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Over the next three years, the Perth CBD office market looks set to be impacted by a combination of weak demand off the back of declining resources investment and rising office completions.
A significant rise in vacancies is not expected immediately, with the vacancy rate forecast to sit around 6 to 7% over the next 12 months.
But with more than 220,000 square metres of office completions forecast over the next three years, we expect the vacancy rate to rise sharply, to a peak of 13% by mid 2016.
On the demand side, office employment growth and net absorption of office space face a sustained period of weakness over the next three years at least as the economic stimulus from construction associated with the minerals resources boom starts to weaken.
This is a key conclusion of BIS Shrapnel’s recently completed Perth Commercial Property Prospects, 2013 to 2023 study.
Based on committed projects, an orderly decline in engineering construction looks most likely over the next three years.
BIS Shrapnel forecast about $110 billion worth of engineering construction projects (or an average of $37 billion per annum) in Western Australia over the three years to June 2016.
Whilst still at historically high levels, the value of engineering construction will be less than the estimated peak of $43 billion in 2012–13.
Critically, a further rise in oil &amp; gas engineering construction (expected to peak in 2013–14 and then fall) is not expected to offset the fall in iron ore investment.
The problem is the record employment levels and demand for office space, seen during the boom years, was underpinned by extraordinary levels of investment, particularly construction, and that growth phase has now finished.
Even the orderly decline forecast will result in a negative contribution to economic growth.
There is a view that the transition from minerals investment growth to production and rising resources exports will drive renewed demand for office space.
Not so. A lot more people are employed during the construction phase of major resource projects than through the production phase.
Perth is geared up to service record levels of minerals investment. As this investment falls, so too will employment and demand for office space.
The CBD in particular has a high exposure to the resources industry, with about half of the office stock occupied by resource companies or those who service them.
The Perth office market has seen a sharp turnaround in demand over the last 6 to 12 months as many resources companies switched from rapid expansion to cost containment and consolidation. This is just the start.
BIS Shrapnel forecasts for net absorption of Perth CBD office space to average just 5,000 square metres per annum over the next three years— significantly lower than the annual average of 45,000 square metres over the nine years to June 2012.
Even if net absorption were to rebound more strongly than we expect, potentially underpinned by demand from oil and gas related projects, the CBD market would still have a hard time absorbing the quantum of office completions due over the next three years.
The Perth CBD office market is at the start of a moderately strong round of office construction.
Over the next three years, BIS Shrapnel estimate 225,000 square metres is due to be completed (or 75,000 square metres per annum).
This level of supply is not that far below the 95,000 square metres completed annually last cycle between 2008–09 and 2011–12.
To date, just over half the 165,000 square metres of new supply underway or committed to start is pre-committed.
However, there is still a lot of uncommitted and backfill space (as tenants move into existing buildings) to be leased in what will be a weak leasing market.
The saving grace for the CBD is that little new supply is due for completion in the next 12 to 18 months. That means the increase in vacancy rate won’t be significant in the short term.
We anticipate the CBD vacancy rate will stay around 6 to 7% over the next financial year.
Our fear is that as more completions come on stream in 2014–15 and 2015–16, the vacancy rate will rise more sharply, potentially up to 13%.
With vacancy rates a key driver of office rents, a sharp rise in the vacancy rate will lead to substantial falls in both stated and effective rents concludes BIS Shrapnel.
Lee Walker is BIS Shrapnel’s senior project manager.
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Rising Perth office vacancy rate heralds the end of the booms: Lee Walker

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Sydney CBD prime office property yields are set to firm by close to 100 basis points over the next three years.
However, according to BIS Shrapnel, it will take until late this decade for average prime commercial yields to approach to their pre-GFC (2007) low and the property forecasting company does not expect average prime yields to reach the lows achieved in the late 1980s boom at all this cycle.
BIS Shrapnel’s just released Sydney Commercial Property Prospects 2013 to 2023 report concludes that the main phase of yield compression between now and 2015 will occur during 2014 and 2015.
The next 12 months will see relatively little tightening in yields because the leasing market remains quite soft.
The missing ingredients are sustained rental growth, underpinned by strong leasing conditions, and investor expectation of capital gain.
There has been a lot of discussion recently about if and when Sydney prime office market yields will firm to underpin strong price rises.
And whether the weight of money chasing property assets will cause yields to firm.
Over the last 12 to 18 months, office sales in the Sydney CBD have ticked along at a reasonable pace, but they have not delivered conclusive evidence of an across-the-board reduction in yields.
Many market commentators believe a significant firming is imminent given the historically high margin between office property yields and 10 year bonds, viewed as the risk free rate for investment returns.
However, BIS Shrapnel believes it will take more than this.
Unlike retail and industrial property, we have never been able to identify a significant independent influence from long term bonds on the formation of Sydney CBD prime office yields.
And while BIS Shrapnel agrees that the current strong investor demand for quality commercial assets, particularly in CBD locations, from both foreign and domestic players is likely to contribute to some yield tightening, they note that most investors are currently focused on yield, not capital gain.
BIS Shrapnel considers that a significant improvement in yields will await a more substantial rise in rents and growing expectation of capital gain.
Right now, the Sydney CBD office leasing market remains quite weak, with low levels of net absorption, a vacancy rate around 7% and only modest rental growth.
The last time prime property yields in the Sydney CBD firmed significantly was between 2006 and 2007, notably a period when the CBD vacancy rate fell below 4% and growth in gross effective rents was close to 30%.
On BIS Shrapnel’s forecasts, a steady recovery in the CBD leasing market over the next two to three years will see vacancy rates fall below 5%, triggering a strong recovery in rents.
In an environment of rising rents, competition for properties is expected to increase, with investor focus moving toward total returns (both yield and price growth).
As expectation of capital gains increases, prime yields are forecast to fall more sharply.
By 2015, BIS Shrapnel forecast CBD prime average yields will fall to 5.8%, down from 6.7% at December 2012, underpinning a strong rise in property prices.
And later in the decade, as the market experiences a second phase of stronger leasing and investor demand, the yield tightening will continue.
Lee Walker is senior project manager - property at <a target="_blank" href="https://www.bis.com.au/">BIS Shrapnel</a>.
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Lee Walker

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