No new projects but CBD’s still changing

New office development is grinding to a halt, but landlords are nonetheless aggressive in attempts to attract tenants to the city.

In the heart of the city, one of the CBD’s newest office buildings sits conspicuously empty.

Leighton Properties’ KS1, the largest development to date at the Perth City Link, presents a good snapshot of where Western Australia is at in the property cycle.

When the green light was given on Leighton’s $1 billion investment in four new office towers in 2011, Perth’s office vacancy rate was firmly in single digits, at 7.8 per cent, and falling.

Today, office vacancies have breached 20 per cent and, according to most commercial market watchers, are set to climb to around 25 per cent before stock starts to be absorbed again.

Nevertheless, Leighton Properties senior development manager Michael Barr said he believed Perth was at a tipping point, while acknowledging developers had to remain patient in a down market.

“Things are cyclical, to a degree, and long-term; Perth is in a great position,” Mr Barr told a recent Property Council of Australia event.

“But it doesn’t turn around fast and we’re right at that point at the moment where it doesn’t feel good.”

At Kings Square, which Leighton now co-owns with DEXUS Property Group, Mr Barr acknowledged it was a concern that KS1 remained empty; and while he would like to see it filled, he said market conditions were increasingly challenging.

“We’ve got a lot of interest in Kings Square but we are competing very hard to get those tenants to come down,” Mr Barr said.

“We’re competing against fitted out space as well. Some tenants want fitted-out space, some tenants would prefer to be on the Terrace as opposed to the Kings Square location, but the ones that have come down there are really happy with their decision.”

However, Mr Barr urged market watchers to take some perspective on Perth’s office market, pointing to the fact that the city had come off an all-time high of development activity.

In 2015-16, about 130,000 square metres, including KS1, were added to the CBD market, closing out a supply cycle that included city-changing office towers Brookfield Place, 140 William and Raine Square.

Building completions in 2015 included Golden Square, 999 Hay Street, the David Malcolm Justice Centre and Brookfield Place Tower Two.

There remains just one major office building under construction in Perth’s CBD – the 55,000 square metre Capital Square, which is being developed by Malaysian investment group AAIG, and will become Woodside Petroleum’s new headquarters once it is complete in early 2018.

And opportunities for new development, according to Qube Property Group managing director Mark Hector, are becoming increasingly scarce.

“It’s back to supply and demand, and at the moment, there is an oversupply of lower-quality office accommodation,” Mr Hector told Business News.

“Until that supply equation comes back into line, the likelihood of getting any new development of any substance is pretty remote.”

Mr Hector said Qube, which delivered 999 Hay Street to market last year, was concentrating mainly on the residential land development side of its business to ride out the downturn.

However, that’s not the only strategy emerging among office owners.

Landlords of the city’s lower-grade office stock are progressively upgrading buildings, as tenants invariably exit older premises with better leasing deals on offer in new space.

But a revamped building in 2016 is about more than just a fresh fit-out on the office levels.

Office owners are increasingly concentrating on the amenity of their buildings to attract and retain tenants, with retail and hospitality precincts emerging across the CBD.

Recent upgrades in the city include 140 William and Cloisters Square, following the success of Brookfield Place. Meanwhile, Mirvac Group is well advanced on a retail redevelopment at Allendale Square, and Primewest and AMP Capital are upgrading the ground floor at Exchange Tower.

AMP is planning to spend $25 million on a redevelopment at 140 St Georges Terrace, while the latest redevelopment to emerge is at the Eureka Funds Management and Investa Property Group -owned QV1, where a development application was approved last month.

Eureka Funds Management fund manager Brett Dillon said a $6.5 million program of works at the ground floor of QV1 would begin in January.

“We have a vision to provide a retail amenity for our office tenants that is fitting for QV1 in terms of it being a premium building,” Mr Dillon told Business News.

“It needs to be a destination in itself that not only satisfies our tenants, but also draws a broader market.”

Mr Dillon said the recently opened QV1 outlet of the popular Mary Street Bakery was an indication of the quality of the hospitality offering planned at the Hay Street tower.

“At a time when the market is quite soft, I see this as the right time to be doing it,” he said.

“We’re fortunate in that we’ve got quite a healthy lease expiry profile, so we don’t have any of the leasing pressures and capital pressures that some other owners do.

“Really, for us it’s about positioning the building for that medium-term cycle when you start to have lease expiries and risks coming to the asset.”

The QV1 development application also included plans for two new office towers, but Mr Dillon said that aspect of the proposal was no certainty to go ahead.

“To be frank, the last thing Perth needs at the moment is another office building,” he said.

“There is potential for us to provide more office accommodation in that area, but we’ll be putting that on ice until the timing is right.”

A refurbishment strategy is paying dividends at Exchange Tower, where three new 1,000sqm-plus tenants had been secured since Primewest bought a half-stake in the building (see page 24).

Primewest director David Schwartz said the building was 34 per cent vacant when the syndicator and developer made its $113 million investment, but since taking over around six months ago, and launching a floor-by-floor redevelopment, about 16 per cent of that vacancy had been leased.

“It’s partly because of the refurbishment program, partly because we are meeting the market and also because it is one of three or four A-grade buildings available in Perth,” Mr Schwartz said.

“Traditionally what happens as the market gets competitive is there is a flight to quality, so tenants are able to get into buildings, or can afford to get into the best buildings in town, which they couldn’t afford to get into before.

“For us, as a countercyclical investor, that’s something we’ve always understood.

“And it’s a very tough, competitive market at the moment, new buildings would be very difficult to stack up.”

The Exchange Tower redevelopment is another that includes a new ground floor offering, with $8 million being spent upgrading the building’s plaza.

However, Lease Equity managing director Jim Tsagalis warned landlords that adding a hospitality precinct to the bottom of a B-grade office building was not necessarily the best outcome for a developer.

Mr Tsagalis said there was a little bit of danger emerging in the commercial property market, as developers followed the lead of success stories like Brookfield Place and 140 William.

“On the ground floor, the cost of running a business is much higher than most people would acknowledge,” Mr Tsagalis said.

“When you’re going through and looking at occupancy costs of retailers, you have to look at all the numbers, and you have to look at wages.

“What I’m getting to is, every building doesn’t have to have a retail and a food and beverage precinct.

“If there is a great piece of infrastructure at Brookfield or Cloisters or wherever, you don’t need to compete with it, we need to complement it with other amenity that is more appropriate for your building.

“You may need to provide a good coffee, but you don’t need to go much beyond that for some buildings.

“We haven’t reached saturation, but you have to be careful about following the leader.”

The other big challenge for developers, Sirona Capital managing director Matthew McNeilly said, was the availability of finance.

He said Sirona, a private equity firm with a strong countercyclical investment bent, was seeing plenty of opportunity in a down market, but the difficulty in getting projects away largely revolved around funding.

“You have got to have very strong financing channels, and that’s not only relationships with the local banks, but it is relationships with offshore funding parties,” Mr McNeilly said. “There certainly has been a significant tightening in credit markets, so the availability of finance is probably as tough as we’ve ever seen.

“But that doesn’t mean you can’t find funding for good projects.

“My sense is that there are other funders, offshore funders and certainly we see it in private equity, we see an appetite to replace or come into those positions where the banks are probably feeling like they can’t participate anymore.”