Melbourne is the most sought after office real estate location in Australia, with unprecedented local and offshore appetite for Melbourne CBD office assets continuing.
Part of what is contributing to this trend is the overall cost of capital. With a strong chance of further interest rate cuts in 2019, pressure is building on banks to start freeing up credit. Another major factor is Melbourne’s anticipated rental growth.
Rents are increasing in Melbourne faster than anywhere in Australia, particularly in the Melbourne CBD. And while investors are naturally attracted to longer leases at lower rents, Melbourne’s market is so strong that we’re seeing an equal amount of rental growth and security with short-term leases at higher rents.
The trend and history of Melbourne’s rental growth
There was a time in the mid-2000s when the Melbourne office market was ‘held back’ because of major developments such as Docklands. Since then, to say that Melbourne’s office space has recovered would be somewhat of an understatement.
Melbourne’s total office vacancy now sits at a record low of 3.3% (including Docklands which now sits at <1%), down from a high of 10% in mid-2004.
More recently, nearly all of the additional 300,000sq m of CBD Prime office space has be pre-committed. These are developments such as 80 Collins St (South Tower), Collins Arch, Olderfleet, 405 Bourke St, 150 Lonsdale St and Flinders Gate. As further proof of Melbourne’s outperformance, a significant amount of the backfill of these major pre-commit deals have been leased.
What the fringe says about the city
Aside from low vacancy and pre-committed leases, probably the most telling rental growth factor is the performance of properties in Melbourne’s city fringe when compared to properties in the CBD.
Traditionally, rents within city fringe areas are cheaper than rents within the CBD, so that when fringe rents are high, we know that CBD rents are even higher.
There are major pre-commit deals currently being leased at approximately $600/sq m net in areas such as Richmond, Cremorne and South Yarra. ‘A’ Grade CBD rents are currently hovering around sub-$600/sq m net and even some Premium Grade passing rental profiles are reflecting rents at similar levels. Most of the recent Premium Grade deals are pre-commit leases. These deals usually reflect a discount to the sitting market, so there is significant room for growth in the CBD in the short to medium term.
While the attractiveness of long term leases may not be going anywhere (particularly amid current and anticipated interest rate cuts), there’s now a significant strength in short-term options. Demand for CBD office assets with the ability to capture rental growth in the short to medium term (i.e. short WALE), will continue to be on the radar of local and offshore investors.
Essentially the Melbourne CBD market covers both ‘cash-on-cash’ or ‘running’ yield buyers, as well as a buyer seeking a ‘total return’, whose basic benchmark metric is an internal rate of return (IRR).
Much of this is predicated on forecasted rental growth. Melbourne’s story for most investors is extremely positive, even for assets with high capital expenditure. Buyers in this space, generally of a B-Grade nature, are backing rental growth to offset the capex spend, as well as B-Grade assets’ rental profiles reflecting sub-$400/sq m net in the Melbourne CBD.
The investment story bodes well for Melbourne in the short and long term, which is reflective of current transaction volumes, which are at an all-time low. Those that own Melbourne CBD assets wish to capture the growth and those that are looking to purchase have a very strong reason to invest.