Flat sector no life on lease

The weakening mining sector and flat job market have led to a deterioration in the commercial property market, ANZ's property department says.

Although capital continues to flow in from super funds and overseas investors to the bricks-and-mortar sector, which offers a haven with higher yields, underlying leasing conditions are tough.

ANZ's property research team head Paul Braddick said a weakening labour market and cutbacks in the finance, mining and public sectors had resulted in net office absorption (leasing) weakening sharply across capital city markets.

Ongoing job cuts in these sectors suggest little recovery soon. Latest job figures show the unemployment rate marginally higher at 5.6 per cent for the past five months.

According to analysts, this will start to affect the share prices of listed real estate investment trusts that focus on the office sector.

The Property Council of Australia will release its half-yearly annual vacancy rates next month and there are rumblings that most of the major cities will see a rise. Sydney's current rate is 7.2 per cent and Melbourne is 6.9 per cent.

Some of the space left behind by tenants moving into new offices in the next few years at Docklands, Melbourne, and Barangaroo South in Sydney, will be taken off the leasing market as it undergoes upgrades. That will take some of the pressure off rising vacancies.

However, the new leases are being completed at lower effective rates, due to the rise in incentives, or inducements, to get a lease signed.

In the report, Mr Braddick said after rebounding strongly since 2010, the recovery in commercial property appears to have stalled. "The underlying market conditions have deteriorated sharply in the past 12 months; tenant demand has weakened, vacancies and incentives risen and rental growth has slowed, particularly for secondary properties.

"While we expect a modest cyclical recovery in physical demand, some market segments face significant structural challenges in the years ahead and the yield gap between prime and secondary properties is expected to continue to widen. The clearest valuation risks lie in secondary properties, particularly fashion-based specialty retail, with high rent-to-turnover ratios. While headline occupancy remains high, incentives have risen and negative re-leasing spreads are becoming increasingly common."

But Mr Braddick said a global flood of liquidity, a rising appetite for yield and the recent decline in the $A are expected to continue to support investor interest in commercial property (although, to date, offshore demand has focused on prime properties).