What's the outlook for the commercial office market
There are many variables that will affect the office market over next decade.
There are many variables that will affect the office market over next decade. The rise of remote working, shifting demographics, more flexible workforces, ongoing business margin pressure, increasing competition from Asian financial hubs and globalisation of the service industry are all factors likely to influence office space demand, both positively and negatively.
In theory, there will be a reduction in office space demand as technology and globalisation allow another round of productivity gains. But AMP Capital’s research suggests investors should also consider a number of other important elements that are likely to impact the office market.
Demand for white-collar services is likely to continue to rise in tandem with a growing population, despite changes to the workforce due to better technology and increased globalisation. So it’s likely that office property assets located close to where the white-collar workforce resides or socialises will outperform other assets.
However, Generation Y is looking for a better work-life balance and more integration of their home, work, and social environments, compared to previous generations that traditionally segregated work, home and play. Technology is playing an important part in enabling this integration. This is prompting demand for offices in vibrant areas outside cities with lower rents and great tech specs.
Nevertheless, evidence from the UK and US indicates some digital economy workers and businesses are increasingly moving towards vibrant inner city and central business district (CBD) locations that integrate all the elements they are seeking.
The key to the office sector of the future will be to attract workforces from offsite working locations by providing places where people actually want to work, fostering a collaborative work environment and elevated service standards, including access to infrastructure to support the latest technology.
Insights from research commissioned by AMP Capital with Deloitte into the future workplace, It's (almost) all about me – Workplace 2030 Built for Us, supports our thesis for the office market.
As such, our funds are always looking for assets in vibrant CBD and inner city locations, as well as assets that are being positioned to become 24/7 destinations in their own right, such as those to be based in the Quay Quarter Sydney and Collins Place Melbourne developments.
While the commercial office sector has a number of medium- to long-term challenges to navigate, the reversal of the two-speed economy is starting to make it easier to lease office buildings in Sydney and Melbourne.
With development pipelines slowing and some offices being converted into residential developments, there is now the strong prospect that office vacancy rates in Sydney and Melbourne CBDs could fall in 2017/18 before the next wave of new supply is completed. As a result, there is the prospect of rental growth in Sydney and Melbourne over next two to three years. This could lead to the need for a stronger development cycle later in the decade, a risk that needs monitoring.
The Brisbane office market is also now starting to stabilise and vacancy rates are expected to slowly decline in the next few years. The Queensland economy is showing early signs of improvement and although there is still pressure on incentives and rents, tenant enquiries are slowly rising, suggesting fundamentals may be starting to stabilise.
Perth is the weakest major market and continues to see substantial falls in effective and, more recently, face rents, which is flowing through to values. We don’t expect vacancies to peak until later in 2016. So in the short term we expect face rents to fall further. As a result, it is likely there will be more downside to values.
Looking forward, the strongest outlook for returns is now in the traditional core markets of Sydney and Melbourne, along with Canberra and some of the suburban markets that have lagged the recovery. Returns in Perth and Brisbane are expected to fall dramatically compared to the last decade. This is particularly true in Perth, where there is a high risk of falling asset values over the next couple of years.
Therefore, AMP Capital’s commercial property portfolios are becoming biased towards the Sydney and Melbourne markets, as their lower vacancy rates are more supportive of investment return in the short to medium term. However, we maintain a watching brief on the office market as the dynamics we have described above start to gather pace.
About the author
Michael Kingcott is the Head of Property Investment Strategy and Research at AMP Capital leading commercial property research and investment strategy.