Despite some companies shelving expansion plans, Colliers International estimates there is still demand for 50,000 sq m to 60,000 sq m of office space from businesses that want an Auckland CBD address.
Although the CBD skyline is dotted with cranes, Colliers International’s latest CBD Office Market Indicators Report says they are likely to become an increasingly rare sight in the next two years as the diminishing availability of credit, cautious tenant demand and dropping capital values of completed projects combine to make development a difficult proposition.
Research director Alan McMahon says for the past 20 years the CBD office market has been led by tenants and restrained by bankers. “Low vacancy rates coupled with continued rental growth had, until the credit crunch, created a solid platform for developers to plan new office projects across the CBD.
“This conservative approach has enabled the orderly building of new office developments to largely match demand. As the economy slows and businesses minimise and fix future expenditure as far as possible, it is logical to expect that new development will reduce pro-rata.”
Although the landscape is now changing quickly, about 78,000 sq m of new office space is under construction and due for completion over the next three years. “More than 70 per cent of the space has already been preleased,” says McMahon.
“There will be little new office space in 2010. While there is 140,000 sq m of speculative development on various drawing boards, most of which will not be finished until 2012, if at all. The global economic downturn is slowing growth, and subsequently so is tenant demand across most grades off office buildings.”
Despite this, says McMahon the CBD continues to be plagued by a dearth of prime quality contiguous office space. The exception is 21 Queen Street, which is being completely remodelled by AMP New Zealand Office Trust. “This is one of the few options for large corporate tenants looking for quality office space next year.”
He says tenants have not been letting the global economic turmoil affect their plans in securing new space in Auckland’s CBD. They have taken 27,000 sq m of space this year. Of this, about 24,000 sq m was snapped up within Quay Park where two new office developments were opened. GE Money, moved into GE Plaza, BNZ into Quay One and Babbage Consultants has moved into Quay Park Health building.
The most recent major lease to be signed was by professional services firm Ernst & Young, which will move its staff in early 2011 to 9500 sq m of premium grade space at Cooper and Company’s East Building complex in Britomart.
Limited prime grade office space and demand for high quality office premises has, in recent years, seen the pendulum swing favourably toward the landlord, resulting in sustained rental growth and leases for prime grade office space with no or few incentives incorporated.
On the downside, when Ernst & Young, Westpac, Deloitte and BNZ move to new premises in the next couple of years they will leave behind empty offices some of which may prove difficult to back fill. In this environment, tenants are demanding flexible lease terms with CPI-based reviews and bigger incentives.
In a market shrouded by uncertainty, McMahon says extended rent free periods and increased contributions to fitouts are being offered by landlords to lure prospective new tenants or keep existing clients.
“In these non-expansionary times, it is a truism that landlords will be careful to choose tenants of substance, who can pay the rent. But this issue also needs to be looked at from the tenant’s point of view.
“The ability of tenants to contribute capital expenditure to their leased property by way of, say, a fitout, is dwindling. Tenants will typically be asking their landlord to fund that, in return for an improvements rent, which represents the amortisation of the cost over the length of the lease. While this is logical, not all landlords will be able to come up with the capital themselves, even if repayments are secured against a lease.
“Tenants need to think about what their capital expenditure requirements might be through the lease, or on any extension to it, and select a landlord accordingly.”
McMahon says quality, as always, reigns supreme in the CBD office market and the dearth of premium grade space is putting upward pressure on rents.
Premium grade rents continue to grow, although at a slower rate than in previous years. The Colliers International average prime rent stands at $356/sq m, growing by 4.7% this year. “We are anticipating rental growth next year of up to 2%-3% for the best quality accommodation,” says McMahon.
Conversely, rental growth across secondary markets is expected to be static next year. “Effective rentals have already begun to soften across B and C grade markets as landlords incentivise new leases.”
Auckland’s overall CBD vacancy rate has softened to 7.7%, the second lowest recorded since Colliers International started its surveys in 1995. McMahon says tenant demand stemming from business growth and expansion, which has fuelled low vacancy levels in recent years, appears to have slowed as the global economic turmoil takes its toll.
As usual, the better quality premises have the lowest vacancy levels. After falling slightly over the first half of 2008, vacancy levels in prime grade buildings rose 1.6 per cent to sit at 4.1 per cent
“Tenants often find that when they move to high quality premises their total property costs per employee do not rise,” says McMahon. “Design and services efficiencies in better buildings allow companies to occupy their space more intensively. While the cost per square metre might increase the cost per person remains stable. This drive for efficiency helps explain the continuing steady demand for the best offices.”
The secondary market’s vacancy levels also increased, up 0.4 per cent to 8.2 per cent.
From a precinct perspective, four of the nine CBD precincts had a drop in vacancy rate. The Anzac Avenue and Britomart precincts had the biggest fall - 3.1% and 1.2% respectively. The biggest vacancy increases were at the Quay Park and Viaduct precincts, rising by 8.4% and 2.2% respectively.
There has been a dramatic slowdown in investment sales this year, says McMahon. “Only a handful of major office transactions have been completed. Buyers and developers have been constrained by the tightening of available finance.
“Over the past five to six years, Auckland’s CBD office investment sales market boomed and yields tightened, fuelled by unrelenting interest from institutions, private syndicates and more recently offshore investment funds, mainly from Australia and Europe.
“Seemingly inexhaustible supplies of capital compressed prime and secondary yields to new benchmarks levels. After a buoyant 2007, overseas investors have left the market, as the global economy tanked and the ability to obtain finance became particularly difficult.”
Colliers International estimates prime and secondary markets yields have shifted out by 0.75 per cent to 1.5 per cent. Yields are expected to stabilise this year at levels which reflect a prudent differential between risk free, prime and secondary rates.
In terms of value, CBD office buildings are only rivalled by larger shopping centres. Arguably, it is in this high value sector, says McMahon that the market has declined most in terms of liquidity, or investor demand.
“Overseas funds are out of the market, and New Zealand’s listed companies are all trading at a discount to asset backing that makes it hard to be competitive. While that situation persists, it will be even more difficult to get a major CBD project off the ground.” Download the full Auckland Office Market Indicators report
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