Sydney - It's a long way down
Sep 19, 2017.
If there’s one thing we’ve learnt from previous property cycles, it’s that no two are the same. Whilst markets invariably react to the fundamental dynamic of supply and demand, the forces driving this dynamic are rarely consistent across different cycles. The one thing that is consistent is the high level of confidence in the sector just before the turbulence begins.
Why is this relevant? In Pepper’s view, accelerating rentals and declining vacancy have been driven by withdrawals in recent times as opposed to genuine demand. Whilst there’s no doubt that some sectors have seen an increase in demand for good quality CBD assets, a lot of the hype around the strength of the Sydney market is the result of buildings being withdrawn for alternate uses or renewal as opposed to underlying demand.
It is a fact that over the past 10 years, the total office space occupied in the Sydney CBD has only grown by 300,000m2 (less than 1% per annum). In other words, Barangaroo has catered for the office space demand of an entire decade. This is particularly interesting given we may see multiple Barangaroo’s delivered in the 2020-2025 window – with additional capacity of between 500,000m2 and 1,000,000m2 depending on further pre-commitments. Can the market handle it?
It’s also important to consider densities. Over the last 10 year period, BIS Oxford Economics reports that densities in the CBD have only reduced from circa 20.5m2 per person to just under 19m2 per person. And there is a long way to go in becoming more efficient in the way we use space with many modern workplaces achieving densities of 1 per 10m2 (WeWork publicise a rate of 1 per 5m2). Most would not have known that up until 12 months ago, effective rents were at similar levels to that of 2007. Recent effective rental growth has forced many businesses to now look harder at intensifying the use of their office space and this trend should gain momentum. There is a point at which office space becomes too expensive and tenants are forced to challenge their traditional views on usage. Arguably, we have reached that point and there is a workplace revolution occurring.
This is an incredibly important piece of the puzzle that is the Sydney CBD office market, most notably because it has the ability to numb any legitimate floor space growth from a forecast pick up in white collar employment. To put it simply, accelerating effective rents have now forced tenants to look at densification. If we, as tenants, don’t grow our businesses by many multiples of the reduction in space we can achieve through better design, the ‘supply tsunami’ that is approaching in the early 20’s will hurt the landlord community in a big way.
And it’s a double edged sword for landlords. The new pre-committed and mooted stock in the CBD is no longer an elephant in the room, it’s a herd of elephants. If you believe what some have said on the potential bursting of the cap rate bubble, it will be a long way down if rents were to fall in a similar fashion.
Whilst new development is healthy for office markets, if Sydney becomes oversaturated, landlords will risk having four major markets (Sydney, Adelaide, Perth and Brisbane) with vacancy rates of 15% or higher.
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