Download What is driving the recovery in the Sydney CBD leasing market?

What is driving the recovery in
the Sydney CBD leasing market?
May 2015
Summary


The recovery in the Sydney CBD office leasing market is
starting to gather momentum. We recorded 34,900 sqm
of net absorption in 1Q15 and 99,500 sqm over the 12
months to March 2015.
However, the demand recovery is uneven. Technology
and mid-tier legal firms are increasing their headcount
and occupational footprint, while we have recorded
consolidation from investment banks and tier 1 legal
firms.
Five successive quarters of positive net absorption
The Sydney CBD is 18 months into a cyclical upturn. The first
phase of an upturn is characterised by a reduction in sub-lease
vacancy. The most recent peak in sub-lease vacancy was 1.8% of
total stock (2Q13) with the current reading at 0.76% of total stock.
Sydney recorded its fifth successive quarter of positive net
absorption in 1Q15 (34,900 sqm) and 99,500 sqm over the year to
March 2015 (Figure 1). To put this figure in context, the 40 year
average for net absorption in the Sydney CBD is 57,500 sqm.
Figure 1: Sydney CBD net absorption, 2008 to 1Q15

NSW is ranked as the strongest performing state in
Australia by CommSec. Moving forward, Deloitte Access
Economics projects that NSW will be the engine of the
domestic economy, accounting for 40% of real final
demand growth between 2014 and 2019.
Sqm
60,000
40,000
20,000
0

The domestic banking sector will be a growth sector of
the Sydney CBD office market. Banks have absorbed
the excess capacity in their workforce and boosted
productivity. The next phase of expansion will see an
increase in headcount.
-20,000
-40,000
-60,000
-80,000
2008
2009
2010
2011
2012
2013
2014
2015
Source: JLL Research

One risk to the demand outlook is a weak recovery in
non-mining sector business investment spending. While
corporate Australia has repaired its balance sheet and is
sitting on excess cash reserves, corporates are reticent
to commit to new capital investment projects.
NSW is the strongest performing economy in Australia
NSW is a beneficiary of the transition in the domestic economy
from mining sector investment growth to more broad based
domestic demand drivers. While the transition has not been
seamless, Deloitte Access Economics reported that NSW state
final demand increased by 3.8% in 2014 – significantly higher than
the 20 year average (3.1%). State final demand is a measure of
domestic economic activity and excludes net exports.
NSW is ranked as the top performing state in Australia by
CommSec1, achieving the top ranking on three of the eight
measures – retail spending, population growth and housing
investment. Deloitte Access Economics projects the NSW
economy will outperform, with state final demand forecast to
increase by an average of 3.1% per annum between 2014 and
2019. Over this time period, NSW is forecast to account for 40%
of Australia’s real final demand growth – almost 10 percentage
points higher than its share of the economy in 2014 (Figure 2).
Figure 2: Share of real final demand, 2014 to 2019
WA
1.7%
SA
6.4%
Figure 3: Computer system design & related services
employment, 2007 to 1Q15
2007 = 100
200
180
160
140
120
100
Others
4.4%
80
2007
2008
2009
2010
2011
Australia
2012
2013
2014
2015
New York City
Source: JLL Research, ABS, NY State Department of Labor
NSW
40.0%
QLD
20.5%
VIC
27.1%
Source: JLL Research, Deloitte Access Economics
An uneven demand recovery
Historically, a demand recovery in the Sydney CBD is led by the
financial services sector and tier 1 legal firms. However,
investment banks have consolidated their footprint and Deloitte
Access Economics states the number of people employed in the
F&I sector in the Sydney CBD is 6.0% lower in 1Q15 than 2007.
Professional services are the locomotive of employment growth
and the take-up of office space in Sydney. Professional services
employment has increased by 7.0% between 2007 and 1Q15.
However, it is not the traditional sub-sectors – legal and
accounting – which are supporting growth, but computer system
design & related services (the technology sector).
The trend observed in Sydney is replicated in New York. Figure 3
shows employment growth in the computer system design &
related services sub-sector for Australia and New York City. While
the numbers in Australia are aggregated to the country level, the
ABS reported that 45% of businesses employing in excess of 20
people in computer system design & related services are located
in NSW. As a result, the trend in Australia’s number relates to
employment growth in Sydney.
1
2
CommSec Research ‘ State of the States, April 2015
What is driving the recovery in the Sydney CBD leasing market? – May 2015
Sydney is benefitting from the expansion of home-grown
technology firms and multi-national companies listed on the
NASDAQ stock exchange. Recent new entrants into Australia
include Twitter and Intuit, while LinkedIn and Adobe Systems
have increased their footprint in Sydney over the past 12 months.
The ABS provides a breakdown of headcount by industry subsector (Table 1). Based on our assumptions of average headcount
and workspace ratios, the underlying demand from the computer
system design and related services sub-sector was 81,200 sqm
between 2011 and 2014.
Table 1: Counts of NSW businesses (Professional services)
Sector
Computer System
Design
Legal Services
Accounting
Underlying
Number of People
Demand
2011
2014
(sqm)
20-199 200+ 20-199 200+
260
23
350
25
81,200
95
106
15
9
148
135
16
11
47,300
30,000
Source: JLL Research, ABS
The legal services sector has experienced a wave of M&A activity
over the past four years. A number of large multi-national firms
have emerged in the sector with an aim to increase the
geographical diversification of revenue streams and achieve
economies of scale across shared services. The consolidation of
Tier 1 legal firms has led to a reduction in their overall
occupational footprint. However, the number of mid-tier legal firms
(employing between 20 and 199 people) has increased across
NSW. JLL estimates underlying demand from the legal services
sector was 47,300 sqm between 2011 and 2014.
Early signs of recovery in the financial services sector
Conclusion
As mentioned earlier, financial services employment in the
Sydney CBD is lower than 2007. Investment banks have
consolidated and relinquished excess office space. While the
short-term drivers of investment banking revenue – M&A activity,
IPOs and trading volumes through equity markets – is firmer, the
investment banking sector is not expected to be a major
contributor to the recovery of the Sydney CBD office market.
The lead indicators for the office sector in the Sydney CBD are
firming. The Seek (NSW) new internet job advertisements
highlighted a 25% increase in internet job advertisements
between mid-2013 and March 2015. Corporate Australia’s hiring
intentions are a positive lead indicator for leasing enquiry and the
underlying demand for office space.
However, sub-sectors of financial services are increasing – the
four largest banks by market capitalisation in Australia are
recording strong revenue growth and an improvement in operating
profit. Retail banking services – the direct execution of
transactions between a bank and its customers – is a driver of
revenue growth and is linked to the expansion of household
balance sheets. The ABS estimates that established dwelling
prices in metropolitan Sydney increased by 35.7% between 4Q11
and 4Q14. House price appreciation has stimulated private sector
housing investment with NSW private sector housing investment
increasing by 11.5% in 2014. Deloitte Access Economics projects
above trend private sector housing investment growth of 7.5% per
annum between 2014 and 2017.
We have observed a strong relationship between NSW private
sector household investment and Sydney CBD net absorption
between 1991 and 2014 (Figure 4). Historically, the demand for
office space has lagged housing investment by two years’. The
lag is explained by banking sector profitability precipitating
employment growth and the demand for office space. Assuming
the recovery in the Sydney CBD office market evolves in a similar
way to previous cycles, it supports our prediction of the Sydney
CBD office market recording above trend net absorption in 2015
(85,000 sqm) and 2016 (120,000 sqm).
Figure 4: NSW private sector housing investment & Sydney
CBD net absorption, 1990 to 2018
(Sqm)
300,000
The recovery in leasing demand has occurred prior to an increase
in completions over 2015 and 2016. Approximately 375,600 sqm
of new and refurbished supply is forecast to complete by the end
of 2016, equating to 7.5% of total stock.
However, completions and supply additions are different
variables. Upon relocation to International Towers Sydney (T2), a
high proportion of Westpac’s backfill space will be withdrawn for
redevelopment, while a number of office assets with adaptive
reuse potential will be converted to residential. As a result, supply
additions will be lower at an average of 61,900 sqm in 2015 and
2016, before supply additions are lower than the long-term and
average 44,600 sqm between 2016 and 2018.
Authors:
(Y/Y % Change)
30%
250,000
25%
200,000
20%
150,000
15%
100,000
10%
50,000
5%
0
0%
-50,000
-5%
-100,000
-10%
-150,000
-15%
-200,000
-20%
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Net Absorption
Private Sector Housing Investment (2 years forward)
Source: JLL Research, Deloitte Access Economics
3
While the factors outlined in this paper have been broadly positive
about the demand-side of the equation, we remain cognisant of
risk. Corporate Australia is sitting on excess cash reserves and
we expect to see a recovery in business investment spending in
the 2015/16 financial year. However, corporate Australia remains
cautious about the outlook and is applying conservative
assumptions in project appraisals. A weak recovery in business
investment spending would, therefore, temper the outlook tenant
demand in Sydney over 2015 and 2016.
What is driving the recovery in the Sydney CBD leasing market? – May 2015
Andrew Ballantyne
Head of Strategic Research
JLL
tel: +61 2 9220 8412
[email protected]
Daniel Kernaghan
Head of Office Leasing - NSW
JLL
tel: +61 2 9220 8721
[email protected]
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