Activity expected to pick up in Perth CBD office market as it adjusts to the pandemic

Despite subdued activity in Perth’s office market since the pandemic took hold in Australia the outlook for the market is one of the most optimistic in Australia, with the Western Australian economy outperforming Australia as a whole, according to the latest research from Knight Frank.

The Knight Frank Perth CBD Office Market Report – October 2020 found activity in the leasing market had slowed significantly since the onset of COVID-19, as businesses assess space requirements, with lower demand impacting the secondary market in particular.

“Demand for office space is likely to remain subdued in the near-term despite the relatively strong labour market conditions in WA,” said Knight Frank Director, Research & Consulting Chris Naughtin.

“Mining and energy companies have reduced capital expenditure plans in the short-term given the substantial fall in oil prices and this could potentially weigh on engineering-related office employment in the Perth CBD.

“But while the office vacancy rate is expected to rise, the limited development pipeline in the next 18 months will contain the increase in the vacancy rate to around 20 per cent by mid-2021.

“With premium space in greater demand, the vacancy rate for this market fell from 7.4 per cent in January to 6.8 per cent in July, while rising significantly in the secondary market from 24.5 per cent to 26.9 per cent.”

Chris said that while the impact of the slowdown in Perth’s CBD office market was yet to fully play out, the most immediate impact had been seen through higher incentives, which had seen effective rents decline, while face rents had remained stable.

Average prime incentives rose by five per cent in the three months to July to 44.2% (of net face rents), leading to an 8.2% fall prime net effective rents to $346/sqm. Over the year, effective rental growth slowed to 5.6%, down from a peak of 20.8% in January.

Despite subdued leasing activity in Perth’s CBD, mirrored in many other cities around Australia, the good news for WA is that the economy is outperforming Australia as a whole, largely due to the state’s success in containing COVID-19 and the relatively rapid easing of restrictions, and the recovery in China, said Knight Frank Joint Head of Office Leasing in Perth Greg McAlpine.

“The improvement in the local economy is reflected in stronger consumer spending, relatively strong mining sector performance and the increase in iron ore exports, underpinned by strong demand from China,” he said.

“Moving forward the outlook is fairly positive. Relatively strong economic fundamentals, demand for premium office space and limited near-term supply leave the Perth CBD well placed to withstand the pandemic downturn.”

The Knight Frank report found retail sales in WA rose by 17.9% over the year to August, significantly outpacing the 7.1% growth rate for Australia.

Australia’s exports of metal ore rose by 14% in rolling annual average terms over the year to July, with exports to China rose by 7% over the same period, reflecting both higher export volumes and a 36% increase in iron ore prices over the year to September to around $123.50 a tonne.

Employment growth in WA has also largely recovered to be just 1.6% below pre-pandemic levels, compared to -3.2% for Australia overall.

Knight Frank Head of Institutional Sales for Western Australia, Nick Charlton, said following strong levels of liquidity in 2019, activity in WA’s capital markets had largely been paused since the onset of the pandemic due to uncertainty.

However, activity is showing signs of picking up, with two pending off-market sales at Kings Square in Fremantle and 190 St Georges Terrace in the Perth CBD, which have attracted strong interest from both east and west coast based investors, close to being contracted, he said.

“Perth remains an attractive destination for investment, with relatively strong economic fundamentals and low interest rates likely to spur a revival in investment activity as the outlook for the leasing market becomes clearer,” he said.

“The significant decline in interest rates since 2019 has seen the spread to 10-year government bonds rise to 552.6 basis points in July, up from 446 basis points in January 2019, and a 10-year average of 440 basis points, making commercial property assets more attractive.

“Despite the headwinds from the pandemic for capital markets, yields on prime office assets have continued to tighten, with average prime yields declining by 12.5 basis points over the past six months to 6.4 per cent, while secondary yields have widened marginally to 7.42 per cent.”