MULTI-SPEED OFFICE LEASING MARKET

Since the onset of the pandemic, Australia’s major office markets have seen a flight to quality as employers look to attract and retain talent. The multi-speed nature of the office leasing market is highlighted by diverging trends in the demand for office space. In the premium market, the increase in net absorption since 1H/2020 across the Australian markets totalled around 324,500 sq m, equivalent to 10.8% of premium office stock, while net absorption in the A grade segment was equivalent to 1.4% of A grade office stock (Chart 1). By contrast, demand for secondary market  office space declined over the same period, with net absorption falling by around 428,500 sq m, equivalent to 3.7% of secondary office stock.

While demand for office space at the prime end of the market has been relatively strong, a well above-average level of new development completions in 2021 and 2022, particularly in Sydney and Melbourne, has driven office vacancy rates higher (Chart 2). The premium vacancy rose from 3.5% at the  beginning of 2020 to 8.9% in July 2022, while the A grade equivalent increased from 6.4% to 12.8% over the same period (Chart 3). Vacancy in the secondary market, which was significantly higher coming into the pandemic, has risen by 3.2 percentage points to 14.3%. While new development completions have led to a narrowing in the spread between the secondary and premium vacancy rates over the past two years, the spread remains high  relative to history.

WEAKER GROWTH OUTLOOK IN 2023 REINFORCES THE FLIGHT TO QUALITY

The deterioration in global economic outlook amid high inflation and rising interest rates will reinforce the appeal of prime assets. While the Australian economy is expected to remain in expansionary territory in 2023 and avoid the worst of the global downturn, the slowdown in economic growth and deterioration in labour market conditions may increase leasing risk in some markets.

In this environment, the flight to quality seen in recent years is likely to continue, with ongoing relatively strong demand for well-located core assets, as well as premium and high-quality A grade buildings with highly rated green credentials.