Expectations that CBD office tower values will take a bigger hit in the hard-pressed Sydney and Melbourne markets compared with other cities have risen considerably over the past three months, as major landlords battle with weaker demand and rising finance costs, an industry survey reveals.
Expressed as a net balance, the Property Council’s quarterly survey shows the gloomy outlook for the office sector had been easing for much of this year before worsening significantly – particularly in the two biggest markets – over the September quarter as a larger proportion of respondents now expect values to fall rather than increase.
Cloudy future: the barometer is falling for office tower values. Steven Siewert
“This is realism,” Property Council chief executive Mike Zorbas told The Australian Financial Review.
“This sentiment reflects the addition of supply above and beyond market demand in those two states.”
The industry survey adds to a drumbeat of recent warnings of more pain to come in the office sector, where some recent deals on major CBD towers have been struck at discounts of up to 16 per cent.
At the annual Financial Review Property Summit this month industry leaders including Morgan Stanley’s chairman and co-head of investment banking in Australia Tim Church and Dexus chief Darren Steinberg foreshadowed values tumbling further anywhere between 10 per cent to 20 per cent for unloved office towers.
In its analysis of the listed property sector this month, Citi analyst Suraj Nebhani sounded a fresh warning for office values, flowing from softening cap rates, an industry metric for expected investment yields whose rise typically signals a fall in values, unless offset by rental growth.
“We believe cap rates will expand more across all asset classes, but the property types with structural rent growth drivers (industrial, storage, land lease and to a certain extent convenience retail) should continue to witness benign/no decline in asset values,” Mr Nebhani wrote in a client note last week.
“On the other hand, we believe office will be the most impacted with both cap rate increases and net effective rental declines (as incentives rise).”
Notwithstanding the stronger headwinds in the office sector, sentiment overall across the commercial property sector has held steady, according to the Property Council’s survey of close to 700 professionals.
Forward work expectations remained positive in every state as well as future staffing expectations. Construction activity expectations are also generally positive across all asset classes, with the exception of
the retail and office sectors, where they slightly dipped into the negative territory, Mr Zorbas said.
Concerns over housing supply and affordability dwarf any other issue to be addressed by federal and state governments, the survey shows.
Those concerns add urgency to the need to deal with skills shortages in the construction sector, where state-backed infrastructure projects are already drawing much-needed labour away from residential projects, Mr Zorbas told the Financial Review.
“The issue is that, of the people that we are bringing in, not enough of that immigration pie is skilled or indeed any kind of trades and construction migration,” he said.
“We’re going to have to increase that percentage over the next few years in order that we can accommodate all the rest of the people who are clearly keen to call Australia their permanent or temporary home.
“That is now also to be thought of in competition with government projects, which obviously offer far more security of tenure.
“We really do need a very significant national focus, to help build everything that people are hoping to build.
“We’re talking to state governments a lot at the moment about how they’re feeding that reality through to the federal government.
“Once their mega projects soak up all that talent, there’s still going to be a labour shortage across particularly the provision of new housing and dwellings.”
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