Attention tenants: deals are being done on CBD office rents
Latest research shows conditions have shifted dramatically in favour of tenants, with competition between owners pushing incentives to levels not seen since the downturn of the early 1990s.
With the CBD office vacancy rate hitting 6.9 per cent at the end of last year, tenants have been demanding incentives of up to 28 per cent for prime-grade space and 30 per cent for B-grade space, according to Colliers International's 2013 Research and Forecast Report.
But industry operators say some "highly motivated" landlords have offered incentives as high as 35 per cent on long-term leases to fill gaps in their buildings, although the sources stress that these deals remain "outliers".
The report found CBD A-grade incentives averaged 26.1 per cent in the second half of 2012, up from 17 per cent in 2011. B-grade incentives rose from 19 to 26.7 per cent over the same period.
"The pendulum has well and truly swung in favour of tenants at the moment," said Andrew Tracey, national director of office leasing for Colliers International.
Landlords were offering big incentives to make it "compelling" for businesses to move when they were focused on economic uncertainty and cost-cutting, he said.
The report found the CBD vacancy rate jumped to 6.9 per cent from 5.6 per cent over 2012. Meanwhile, leasing inquiries were at 60 per cent of the level recorded in the previous year.
"You can't fight the market. You can make the decision as a landlord that you want to sit it out for a little while, but at the end of the day, if they are good-quality tenants then it's better to have the income there. And it's pretty important from a valuation perspective," it said.
But Colliers International also believes that incentives may have "peaked", with demand likely to improve as several large and medium-scale leases begin to expire in 2014-15 and tenants begin to compete for space again.
"The [tenants] who do deals now will be able to lock into their cost base for 10 years. It's the second biggest cost after people and if you can lock [it] in with solid incentives at a low point in the marketplace, it makes a lot of sense," Mr Tracey said.
Stuart Colquhoun, Victorian head of leasing for Jones Lang LaSalle, said it was possible that incentives could peak at an average of 30 per cent by the end of the year but were likely to come down by early 2014.
Mr Colquhoun said incentives were still "predominantly" applied to fitout contributions and only a minority of deals involved rent-free periods.
"The incentive provides cheap financing for the tenant to fund the capital expense of the fitout," he said. "But it also allows the landlord to maintain the same face rents, which they just don't want to reduce."
Frequently Asked Questions about this Article…
Rising CBD office vacancy and tougher competition for tenants have pushed landlords to offer large incentives to attract occupiers. The report cited a jump in vacancy to 6.9%, and industry sources say owners are using rebates and fitout contributions to fill gaps and preserve building income and valuations.
According to Colliers International's research, tenants have been demanding incentives up to about 28% for prime-grade space and 30% for B-grade. Average A‑grade incentives were 26.1% in the second half of 2012 (up from 17% in 2011) and B‑grade averaged 26.7% (up from 19%). Some highly motivated landlords have even offered up to 35% on long‑term deals as outliers.
The CBD office vacancy rate rose to 6.9% at the end of the reported period, up from 5.6% during 2012. Higher vacancy puts downward pressure on effective rents, forces landlords to offer larger incentives, reduces leasing activity (inquiries were at about 60% of the prior year), and can affect property valuations and investor returns.
Most incentives are predominantly applied to fitout contributions rather than widespread rent‑free periods. Jones Lang LaSalle notes fitout contributions act like cheap financing for tenants while allowing landlords to maintain headline or face rents.
Tenants who sign now can lock in their occupancy cost base for around 10 years at a low point in the market, combining solid incentives and favourable terms. That can be a meaningful saving since occupancy is typically one of a business's largest costs after staff.
Views in the report suggest incentives may have peaked: Colliers believes incentives could have reached their high point with demand likely to improve as several large and medium leases expire in 2014–15. Jones Lang LaSalle warned incentives might peak near an average of 30% by year‑end but could decline by early 2014.
Leasing inquiries were running at about 60% of the level recorded in the previous year. Lower inquiry volumes mean landlords face more competition to secure tenants, which contributes to larger incentives and softer leasing conditions in the short term.
Larger incentives can compress effective rental income and affect valuations, so many landlords prefer to offer incentives to secure good‑quality tenants rather than leave space vacant. Maintaining face rents while providing fitout contributions is a common strategy to protect headline rent levels and long‑term value.
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