The strongest level of demand in four years has propelled Sydney to the leading position in nation’s office market as a strengthening economy drives strong employment growth in traditional office occupying sectors such as finance and technology – albeit with the market set to be tested over the near-term as a number of office towers in Barangaroo and the CBD come online.

Releasing its latest Office Market Report, the Property Council of Australia said despite relatively stable demand conditions, net supply additions of more than 111,000 square meters pushed overall vacancy rates throughout the country from 10.7 percent last July to 11.2 percent in January.

But it said the ‘two-speed’ nature of the national economy had created a ‘three-speed’ office market amid strong demand in Sydney and Melbourne, growing vacancies in Brisbane, Perth and Canberra and little change in Adelaide, Hobart and Darwin.

“The picture emerging from the office market is that the two-speed resource boom economy has flipped and fragmented into three very distinct positions – strong, weak and flat,” Property Council of Australia Chief Executive Ken Morrison said.

Leading the way was Sydney, whereby vacancy has dropped across all building classes (especially premium and A grade) as a strengthening economy and a return to employment growth in key office occupying sectors such as finance and technology drove net absorption of 54,279 square meters over the past six months, with A grade space accounting for the bulk of demand.

“We have seen a lot of economic data in the last six to twelve months point to a strong improvement in the New South Wales economy,” Property Council of Australia (NSW Division) Executive Director Glenn  Byres said, asked what was behind the demand surge.

“Whether it’s an uplift in retail sales or in housing starts, there has been a batch of good economic data which has shown that the New South Wales economy is in a good healthy place right now.”

Elsewhere, demand in Melbourne remained strong even though supply additions saw vacancy levels rise in that market whilst conditions across other markets were flat to negative (see below).

Going forward, from an overall perspective, many commentators feel the subdued nature of the economic outlook does not bode well for market conditions across the sector.

In its latest report released in December, for example, international research firm CBRE said it expected growth in supply to outstrip demand across all markets over the three years to 2017, and that office rents throughout the country would drop by 1.3 percent throughout 2015.

Participants in the latest NAB Quarterly Australian Commercial Property Index, meanwhile, see negligible rental gains within the sector over the next two years.

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As mentioned above, record demand in Sydney saw the vacancy rate in that city drop from 8.4 percent in July to 7.4 percent in January as 54,279 square meters of net absorption more than offset a modest net addition of space, causing vacancies to fall across all grades of space. Demand is being driven by robust conditions throughout the New South Wales economy including strong residential and infrastructure markets in Sydney as well as a pickup in growth in employment within key office occupying sectors such as finance and technology.

Going forward, however, the market is set to be challenged as new towers in Barangaroo and the CBD come online – in the next two years alone, more than 300,000 square meters of space is set to hit the market.

In Melbourne, meanwhile, strong demand remains amid net absorption of almost 38,000 square meters of space in the six months to January, albeit with supply additions of more than 67,000 square meters pushing the vacancy rate up from 8.5 percent to 9.1 percent.

Civic and Docklands remain the most sort after markets though supply is also short in the city’s north-east. Vacancies are lowest in A and D grades.

Whilst an anticipated 121,335 square meters of anticipated new stock in 2015 will test the market in the near term, supply additions are set to ease off beyond that.

By contrast, vacancies in Brisbane climbed from 14.8 in July to a record 15.6 percent in January as a drop in vacancies in premium space is being more than offset by appalling conditions in secondary markets. Indeed, vacancies in B grade space – which accounts for just over half of the market – sit at a whopping 23 percent as very soft economic conditions persist in that market notwithstanding expectations of a housing comeback as resource sector work drops back. Without any apparent sign of the situation turning around, talk abounds of the need to convert disused space into other uses.

Likewise, vacancies in Perth have ballooned out to almost 15 percent as the resource sector pull-back has seen demand plummet across all asset classes (especially class A and B), and are expected to rise further this year with a whopping 146,601 square meters of stock set to hit the market.

Vacancies also hit record highs in Canberra, which is being impacted by significant levels of supply additions as well as tight conditions in federal spending and what the Council says are growing levels of ‘urban decay’, albeit with the ACT Chief Minister making positive noises about urban renewal.

In smaller capitals, vacancy rates are broadly stable for now in Hobart, Adelaide and Darwin, although the underlying health of these markets differs as demand is rising in Darwin and confidence is starting to pick up in Hobart (albeit with the industry in the latter complaining of being consistently stifled by 29 local councils) but high levels of vacancies in Adelaide are being stabilised only by stock withdrawals amid a fundamental lack of business confidence in that city and a significant property sector push for policy change.