December 1, 2023

Supply demand imbalance coming for new premium Sydney CBD office


Supply demand imbalance coming for new premium Sydney CBD office, and it’s not what you’d expect!

  1. For the first time in 50 years, no new office developments are expected to be completed in the Sydney CBD for a two-year window – 2025 and 2026 (JLL). This is in addition to no new office developments delivered in the first nine months of 2023 and anecdotal evidence of listed REITs putting +$1bn projects on hold.
  2. This shows an extraordinary supply-side contraction given the demand drivers for new best-of-breed offices have remained robust, with face value rents increasing year on year and vacancy tightening post-COVID.
  3. As the funder of six senior secured office investments across Sydney, Melbourne and Auckland, we have seen a clear demand bifurcation between new and existing product. We expect this to widen further in 2024.
  4. Tenants want compelling amenities when selecting new office space, prioritising location and energy efficiency that meets increased corporate ESG requirements.
  5. Based on the bid/ask spread we’re observing from prospective opportunistic purchasers who seek finance to buy older A-grade and B-grade offices, we expect further price declines of 10-20% over the next 12 months for this subsector if vendors are pushed to transact. We’re less inclined to finance this lower-quality subset unless leverage is extremely conservative.
  6. The negative sentiment towards Office as an asset class has resulted in a scarcity of lending capacity and very wide spreads for new loans. Our Merricks Capital Partners Fund has maintained office loan exposure of 15-25% since the onset of this theme. With limited competition in lending and a focus on premium product in desirable locations, this subset of the portfolio has performed well.
  7. Over the next six months, we expect to see three of our office investments repaid with projects near completion on Premium and A-grade developments. Leasing has been strong across these projects and only showing modest capitalisation rate expansion of 50-80bps, significantly below the rise in long-term bond yields over the past three years (~350bps ) due to the higher face value rents and tight supply for this specific product.

During November, the Stage 2 Development Application was submitted for our largest office investment, Pitt and Hunter, a loan facility funding the aggregation of existing office sites holding a unique prime location in Sydney’s CBD. The proposed 55-storey mixed-use Premium grade commercial tower, the funding of which is separate from our loan facility, is expected to be 220 meters tall and one of the world’s tallest hybrid timber towers. Bates Smart designed the development with ESG credentials as a priority, targeting 6-star NABERS and Green Star Ratings and with solar panel capacity on effectively all of the external glass.

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