CBD office market in Sydney showing signs of recovery

There are early signs of a recovery in Sydney’s CBD office market, according to the latest research from Knight Frank.

The Sydney CBD Office Market Report - March 2021 found that while both leasing and investment activity had been impacted by COVID-19, there are emerging markers of improving sentiment.

While investment volumes over 2020 were 67% below the record $9.174 billion seen in 2019 and at the lowest level since 2013, there was a rebound in Q4 last year with $2.08 billion in transactions recorded, which was well above the 10-year average of $1.6 billion, said report author and Associate Director of Research & Consulting Katy Dean.

Offshore investors are showing the strongest interest, with the share of deal volumes growing from a historical average of about 50% to 68% in 2020, she added.

Partner and National Head of Capital Markets Paul Roberts said, “Although border restrictions and snap lockdowns in some states and territories slowed down the momentum for offshore and domestic investors for most of 2020, investors were still focused on shoring up balance sheets by selectively investing in high quality, well-leased assets with potential for capital growth.

“This strategy began to play out in the last quarter of 2020, with the above average level of transactions reflecting pent-up demand from capital for prime core grade assets in Sydney and potentially an increased willingness by investors to look beyond the current cycle.

“Investment demand for core assets in Sydney remains compelling amidst global uncertainty and geopolitical instability.

“Australia looks relatively attractive compared to other global markets in managing the pandemic and with higher risk to incomes and lower expectations for capital growth in those markets, more prevalent, offshore buyers are stepping up their exposure to office assets in Australia.”

In a sign of confidence, two offshore groups have recently upped their stakes in existing assets in Sydney, said Paul.

China’s sovereign wealth fund, China Investment Corporation (CIC), has acquired an additional 50% stake in Grosvenor Place from Dexus (in partnership with CPPIB) for $925 million.

Meanwhile, M&G Real Estate also acquired an additional stake in 400 George Street from Investa for $300 million, increasing their ownership to 50%.

In recent news to support this sentiment, Investa has partnered with Canadian group Manulife to acquire 39 Martin Place for $800 million.

The Knight Frank research found prime yields for Sydney CBD office assets are holding firm between 4.25% and 4.75% after sustained compression prior to the pandemic, with an increasing focus on covenant strength and length of income.

Leasing market improving

In the Sydney CBD office leasing market volumes have also declined, continuing to be impacted by pandemic conditions, but there are early signs emerging that tenants are on the move.

“Sentiment is improving as more office workers begin the transition back to the workplace, and the stronger than expected economic recovery, with consumer spending and employment growth performing particularly well,” said Partner and Head of Office Leasing NSW Al Dunlop.

“Business investment has also increased for the first time since the third quarter of 2019, which is particularly encouraging.

“Despite the strength in recent figures, the uncertainty around COVID-19 restrictions and the tapering of government support this quarter is still impacting some businesses with plans for relocation or expansion in the short term.

“However, the easing of restrictions and growing confidence in the public health initiatives is providing some momentum for continued improvement in the business sector into 2021, and we are seeing greater activity in the office leasing space as a result.”

The Knight Frank research found there was a halt in leasing activity during the second quarter of 2020 relative to the historical average, which resulted in the total vacancy rising to 8.6% in January 2021, up from 5.6% in July 2020, and total net absorption declining by 54,671sq m over the same period.

However, as the year came to a close, transaction activity was beginning to improve and the fourth quarter finished just 27% short of the same period in 2019 and 2018, said Katy.

“Preliminary figures for the first quarter of 2021 show that almost 40,000 square metres in lease transactions have been recorded, suggesting that tenants are once again reviewing and acting on leasing options in the market.

“Further analysis of the initial numbers for the first quarter show that more than 62% of deals by volume of square metres have been for new leasing deals, with 26% for pre-commitments and 12% on sublease space.”

The research found average incentives have increased to above 30%. Face rents are holding but with incentives up, gross effective rents declined by 6% in prime and 7.5% in secondary in the six months to January 2021.

Read the report