As new supply comes online and demand remains subdued, vacancy rates in the office market within the Brisbane CBD are set to rise further in 2016.

While this creates opportunities for tenants whose leases are close to expiry to secure deals on more favourable terms, it provides challenges from the point of view of landlords.

Having been as low as six per cent only a few years back, CBD vacancy rates edged back marginally over the first half of the year but remain at 15 per cent as at July, according to Property Council data. Indeed, negative net absorption figures show that overall demand is still falling and that indeed, vacancy rates would be higher were it not for the withdrawal of stock.

Worst affected are B grade buildings, where vacancies are only just below 20 per cent and few drivers of demand exist outside of education related tenants.

For Brisbane Fringe stock, the situation is not much more encouraging, and again, the current vacancy rate (12.6 per cent) would be higher but for the withdrawal of almost 22,500 square metres of stock.

Reasons for this are not hard to understand. As major gas projects wind up, resource clients are pulling back on space requirements. Public sector clients have been doing the same since the previous state government’s fiscal measures. Overall, the state’s economy contracted by more than two per cent in the 12 months to March. White collar employment levels are virtually stagnant and are only expected to improve modestly over the near term.

Furthermore, with the Property Council expecting more than 195,000 square metres of new space to hit the market between now and the end of 2016 as stock associated with developments such as 180 Brisbane, 480 Queen Street and 1 William Street come onto the market, CBRE reckons CBD vacancies will peak at almost 20 per cent next year.

While such conditions are welcome from the viewpoint of those tenants whose current tenure is set to expire within the near future, weak demand conditions pose challenges for landlords – though that’s nothing new as vacancy rates have been rising steadily over the past four years.

In response, many are turning to upgrades. At its 175 Eagle Street building, for example, Charter Hall is spending $25 million improving features such as air-conditioning, lighting and elevators.

“Landlords that have capital or access to capital are in upgrade mode,” CBRE Queensland State Director, Office Services, John Walklate said. “There are improving their buildings and making them more attractive to tenants who are in the building so they can talk to them about renewing leases and more attractive to those groups who are actively looking for accommodation.”

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“[In addition,] I think a good proportion of landlords have worked very hard with their sitting tenants to talk to them early about what their needs are ahead of lease expiry. So I guess the strategy has included two things: it’s been upgrades to properties but also a lot of communication work with sitting tenants.”

Outside of Prime stock, a possible strategy for stock within the troubled secondary market revolves around conversion into alternative uses. Fraser Group has converted a former office block at 74 Albert Street into a hotel. In February, Valparaiso Capital Partners purchased 363 Adelaide Street from Investa Group with the intention of converting that into student accommodation. Some withdrawal of government buildings in George Street is expected prior to the development of the new casino.

Still, Walklate says these transactions are largely one off in nature and are not as of yet sufficient to indicate any form of broader trend.

“It’s not what I would call significant momentum,” he said.

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Investor Demand Still Strong

Meanwhile, as money from overseas continues to pour in, demand on the investor side of the equation remains strong. Around $1 billion worth of stock changed hands in the first half of this year, and Prime yields are now down to 7.25 per cent for the CBD and 7.8 per cent in the near city.

Going forward, CBRE reckons demand for Prime assets should remain reasonably strong in the CBD whilst ‘core plus’ opportunities would be the focus in the near-CBD and development sites should continue to be sought after by Asian capital.

After bottoming out later this year, however, CBRE reckons yields should slowly begin to edge up from next year onward.