Further Growth For Melbourne CBD Office Rents Expected Amid Higher Enquiry Levels

Posted on 08th June 2023

Increasing competition among tenants has pushed Melbourne CBD office prime rents further into record territory and secondary rents back into a growth phase, according to Fitzroys Melbourne CBD Office Market Report for Q1 2023.

“The increased tenant enquiry levels have been driven by smaller-sized tenants seeking to capitalise on the attractive leasing terms on offer and employers encouraging staff back into the workplace within better quality office buildings, prompting more landlords to upgrade their assets,” said Fitzroys Director Phillip Cullity.

“Businesses have been exploring their real estate requirements post-COVID, and have gained an understanding of how much space is needed per person, what type of space they want to work in and how they want to work in it.

“We’re now seeing tenants make decisions.”

Prime office net face rents hit another new high in the March quarter, according to Fitzroys data, as the post-COVID flight to quality continued apace. They now sit at $655 per sqm, reflecting growth of 1.6% over the March quarter and 4.0% year-on-year.

“The flight-to-quality continues to see tenants seek out new or recently refurbished spaces, buildings with quality end-of-trip facilities, good sustainability credentials and attractive hospitality options in the building or close by,” Cullity said.

While incentive levels for both prime and secondary offices in the Melbourne CBD market remain elevated, incentives for prime space have recorded a marginal decline, according to Fitzroys, reflecting the increased enquiry levels.

“We expect more elevated enquiry as businesses make decisions on their real estate requirements, with a preference for higher-grade and recently refurbished spaces. Prime face rents are likely to increase again, and incentives to moderate further, leading to more effective rental growth for prime Melbourne CBD offices,” Cullity said.

“Rental growth for secondary offices will likely remain modest for the medium-term until the vacancy rate has peaked.”

Secondary rates moved back into a growth phase during Q1. Fitzroys data shows a rate of $467 per sqm at the end of the March quarter, reflecting growth of 1.1% over the quarter and 0.4% year-on-year.

According to the Property Council of Australia, vacancies have grown to 13.8%. This was underpinned by a wave of new supply to the CBD, while the flight to quality put upwards pressure on vacancies in the secondary market.

Smaller tenants drive enquiry, fitted suites popular

The elevated levels of enquiry have been led by smaller-sized tenants. By size, Fitzroys data shows the 200-499sqm market received 37.9% of all enquiry in Q1, followed by the 500-799sqm market, with 34.2%. Tenants looking for 1,500sqm-plus represented 13.3% of enquiries, while the balance was split between 0-199sqm (8.1%) and 800-1,499sqm (6.5%).

Fitzroys Associate Director - Stephen Land said the sub-500sqm and sub-800sqm markets have been particularly busy given the agility of tenants, and there has been a strong correlation of activity within this market for quality existing fitted office and spec suites.

Multiple deals have recently been struck 50 Queen Street, where Fidinam (Australia) is reimagining the building. Umwelt, The Australian Greens and most recently Geosyntec Consultants are all amongst the new tenants, with rental rates at $760 per sqm gross plus GST - reflecting a circa 30% net rental rate increase in the property as a result of the spec suite build and design concept. Fitzroys, in conjunction with Colliers, is leasing the property.

“Landlords upgrading their assets are being rewarded,” Land said.

“It’s well-publicised that construction costs are higher for refurbishments and fit-outs, but the benefits of attracting tenants in the current market outweigh the costs of having an empty asset that’s less likely to attract businesses and staff coming into work,” he said.

Land said tenants in sub-500sqm and sub-800sqm range are mostly attracted to the convenience that a spec suite offers.

“You can see, feel, touch and plan for occupying the office far easier than a blank canvas. Tenants can avoid the higher costs and the uncertainty of timing of fit-outs, and the overall hassle of having to manage an office relocation and build at the same time.

“With changing working environments and the ‘work from home’ shift, tenants are not only exploring ways to attract staff back into the office, but also to provide attractive working space as part of the employment. A driving factor of this is the quality of office space they have to offer and that is also a large appeal of the ‘spec suites’ in this market.”

At 406 Collins Street, Fitzroys leased the former Afterpay offices to Kyriacou Architects. Kyriacou has leased Level 5 of the building for 4.5 years for its head office, and has taken a short-term lease over Level 6 which is being used as a project space.

“Kyriacou Architects was drawn to the creative existing fit-out in situ including the exposed ceilings and partial concrete flooring, and they undertook some alterations to suit their layout.”

The deal was struck at circa low-to-mid $500s per sqm gross.

At 90 William Street, at Scottish House, Land and Cullity leased a 564sqm partially-fitted whole floor to novated lease providers Leaselab.

“The sub-500sqm and sub-1,000sqm markets, across all grades, continue to be dominated by tenants seeking quality existing fit-outs or brand new spec fit-outs.”

“These deals are evidence of the growing trend for tenants to look at a total cost solution in leasing existing fitted space.”

During Q1, Fitzroys also negotiated a number of deals in the popular East End of the city where building renewal projects have paid off for multiple owners. At 124 Exhibition Street, which is going through repositioning, Cullity and Land concluded multiple leases at between circa $650 to $700 per sqm net.

Among the notable recent larger transactions of Q1 were Suncorp taking 9,000sqm at 530 Collins Street, Allianz Australia pre-leasing 6,250sqm at Charter Hall’s 555 Collins Street project, WSP sub-leasing 6,000sqm at 567 Collins Street, and AEMO leasing 5,000sqm at 171 Collins Street.

Tenant enquiry for Melbourne CBD office accommodation was generally in line with growth of employment across Melbourne with demand for office space led by Finance and Insurance (31%), followed by Professional Services (26%) and Government (18%). While the IT & Telecommunications sector was relatively subdued over 2022, interestingly, there was strong growth recorded in the Arts & Recreation sector.

Ongoing economic growth in Victoria[1] and record migration levels[2] are expected to provide extra drivers of tenant enquiry through 2023, Land said.

New supply has peaked

New supply peaked in 2020, while 109,231sqm was added to the CBD office market in 2022, according to the Property Council of Australia, being a driving factor of the overall increase in vacancies. By precinct, 41% of the new and refurbished stock added to the Melbourne CBD was located in the Western precinct followed by the North Eastern and Docklands precincts. The Western precinct continues to hold the most office space in the Melbourne CBD with 33%, followed by the Docklands which comprises 1.2 million sqm, having doubled in size over the past 10 years.

Looking through to 2026, the pipeline of new supply is expected to deliver 264,700sqm of new and refurbished space across the Melbourne CBD.

Hybrid work here to stay - and so is the CBD

A recent survey Victorian Chamber of Commerce study[3] showed 46% of employees were working three to four days in the office in the CBD, and 38% were working one to two days in the office, both higher rates than in late 2022.

“The hybrid working model is clearly here to stay, and we’ve also seen Melburnians make it clear the CBD is a preferred and popular place of work and play,” Land said.

“We’re continuing to see an exchange of businesses moving in and out of the CBD, but the CBD provides a unique offering. Businesses and workers want to be in easily accessible locations with quality lifestyle and hospitality amenity, and the CBD remains unmatched for these. That’s been reflected in the growing enquiry as tenants make decisions after a period of reassessing real estate requirements.”

Kyriacou Architects is relocating from Southbank as the growing team wanted the greater amenity of a more central CBD location, while Leaselab is moving into the CBD from South Melbourne.