Mining, finance cuts blamed for fall in leasing
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, the underlying leasing conditions are tough.
The head of the ANZ Bank's property research team, Paul Braddick, said a weakening labour market and cuts in the finance, mining and public sectors - with little recovery in the near-term - have seen leasing weaken sharply across the capital city markets.
The latest job figures showed the unemployment rate sat at 5.6 per cent for the past five months.
According to analysts, this will start to effect the share prices of the listed real estate investment trusts that focus on the office sector.
There are rumours there will be an improvement in most major cities when the Property Council of Australia releases its half yearly annual vacancy rates next month.
Sydney's vacancy rate stands at 7.2 per cent and Melbourne's is 6.9 per cent. Some of the space left behind from tenants moving into new offices in the next few years - at Docklands in Melbourne and Barangaroo South in Sydney - will be taken off the leasing market as they undergo upgrades.
That will take some of the pressure off the rising vacancies. But the new leases are being completed at lower rates, due to the rise in incentives to get the lease signed.
In the report, Mr Braddick said the broad-based recovery in commercial property appears to have stalled after rebounding strongly since 2010.
"The underlying market conditions have deteriorated sharply in the past 12 months; tenant demand has weakened, vacancies and incentives have risen and rental growth has slowed, particularly for secondary properties," he said.
"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 heightened appetite for yield and the recent fall in the Australian dollar are expected to continue to support investor interest in commercial property.
"REITs (real estate investment trusts) will increasingly return to the purchase market as equity valuations revert to above net tangible asset value," he said.
On the supply side, the report added that underlying commercial property construction activity remained subdued.
"Nonetheless, despite a soft outlook for building activity, lumpy additions to existing supply are expected to challenge some market segments, including the Sydney and Melbourne CBD office markets," the report said.
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The article says a weakening mining sector and cuts in the finance and public sectors, combined with a flat labour market, have reduced tenant demand. ANZ Bank property research head Paul Braddick notes these factors have led leasing conditions to deteriorate sharply across capital city markets.
Sydney's vacancy rate is around 7.2% and Melbourne's about 6.9%. Higher vacancies mean more competition for tenants, growing incentives from landlords, slower rental growth, and increased pressure on office landlords—especially for secondary properties.
The report highlights that incentives have risen as landlords try to secure leases, and new leases are being completed at lower effective rates. Overall rental growth has slowed, particularly for secondary properties, and negative re-leasing spreads are becoming more common.
Analysts in the article expect the weaker leasing market to start affecting share prices of listed REITs that focus on office assets. However, ANZ also says global liquidity and a search for yield should sustain investor interest and may prompt REITs to return to the purchase market over time.
Paul Braddick warns that the clearest valuation risks lie in secondary properties because tenant demand has weakened, incentives are higher, rental growth has slowed, and re-leasing spreads are often negative. Some specialty retail segments with high rent-to-turnover ratios are particularly exposed.
The article points to a global flood of liquidity, a heightened appetite for yield, and a recent fall in the Australian dollar as factors that continue to support investor interest in commercial property, offering higher yields compared with other assets.
Underlying commercial construction activity remains subdued, but the report warns that lumpy additions to supply could still challenge some markets, notably Sydney and Melbourne CBD office markets, which could add pressure to vacancies in specific segments.
The article says the broad-based recovery that began after 2010 has stalled. While a modest cyclical recovery in physical demand is expected, some market segments face structural challenges and the yield gap between prime and secondary properties is likely to widen in the years ahead.
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