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Real Estate

Resisting the lockdown blues

By Martin Patz
Director - Real Estate Research Sydney, Australia

Following the sharp contraction in office demand, increase in vacancy levels and steep decline in effective rents during 2020, the Australian office market was off to a very promising start in the first half of 2021. In line with the general economic upswing, office fundamentals showed early signs of recovery with demand conditions turning positive for the first time since the pandemic took hold from the end of Q1 2020.

In late June 2021, as Sydney entered what turned out to be its longest lockdown yet, it appeared the emerging recovery would be short lived with concerns that we would see a repeat of the devastating 2020 destruction in demand. After all, as we have learned the hard way, lockdowns are everything but good news when it comes to the office market.

Past performance is not a reliable indicator of future performance.

As it turns out any concerns appear to have been overstated with both the Sydney and Melbourne CBDs posting the highest quarterly demand (Q3 2021) since late 20181. While the positive leasing momentum that started to emerge in the first half of the year was expected to cushion the lockdown blow to some extent, the better-than-expected demand figures caught many by surprise.

The key driver for the turnaround in Sydney CBD demand has been the ongoing reduction in sub-lease vacancy, which reduced by 50,000 sqm (36,000 sqm in Q3 alone) from its peak of 170,000 sqm in Q4 20202. The reduction in sub-lease space was not entirely unexpected and, as we have highlighted previously, it appears many tenants underestimated just how much space they may require after all. The drop in sub-lease space is a very promising sign as activity in this sector of the market tends to be the ‘canary in the coal mine’ for office market downturns, as well as for recoveries.


Welcome back?

With both Sydneysiders and Victorians experiencing their first taste of freedom during October, the ‘open for business’ signs are appearing across our two largest CBDs and organisations are slowly encouraging staff to return to the office. However, having spent a large part of the past 20 months working from home, questions remain - will the office crowd return to the CBD and what are the long-term impacts on demand for the office market of the great work from home experiment?

The approach to remote working tends to vary widely, not only by industry but also on an individual company level, with some organisations pushing hard for a return to the office whilst others, particularly in the tech space, are looking to integrate more permanent remote and flexible working policies.

A ‘one-size-fits-all’ approach when it comes to remote working certainly has not emerged and it will take some time for companies to figure out what works best for them. The problems all organisations are facing is the uncertainty of the long-term impact on productivity, innovation, team & company culture of a hybrid workforce. Office-based organisations will have to find a balance in managing employee preferences and business requirements. Most companies are reacting in the first instance to employee feedback around location preferences, but the long-term preferences themselves remain unclear and are evolving as the pandemic shifts into different phases.


For business leaders, this represents a real issue when it comes to long-term considerations including physical workplace requirements, particularly where decisions traditionally have been made on a 5-10 year horizon. Although greater remote working was widely welcomed at first, it appears the novelty of working from home permanently has worn off.

According to a JLL survey of Australian office workers the preference to work from home has dropped from 1.9 days per week (as at Oct-20) to 1.5 days per week as at March 2021. As we have outlined previously, based on our estimate the office market should be able to absorb greater WFH, noting that a large component of corporate and public sector Australia offered flexible working arrangements prior to the pandemic.

Making space for the hybrid workplace

Moving to a hybrid workplace model on a permanent basis will require the implementation of new workspace practices and modifications - the majority of offices have not been designed with employee collaboration or team engagement in mind. Instead, over the past few decades tenants have mainly focused on driving greater office space productivity through densification initiatives such as hot desking, which has seen workspace ratios (sqm per employee) continuously shrink to the point where the situation is fairly tight.

The integration of collaborative spaces and a greater emphasis on amenities that promote employee health & wellbeing (including social distancing) is expected to lead to a reversal of the densification trend with workspace ratios set to rise. This in turn is expected to further mitigate any impact of greater remote work on overall space requirements.

While greater workplace flexibility is here to stay, the impact on overall space demand appears to be less than initially anticipated. Well-located prime assets that cater for a shift in tenant preferences towards greater amenities, health & wellbeing, as well as offer quality sustainability credentials, will benefit from the tenant relocation to prime assets.

Primed for recovery

With Australia slowly but steadily moving into a position where widespread lockdowns are no longer part of the pandemic recovery plan and economic recovery is forecast to be strong, it appears the right ingredients are in place to place the office market well on the road to recovery.

Whilst the anatomy of an office market downturn is generally well understood, they tend to be short but punchy, there appears to be a widely held view that recoveries are an elongated process that take a long time to pick up momentum. However, based on previous market cycles, this is not the case with recoveries also carrying quite a punch. In fact, Sydney and Melbourne CBDs recorded an increase in average occupied space of 5.6% and 5.5% respectively over the two years following a major downturn. This also holds true for rents. Following all the five major downturns over the past 40 years, the Sydney CBD experienced double-digit growth in prime effective rents within the first two years of recovery.

Source: JLL & AMP Capital Real estate

Any office market recovery, however, is expected to be uneven across different asset grades. As illustrated above, during previous market recoveries prime grade stock has significantly outperformed secondary assets as tenants in lower grade stock take the opportunity of lower rental pricing to upgrade. With prime and secondary rents currently sitting at a relatively tight margin the expectation is for higher quality assets to perform significantly better compared to secondary stock over the medium term.

Dip in supply to support the recovery

Demand is obviously just one side of the equation with supply forming the other. In hindsight, the 2020 demand downturn could not have come at a less opportune time. After years of modest supply levels, a number of new projects reached completion in the Sydney CBD over the course of 2020,whilst Melbourne CBD also recorded a large addition to stock. However, following the market correction last year, medium term supply risks have significantly reduced as new projects have been scaled back, put on hold or have been withdrawn altogether.

Overall, the JLL Research estimate for additional supply in the Sydney CBD from 2021 to 2025 has already reduced by over 50% compared to the pre-COVID forecast. As has occurred in previous cycles, we expect older and redundant office stock (primarily in secondary grade) to come under pressure in the near term with some to be withdrawn from the market. This is likely to reduce supply even further with low to moderate supply levels over the medium term expected to support a strong office market recovery.


Brighter days ahead

With the re-opening of Australia’s CBDs underway and an overall positive economic outlook, expectations are for office demand to recover and further improvements once lockdowns and office attendance restrictions are fully lifted.

Indeed, we expect 2022 to mark a turning point not only in market conditions but also for the sentiment towards the sector. We estimate existing tenant pre-commitments in the Sydney CBD to drive in excess of 60,000 sqm of positive net absorption next year. This, in combination with the expectation for ongoing strong job creation and improvement in office attendance, is expected to drive a solid rise in office demand and a subsequent drop in vacancy. We should then see the market return to positive rental growth. Melbourne CBD is also expected to see an improvement in market conditions but is likely to somewhat lag Sydney CBD in its recovery with rental growth to remain muted in the short-term given current vacancy levels.

1. JLL Research
2. JLL Research
3. JLL Research
4. JLL Research
5. JLL Research


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Martin Patz, Director- Real Estate Research
  • Covid-19
  • Institutional Edition
  • Opinion
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  • Real Estate
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While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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