Riding the office market boom

Higher yields, longer leases and lower maintenance costs all help lure private investors away from the residential market - in fact the only problem seems to be finding available property in Australia's hottest office markets


For investors seeking an alternative to the residential market, the office sector has a lot to offer - especially in Queensland and WA. The market in Perth was recently revealed to have the world's lowest vacancy rate (0.7%) and the bubble shows no sign of bursting any time soon.


"Perth is now the tightest office market in the world," says David Green-Morgan, national director, research at DTZ. "With demand continuing the market will stay red hot for the foreseeable future."


It's a similar story in Brisbane, with Green-Morgan saying that rental growth seen there during 2007 "will be amongst the most impressive in the world."


Both markets have been driven by the global commodities boom, stemming from expansion in the Chinese and Indian economies.


What's fuelling demand?

The economy is the major driver of the office market according to Green-Morgan, as a boom period pushes companies towards expansion, and more demand for office space.


"Perth and Brisbane are classic examples of how the economy doing well, driven by global factors, is making demand for office space very hot," he says. "International companies want to be close to their resources, and Brisbane and Perth traditionally have quite small office markets which have been swamped by the demand from these companies."


This in turn has triggered demand from the likes of financial service companies, law firms and accountants who are all there to service the multinationals.


"It could be that the economies of Queensland and WA are actually linked more to activity outside Australia," says Green-Morgan. "You could see a downturn in the Australian economy in NSW and Victoria but the states of Queensland and WA still continue to do very well off the back of improved growth in the rest of the region."


Events over the past two years have, he says, almost resembled a "two-speed economy" with the NSW economy "really stagnating and just bumbling along. It's now starting to come out of the doldrums and is improving gradually and the same can be said for the Victorian economy as well", he says.


Green-Morgan adds that it's hardly possible to look at any property investment without looking at the much bigger economic picture, as this is what will drive returns and rental growth. "Brisbane and Perth will continue to see increased rental growth for the next two or three years until the construction/supply comes through," he adds. 


No vacancy

But with so little office space available in Perth and Brisbane, investors hoping to capitalise on the boom market there will just have to join the queue - or look elsewhere - with no prime vacancies in either city.  


The Sydney market is one alternative; vacancy rates are at a six-year low, according to Property Council of Australia data, though unlike Queensland and WA, there are still deals to be done.


"It has been a real struggle for the Sydney market in recent years, and the competition from Brisbane and to a lesser extent Melbourne hasn't helped," says Felice Spark, associate director of research, Colliers International. "Its underlying strength is now showing real results with probably the best and most soundly based performance indicators since early 2001.


"We've seen the vacancy rate fall to 5.6% in July, and we've seen strong face rental growth and a dramatic reduction in incentives, which have resulted in some instances of effective rental growth as high as 20-30%, a level which equates to a very healthy market."


She says that as demand peaked in the critically undersupplied Brisbane and Perth markets, Sydney, Melbourne and Adelaide would be the beneficiaries, adding that investors had already recognized that inevitability with high levels of sales activity in those markets.


Solid fundamentals

Financial markets and government finances are also key drivers of demand in the office sector according to Jones Lang LaSalle, and as all three appear to be in "reasonable" shape at present, this property cycle may last a little longer than economists have come to expect.


There has been a 5.5 year average recorded from peak to peak over the last 15 years, but the good times have been rolling for two or three years now in the office market, and there's no sign of this slackening off.


"The strength of the Australian economy, strong corporate profits and a tight labour market are all resulting in very strong demand for quality space," says Kathryn Matthews, head of research and consulting - Jones Lang LaSalle. "This demand has driven construction."


Jones Lang LaSalle report that the amount of office supply under construction has increased by over 70% during the past year, from about 768,000/m2 to more than 1.32/m2 in the September quarter.


This new stock is expected to put pressure on older secondary buildings when it reaches the market, but this won't be for some time yet - meaning no sign of immediate relief for the most over-subscribed markets. 


The global perspective

While the residential market tends to be reasonably self-contained within Australia, the office market is more beholden to global factors, and the state of the economy is key.

But according to Spark, the Australian office markets are in excellent shape, and the bubble certainly won't be bursting just yet.


"It is clear that Australian cities are experiencing exceptional growth and will continue to attract foreign investment dollars as rents and capital values trend upwards," she says.


"While rising interest rates and credit concerns have begun to place a cloud over the global economy, there remains a significant degree of momentum which will keep most office markets static at worst."


Kevin George, Australian head of leasing - Jones Lang LaSalle agrees, saying that there has been no evidence of negative consequences from the US sub-prime crisis, with strong demand still apparent from both tenants and investors.


"There still seems to be an appetite from the bigger tenants to pre-commit, and considering that many of these plans are made about three years in advance, this is a good sign of longer term confidence," he says.


"As soon as we see pre-commitment levels declining, then this well be a warning that there are clouds forming on the horizon."


Location counts

Green-Morgan advises investors not to get too big for their boots when it comes to choosing office space to invest in however, saying, "the CBD markets are the reserve of the big boys really because the prices they command are huge".


The strata market is a more affordable alternative, giving investors on tighter budgets an opportunity to purchase a particular suite in a much larger building. "Smaller suites within the best buildings in Sydney are commanding some good rent," Green-Morgan says. "Hopefully they can then benefit from the substantial rental growth." 


Even then, investors are advised to do their homework, analysing the building they're interested in buying in very carefully, as well as its precise location. Even moving two or three streets can have a huge impact on the rent you will achieve.


"See what other tenants are in the building, find out what other rents are being paid and be prepared to put in some money for refurbishment to make sure your suite is among the best of them," says Green-Morgan.


Start small

An increasing number of smaller private investors have become involved with the office market of late, says Craig Minahan, executive director at Ashington.


"In general, interest in the office sector from private investors is on the rise as many steer away from traditional residential property investments," he says, referencing the recent corporate collapses of property groups like Westpoint and Fincorp which have also "led investors back to direct investment".


Ashington's newly completed CROSS+ development in Sydney's Kings Cross is a case in point, with more than half of its pre-sales to investors.


"We have had strong off-the-plan sales to investors who live in the area and have experienced first-hand the robust growth of the precinct," says Minahan.


He adds that the price levels of the commercial strata market are critical in attracting private investors, with offices at CROSS+ starting from just $211,000.


"These price levels compete with the traditional residential property investment market and a key benefit for the investor is that commercial property requires less intensive property management than a residential property," he says.


"There is a distinct lack of quality office space in the area - yet it is an ideal location for business. The access to transport and continued improvements to the area all point to strong capital growth for investors."


Further minimal increases to interest rates are unlikely to change the level of private investment activity in the strata office market in the short-term says Minahan, as office investments remain better performing assets than residential.


"With rentals remaining strong and continually climbing, demand for quality office stock within Sydney will remain strong," he says. "These favourable market conditions will continue to attract Mum & Dad investors to the commercial strata market."

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