Metropolitan office markets are set to reap the benefits of unprecedented demand for CBD stock and increased appetite from developers and Chinese capital for suburban assets.
According to new research from Colliers International, Australia's metropolitan office markets are seeing a noticeable increase in activity from private investors, developers, institutions and offshore capital alike.
"There is currently unprecedented demand for office assets in our capital city CBDs from both local and offshore investors," Colliers International Managing Director of Capital Markets & Investments John Marasco said.
"Even developers are scouting underutilised or ageing office buildings, with the intention of capitalising on the nation's seemingly insatiable appetite for residential property by converting existing office buildings into luxurious apartments.
"Metro office markets are now very much witnessing this demand spill over into their suburban markets."While stock in CBD markets was increasingly hard to come by and highly competitive when listed, it was not just spillover demand targeting metro assets, Mr Marasco said.
"Many investors are taking a deliberate approach to invest in our metropolitan markets, attracted by the higher yield, long term development upside potential, as well as infrastructure improvements that are benefitting some markets," he said.
"Given the strong demand for quality assets in our metropolitan markets, it is not surprising that there has been yield compression across most precincts. In Parramatta, yields for A grade stock now average 7.63 per cent, down from 8 per cent per cent in March 2015.
"In St Leonards, yields have compressed by 50bp over the six months to September 2015, to now average 8 per cent, while Melbourne, St Kilda Road A Grade yields now average 7.63 per cent, down from 7.88 per cent in March 2015, and City Fringe yields now average 7 per cent.
"In particular, NSW development demand is set to increase on the back of significant infrastructure investment."
Anneke Thompson, Colliers International Associate Director of Research, said offshore investment into metropolitan office markets increased from $2.25 billion in the 2014 financial year, to $2.63 billion in 2015 (for assets over $20 million). Private investment more than doubled, increasing from $477 million to $1.15 billion.
"Demand for metropolitan office investments was strongest in Sydney, where over the 2015 financial year, metropolitan office sales volumes outperformed even Melbourne CBD sales volumes," Ms Thompson said.
"The Sydney metropolitan office market offers some quality investment grade assets with good tenant covenants, and in 2015 it has been predominately offshore and institutional purchasers who acquired assets although private investors increased their activity compared to 2014."The largest sale in the Sydney metropolitan market was also to an offshore buyer, being the sale of 101 Miller Street and Greenwood Plaza to Henderson Global Investors and TIAA CREF for $302.6 million in November 2014.
The much-discussed influx of Chinese capital into Australia was now also spreading to metropolitan markets.
"In North Sydney, four office assets have been sold to Chinese investors for a total of almost half a billion dollars in 2015 alone," Mr Marasco said. "All of these buyers were major Chinese institutions.
"In Melbourne, Chinese buyers have been active in metropolitan markets, however they have all been private buyers. We expect that these buyers will continue to scour metropolitan markets for good quality assets, with long term development upside and strong attraction."
As metropolitan markets became increasingly popular, particular pockets were attracting the institutional and offshore investment that previously focussed almost solely on CBD markets.
"Institutional buyers traditionally prefer the established metropolitan markets of Parramatta, North Sydney and St Leonards in Sydney, Fortitude Valley and West End in Brisbane, and St Kilda Road and Soutbank in Melbourne," Mr Marasco said.
"A number of groups, including Centuria and GPT, have recently created listed metropolitan office funds, however, it is offshore and private buyers who are driving the bulk of demand for metropolitan office."Parramatta saw almost half a billion dollars of investment activity (greater than $20 million) in the 2015 financial year.
“Parramatta has become increasingly popular with investors who are attracted to the strong occupancy fundamentals of the market. The office vacancy rate in January 2015 was 6.3 per cent, and this increased to 7.4 per cent in July 2015.
“These vacancy rates are still some of the lowest of all PCA-monitored metropolitan markets in Australia. At the prime end of the market, the vacancy rate is virtually negligible, with only 6,573sqm of space currently vacant.
“In Melbourne, institutional activity in the metropolitan market is traditionally centred around St Kilda Road and Southbank, although currently this year there have been no sales in these markets. This is due to a lack of supply, rather than a lack of demand. We expect some sales to transact by year’s end.
“We are also seeing a decline nationally in average tenancy size, with significant growth in small-to-medium size enterprises looking for space. Increased tenant activity between CBD and metropolitan markets is also playing a role in increased demand.”