What’s the outlook for Australia’s office market? Key findings from the latest Property Council of Australia report and panel discussion

Representatives of MRI Software recently gathered with industry peers at Sydney’s Fullerton Hotel to hear an expert panel discuss the Property Council of Australia’s July 2023 Office Market Report and its implications for the commercial real estate sector.

The attendees were treated to some insightful perspectives on factors shaping the office market at a time of significant structural change. The panel talked about drivers for office space demand, how the flight to quality and the crafting of meaningful spaces is playing into that demand, what tenants are looking for in terms of collaboration on ESG and decarbonisation, and what needs to be done about building a partnership model for the future.

Dominic Brown, Head of International Research at Cushman & Wakefield, moderated the panel and made the following key observations on the data:

• First of all, our CBDs are showing incredible durability, with vacancies largely tracking sideways, demonstrating resilience as they continue to face significant structural challenges.
• With respect to the international office market, Australia is faring well and sitting favourably in comparison with its global peers.
• Even accounting for a decline in the past six months, 225,000 more square metres of office space is occupied in Australian CBDs now than two years ago.
• The strong performance of the Sydney CBD, in particular, is a good news story to come out of the report.
• Unfortunately, in non-CBD locations, the results are less consistent, with smaller centres being affected by adverse conditions and drops in demand.
• We’re seeing a clear bifurcation of demand that favours premium space with 80,000 square metres more prime space being occupied in Sydney’s CBD than two years ago and a heavy focus on key locations that include high quality amenities and transport infrastructure.
• This flight to quality has come at the expense of the secondary B and C-grade market, where 100,000 square metres less is occupied now than two years ago.
• 200,000 square metres of new supply is set to come onto the market in the Sydney CBD over the next 12 to 18 months, after which there is a period of hiatus until 2027.
• This pause will provide an opportunity for the market to digest the supply and give corporate occupiers time to refine their return to office strategies. It will also give developers and landlords the chance to deliver the buildings that truly meet tenant needs.
• There’s a real need to look forward in terms of shaping commercial real estate strategy. While many are focusing on near term trends, strong population and employment growth are set to be huge drivers for the future.

Meeting flexible demand

In an uncertain environment post-COVID, managing office vacancies is a major challenge.

“Before COVID all the big employers in the country were talking about how we can make our workplaces more flexible. How we can encourage hybrid working to champion change and work towards gender equality,” said Michelle Dance, Fund Manager, Cromwell Property Group. “So to come back post-COVID when we finally got what we wanted to the ‘shouting space’ that everybody needs to be in the office five days a week is pretty disappointing.”

She believes that mandating a return to the office should be replaced by having intelligent conversations about how we can help workplaces be more attractive to employees.

A balance between peaks and troughs needs to be achieved by setting up tenants for flexibility from Mondays through Fridays.

“We’ve got to think of our buildings like stadiums,” she said. “Just because the stadium is empty for three days a week and then has 40,000 people over the weekend, doesn’t mean you build a stadium that can only accommodate 20,000 people.”

Pricing pressures and flight to quality

Dominic asked the panel about how they view pricing pressures – what’s happening and what can be done to insulate assets against some of those pressures and risks?

According to Peter Menegazzo, CEO, Investa, quality of assets is a real factor. “The variation between how much prime holds up in relation to secondary is really starting to play out,” he said. “Those secondary assets are going to be hit alot harder from a valuations perspective.”

Michelle said that, in terms of value and pricing, the Western Sydney corridor has been affected, along with lower-grade ESG quality buildings. “So I think that’s where we should be placing CAPEX to get an upgrade.”

“There’s a wide variation in quality and location of A grade stock. So it’s not just a specific grade that’s going to be the one that everybody wants. People want the best quality for the price point that they can pay.”

Lolita Southwell, Senior Asset Manager, Brookfield Properties, added that preserving cash flow and protecting value comes down to “creating demand by providing experiences and places that people actually want to be spending time in.”

ESG and decarbonisation

According to Amanda Steele of ISPT “ESG is an absolute fundamental of what we deliver and we want to ensure that we are outperforming there and continuing to outperform for our tenants’ benefit.”

Lolita agreed and added “Organisations are exercising caution and evaluating their accommodation requirements with a lot more rigour. For us, regardless of industry, and regardless of the asset, sustainability and ESG are at the top of the priority list.”

In terms of ESG, several panelists thought that embodied carbon emissions would have an increasingly crucial role to play.

Michelle pointed out that Australia is well placed internationally for upgrading its lower grade assets and protecting the embodied carbon in our built environment. “We look after our assets, we invest in our assets. We’ve been focusing on operational sustainability for decades. And I think the next phase of that is really focusing on that embodied carbon story.”  And, in the current climate, with cost and supply pressures, there’s also a much stronger economic imperative to adapt and reuse.

While flipping office space over to residential has been widely touted, Michelle thinks this calls for some creative problem around issues like floor plans and light penetration. That said, with a current housing shortage and population increases coming, the conversion of B and C grade stock into residential is something that definitely needs to be tackled.

Peter agreed and said “I think the new frontier is coming where businesses will need to report on embodied carbon. It’s something that will continue to emerge.” He adds that Investa is actively considering adaptive reuse and sees it as an opportunity to reposition with offerings in areas like boutique office space.

Placemaking and partnership

Michelle said the golden era of the landlord is over and the subsequent focus on the occupier has narrowed even further to individual employees who are asking “why do I want to come back to the office, what will attract me back?”

“When we look at our touch points with our occupied clients in the last six months, more than ever, we’re dealing with the heads of HR. That wouldn’t have happened four years ago. (This) is demonstrating how important the individual employee experience is and what’s driving that return back to the workplace.”

According to Lolita, “As people have a people have a choice about where to work, where to spend their day, it really becomes a story of a flight to experience.” 

And she insists that tenants can’t possibly do it all. “They’re looking for a partner to help them achieve their objectives, to elevate their health and well being offerings by way of flex spaces, outdoor spaces and terraces. They want a partner to help them broaden their community outreach, and they want a partner to help them reach their ESG perspective.”

Amanda echoed these sentiments and said, “I think as an industry we’ve been quite unsophisticated in partnerships for a long time. It’s been very transactional and we need to shift to a partnership model, understand our tenants’ employees and assist them in what they’re trying to do.”