank Mine in the Pilbara. The project will be the single largest annual production iron ore mine that BHP has ever developed and is expected to generate 2,500 jobs during construction and about 600 operational roles once in operation.

ConocoPhillips and its joint venture partners, as operator of the Barossa Offshore Project, have just awarded three new engineering contracts, which is likely to result in an increase their requirements in the short term. 

Mr Postma said there had been an uplift in exploration spending and although predominantly led by major producers, the demand created for project space would also drive growth in other industries.

“P&N Bank has recently committed to 3,000sq m in the CBD and the Department of Human Services has taken 9,000sq m,” he said.

“There are also several large leasing mandates in the market from larger space users, including Fortescue Metals Group for 12,000sq m, TechnipFMC for 6,000sq m, Rio Tinto for between 4,000sq m and 14,000sq m, Worley Parsons for more than 8,000sq m, and the state government for 18,000sq m, that are and will continue to impact availability within the prime sector of the market, significantly limiting future availability in the better quality assets, particularly for large contiguous tenancies.”

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