Why the office property sector is not dead

Thursday, 4 July 2024

High interest rates and the rise in remote working have hit office property markets overseas hard, but in New Zealand the sector is faring better, commercial property experts say.

Traditionally, office blocks were the glamour assets of the commercial property world, and owning or leasing a prime block was popular with high-flying business folk. Think Trump Tower in New York, or Sir Bob Jones’ holdings in Auckland and Wellington.

When Covid hit, offices around the world emptied out as employees embraced the ability to work from home, and the trend became widely accepted. In 2020 The Economist even ran an article on “the death of the office”.

Empty office buildings, and the semi-deserted business districts they contribute to, have always been considered a problem, and companies started to encourage the “return to the office”.

But tougher economic times have not helped, and office markets in Australia, the UK and particularly the United States are struggling, and characterised by high vacancy rates and declining values.

In its latest Financial Stability report, the Reserve Bank said in many countries commercial real estate owners are under pressure, due to tight monetary policy and structural changes to demand in the office and retail sectors.

In New Zealand, stresses in the commercial property industry are concentrated in lower-quality office and parts of the retail sector, it said.

“Internationally, several banks have experienced large falls in equity prices and credit downgrades in recent months due to their high exposure to commercial real estate.”

“Risks to New Zealand banks from commercial property exposure are much more limited, with commercial property lending representing less than 10% of overall lending portfolios, and a lack of concentration in individual banks.”

But New Zealand is in recession, and many jobs are being cut in the public and private sectors. So how are the office property markets in the three main centres faring?

Auckland

Auckland’s office property sector was hit hardest by the Covid era as the region was locked down for a longer period than the rest of the country.

Images of the CBD’s empty streets became synonymous with the lockdown, but New Zealand workers’ return to the office is ahead of the global trend, according to commercial real estate firm JLL.

Its latest Office Sentiment Survey showed that 70% of New Zealand employees wanted to spend about three days a week in the office, whereas in the US, for example, attendance was sitting at around 50%.

JLL head of research Gavin Read says after Auckland spent three months in strict lockdown in 2021 when the opportunity to return to the office presented itself many people took it.

Recent CBD foot traffic data shows it is not quite at 2019 numbers, but is progressing well, while a lift usage survey by Precinct Properties last year showed worker numbers were not far off pre-Covid levels, he says.

“Many people won’t have an appropriate environment for full time work at home, but the biggest reason for the return is the desire for collaboration and networking, and for mentoring and development.

“It’s hard to do those things effectively online. But companies have had to review what they offer their staff in their office, and reconsider the space, location, amenities, and so on to attract employees back.”

The fact that many workers have returned means the state of play in the city’s office market is different to overseas markets, Read says.

JLL’s figures put vacancy rates in CBD premium office buildings at a historic low of 1.9% in the first quarter of this year, although prime vacancies in the core CBD increased to 12.2%, from 8.8% late last year.

In the Wynyard Quarter prime vacancies increased to 6.3% from 3.5% over the same period, but 13 out of 19 buildings in the precinct had 0% vacancy.

While JLL’s figures do not include secondary office stock and focus on the central city, Colliers latest research has some broader market figures. It puts the city’s prime grade vacancy rate at 6.8%, but the secondary grade stock’s vacancy rate higher at 17%.

Read says there has been a pronounced “flight to quality” among office tenants for some time, and that will continue, with demand high in that space.

He expects moderate rental growth for well-located, quality properties to continue this year, and that the yield-softening cycle is close to its peak for higher quality buildings.

“In terms of sales, there is not a huge amount of turnover as they are big purchases. But the overall Auckland office market recorded sales of $147.65 million in the last quarter of last year, with $89.65m in the CBD.”

A notable transaction in that quarter was the sale of 32-34 Mahuhu Crescent for $19.65m, he says.

Last year Jones’ company bought the 18-storey tower at 51-53 Shortland St. It was valued at $70m, but the purchase price was not made public.

More recently, Kiwi Property Group announced its plans to sell the 38-storey Vero Centre on Shortland St to a Hong Kong-based conglomerate for $458m.

Wellington

Earthquake issues and the predominance of the public sector make Wellington’s office market unique in a global sense, according to Bayleys’ head of insights and data, Chris Farhi.

After the Kaikoura earthquake in 2016, some stock was damaged irreparably while other stock needed repairs and strengthening, and that left a bit of a shortage of stock, he says.

“That’s left the market pretty tight for nearly a decade. It means there is fast uptake for the high quality office stock, and quite good rental growth for it too.”

He puts the city’s overall vacancy rate at about 6%, although the agency is currently analysing the latest data to get a definitive figure, he says.

“On a preliminary basis, vacancy rates have been flat, and show no material change. It’s tighter than Auckland’s market where our figures shows an overall vacancy rate of 10%.”

JLL’s figures show the Wellington prime office vacancy rate increased slightly to 5.9% in the first quarter of this year, from 5.3% late last year.

Bayleys commercial leasing specialist Luke Frecklington says a year ago the Wellington market was at record low vacancy rates, but rates are now starting to creep up.

The change is due to the economy cooling off, and the public sector scaling back, the full effects of which are yet to be seen, he says.

“I’ve been through a few cycles of public sector cutbacks, and when it happens all the cuts have to play out in full, before it filters through to the office market.

“That won’t be till late this year or early next year when various departments have consolidated their workforce, and established what it means for their office space. But many are in leases they can’t just walk away from.”

The economic downturn has left many businesses hurting, so he expects some scaling back from the private sector too.

It could create an oversupply in future, and an increase in vacancies will be challenging for some landlords, he says.

“We are seeing some impact as more space is coming to market, and the market is more tenant favourable than it was.

“Rents haven’t softened, but the level of incentives a landlord might offer to secure a tenant, such as a fit out cost contribution, that’s crept up. If a lot more stock comes on the market, then rents will soften too.”

Frecklington says it is a tougher market but reasonable deals are happening, and compared to overseas markets where the office sector has been hit hard, the Wellington market is doing well.

There is still a level of business confidence out there, and he is dealing with a number of businesses that want to find better space, or upsize it, he says.

“That’s because more people are coming into the office again. You only need to look at the increased motorway traffic and public transport numbers for evidence. Overseas, people are just not returning to the office.”

Christchurch

The 2010/11 earthquakes and the resulting rebuild have left the Christchurch office market moving to a unique beat, much like the city’s housing market does.

It has vacancy rates of 3.7% across the CBD office market overall, and of 3.1% for prime office stock, the latest CBRE figures show.

JLL’s figures have the prime office vacancy rate at 3.4%, up from 1.1%, but notes 15 out of 18 buildings in the city have 0% vacancy, and 13 of them have had no vacancy every quarter for the past two years.

CBRE Christchurch managing director Tim Rookes says vacancy rates are at all-time record low rates, and reflect the strong fundamentals that evolved post-earthquake.

The rebuild resulted in billions of dollars spent on infrastructure, and 90% of the CBD completely rebuilt to world leading seismic standards, he says.

“We have brand new, top of the line modern office space, but there is limited supply, and strong demand.

“Tenants might move to upsize or downsize, but they have great space already so the imperative to move is not pressing. So the market is influenced by factors on the margins.”

Another driver is that the earthquakes left many people working from home for prolonged periods, so Christchurch did its tour of duty in that space before Covid, and they have had enough of it, he says.

“Christchurch is easy and quick to commute around, so there are not the same deterrents around it as there are in other cities. People here wanted to get back to the office after Covid.”

But the CBD market is entering a new supply phase this year, with 33,450m² of new and repurposed office stock due to come online, CBRE research shows.

The new developments were exciting and needed, and will ensure Christchurch is a city of the future, Rookes says.

“Sales transactions are very low, as owners do not need to sell, and rental growth has plateaued because transactions are not high.

“Supply is set to get a bit higher though, and that will create a bit more competition, and that will impact on rents eventually.”

It would be naive to think there is no pressure in the system, and economically, and the sector has tightened up, but the Christchurch market is in pretty good shape, he says.

“But the situation is very different in other regions. I was in Asia late last year, and investors were offloading office property in Europe and the US where there are huge vacancy rates in some markets.”

Despite the headwinds, he is optimistic and thinks investors are waiting for interest rates to come down and the economy to improve.

Once people can price in the cost of their debt they will be more confident, and will start to get on with it again, he says.

“Many international investors want to buy somewhere safe, and we have that here. In the past, Christchurch’s lack of population growth has been an issue, but that has improved, and should continue to.”